Dolors & Sense
by Sanford Rose
What the world needs is a touch of St. Nick—that is, Nicholas Brady and the rebirth of his bonds.
Remember Nick Brady? He was Secretary of The Treasury under Reagan and George H.W. Bush. Mexico had just defaulted, and Brady came up with a plan to ease the crisis by exchanging new bonds for the suitably “haircutted” defaulted old bonds. The plan worked and restored some calm to a worsening international climate.
Nowadays, people are talking about new Brady-type bonds for Greece, Spain and Italy.
It may happen. If it does, the idea should be extended to the US housing market, where it has been needed since 2007.
Just to recapitulate: The 2008-2009 recession would never have happened if lenders who held bank bonds had agreed either to swap their bonds for bank equity or, what amounts to the same thing, to take measurable, but still tolerable, losses on those bonds. Similarly, investors in securitized mortgage paper needed to write it down.
Had this happened, banks would have had the real capital to remortgage homeowners at existing real estate values.
That step would have done much to arrest the fall in house prices, which in turn would have prevented the recession, which of course greatly exacerbated subsequent housing price declines.
To be sure, house prices, though falling, were historically still quite elevated in late 2007. The objective, however, would have been to manage a more orderly and protracted adjustment of these prices.
Unfortunately, markets don’t function with perfect, or even reasonably good, knowledge of the future. So few realized that the failure to take tolerable losses would mandate taking intolerable ones.
Four years later and bondholders may be a tad wiser.
They can’t collect the face value of their Greek, Italian and Spanish debt.
They can’t collect the face value of their US mortgage debt or that of the bonds they’ve bought directly from mortgage-lending banks.
So we need Christmas in August—St. Nicholas (Brady).
The real question is not whether we’ll get a visit from St. Nick.
The real question is how much of a Nick (to face values) this will entail.