Bail-In refers to the concept, baked-in to Dodd-Frank, that regulators can force the conversion of debt holders to equity holders, effectively forcing current bond holders to accept a de facto reduction in their seniority.
Q. Well we’re all too familiar with bailouts, but what’s a bail-in?
A. It refers to the idea that financial regulators can force conversion of debtholders to equity holders (and wipe out equity along the way). This idea has been baked into Dodd Frank and is, to some extent, what’s actually happening in Spain: if the new bailout dollars prime existing bondholders– and there’s a lot of fear that they will –those bondholders are involuntarily participating in a restructuring by which their seniority is reduced.
Q. So, it almost sounds like a bankruptcy reorganization.
A. Yes, it does, sort of a prepack, but executed on the fly by regulators. The big idea is that there’s really no time for a bankruptcy proceeding when you’re talking TBTF banks. With a Bail In, regulators might force these changes literally over the weekend, providing assurance to the financial markets, but wreaking havoc with the capital structure of the instituion.
Q. You mentioned this idea is baked in to Dodd Frank?
A. Yes, and many governments and central banks around the world have taken notice, including the ECB. After the big US bailouts, of course, there was a lot of moaning that the taxpayers got dinged badly, but the bank bondholders were left completely whole. This addresses that concern, although of course it raises another one for investors in those institutions.
Q. But a “bail in” is not explicitly the case in Spain right now, is it?
A. Not explicitly, no. But if the FROB or the ESF are the providers of the bailout to the Spanish banks, the existing bondholders may well be effectively subordinated to the new money… sort of like a debtor-in-possession financing result without a bankruptcy proceeding. Of course, that would push the existing holders down in the capital strucutre…. just as a bail-in would.