Bondholders To Take a Big Haircut

Bloomberg writes that bondholders are going to take a haircut, due to the extreme stresses on bank debt:

Bank debt is as stressed as when Bear Stearns Cos. had to be bailed out and Lehman Brothers Holdings Inc. collapsed, according to analysts at BNP Paribas ….

The Markit iTraxx Financial index of credit-default swaps linked to the senior debt of 25 banks and insurers were more expensive today than the Markit iTraxx Europe corporate index. That hasn’t happened since Lehman went bankrupt in September and, before that, JPMorgan Chase & Co.’s takeover of Bear Stearns and it reflects “systemic stress” in the financial system, according to BNP Paribas.

“We’re seeing the start of the next leg of the crisis and that’s going to be financial bondholders taking a haircut as lenders default,” said Mehernosh Engineer, a London-based strategist at BNP Paribas. “There’s been a perception that banks’ senior bondholders are untouchable but that’s going to change.”

This mirrors what the chief economist for Business Week – Michael Mandel – and Mish previously wrote about the government’s real plan with regard to Citigroup and the other financial giants:

“At some point the bondholders are going to have to take a big haircut.”

We can now see that the plan is to slowly boil the frogs in order. In other words, the government preferred shareholders need to be wiped out first in a manner that offends foreign investors the least. That manner was to wipe out US government (taxpayer) preferred shares along with foreign governments common equity and preferred positions.

The next frog to be boiled will be after Citigroup fails the stress test. At that point, there will be no way to avoid “an adult conversation” between the US government and foreign bondholders.

In other words, the government’s plan is not to “save” the banks or to protect taxpayers, but to set up a situation where the government can beg foreign bondholders to be patient, take a haircut, and not to get so mad that they pull the plug on the U.S.

Here’s an update from Bloomberg.

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