Bail-In
Governments dished out $1 trillion in taxpayer money to bail out banks during the financial crisis that erupted in 2008. Their voters were furious. Since then, regulators came to a broad agreement on a better approach: Instead of bailing out a faltering bank, force the creditors to bail-in — or share the burden of losses. The idea is to sell debt to investors with the understanding that in the event of a failure the earmarked bonds might quickly lose their value or be swapped for equity. Few people would argue with the principle that investors in banks should lose money when the bets they make go belly-up. Yet in practice, bailing-in has proven politically tricky, as regulators must make tough choices about which creditors are wiped out and which are saved. Plus loopholes abound.
Recent bank failures in Europe have sparked debate about whether bail-ins are working as designed. The theory appeared to work when Spain’s fourth-biggest lender, Banco Popular Espanol SA, was forcibly sold to a bigger competitor in June 2017, wiping out shareholders and about 2 billion euros ($2.3 billion) owed to bondholders. It was heralded as a victory for European Union regulators, since no taxpayer funds were used. But investors are suing, saying the deal was arbitrary and could have been avoided. By contrast, Italy is using public funds to prop up its oldest bank, Banca Monte dei Paschi di Siena SpA. It’s spending up to 20 billion euros and rescuing most — though not all — bondholders of that institution and two failed regional banks. Because those bailouts happened in one of Europe's most indebted countries and spared ordinary citizens who owned the bank’s debt, they rekindled fears that weak banks and poor countries would get caught in a vicious debt spiral. Some policy-watchers brushed off the controversy as a transition problem, since many banks have yet to build up enough of the “loss-absorbing” debt they're now required to sell to make bail-ins easier. More than $500 billion of such securities have been sold in the U.S. and Europe in the last two years.