The morals of bailouts

By Felix Salmon
December 1, 2009
pointed out the contrast between the expected actions of Sheikh Mohammed bin Rashid al-Maktoum in Dubai, on the one hand, with those of normal homeowners in the US, on the other: while American individuals are ceaselessly told that they have a moral obligation to pay their debts, the ruling family in Dubai is simply defaulting on its non-recourse underwater loans in accordance with the amoral principles of capitalism.

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Sudip Roy has gone me one further today. I pointed out the contrast between the expected actions of Sheikh Mohammed bin Rashid al-Maktoum in Dubai, on the one hand, with those of normal homeowners in the US, on the other: while American individuals are ceaselessly told that they have a moral obligation to pay their debts, the ruling family in Dubai is simply defaulting on its non-recourse underwater loans in accordance with the amoral principles of capitalism.

Sudip, however, goes so far as to say that Dubai is morally obliged to reject a possible sovereign bailout. I’m not sure where he finds this moral obligation, especially since Dubai is not a democracy and its treasury has no fiduciary duty to the citizenry as a whole. But I can see where he’s coming from: there is something morally dubious about throwing good money after bad, given all the other things that any of us, be we citizen or ruler or corporate entity, can do with our cash.

In general, a government has the right — but emphatically not the obligation — to bail out absolutely any company it wants, anywhere in the world. Some such companies carry an implicit government guarantee, even in the face of explicit denials that such a guarantee exists — that was the case with Fannie and Freddie. Some companies (Citigroup, AIG) are considered too big to fail, and the implicit government guarantee is replaced by a very similar moral-hazard play. Other companies are just so politically important that government ultimately steps up with a bailout: think GM and Chrysler. But it’s crucial that all such determinations are made on a case-by-case basis, and that the government at least retains the option to say no to a bailout in each case.

That’s why I was happy that Dubai left Dubai World to sink: defaults at state-owned companies are rare things, and we need a few more of them to underline the fact that such companies are not, just by dint of being state-owned, vastly more likely to get bailed out than anybody else.

Sudip talks about the precedent of Naftogaz in the Ukraine, where the government negotiated a restructuring where creditors took a haircut in return for a sovereign guarantee on the remaining debt. (How much a Ukrainian sovereign guarantee is worth, of course, is another matter entirely.)

But it’s also worth remembering in this context that even when there is an explicit sovereign guarantee, it’s to all intents and purposes unenforceable in the event of default. Sovereigns are, by definition, sovereign, and it’s very, very difficult to sue them — which is one reason why some creditors end up settling for three cents on the dollar. Even if Dubai World did have a sovereign guarantee, the Dubai government could still have let it go into default, while remaining current on all other debt — and there’s almost nothing that Dubai World’s creditors could do about it.

This financial crisis has been one of commercial debt rather than sovereign debt, but there have been sovereign debt crises in the past and there will be more in the future. So anybody thinking that a sovereign-debt play constitutes some kind of flight to quality would be well advised to think again. Sovereigns can and will do whatever they like, including defaulting on state-guaranteed obligations. And they’re prettymuch the hardest entities in the world to sue if you want to attempt a legal strategy for getting your money back.

Update: John Carney adds that “guarantees on debt are prohibited by the shariah” — maybe that’s the moral obligation that Sudip is referring to.

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Comments
3 comments so far

“the ruling family in Dubai is simply defaulting on its non-recourse underwater loans in accordance with the amoral principles of capitalism”There’s nothing amoral about it. The banks loaned their money to entity A. A may go bankrupt. The banks said they thought the sovereign would bail them out, but the sovereign never said so. So because the banks made a mistake, the sovereign is supposed to pay them off? In what bizarro world?”Some such companies carry an implicit government guarantee, even in the face of explicit denials that such a guarantee exists — that was the case with Fannie and Freddie.”So who gave this implicit government guarantee? Oh I know, the *buyers* of the Agencies, since no one in government ever did. So again those who lent the money talked up the point that they *thought* that the Agencies had a guarantee, even though every prospectus said clearly that they were not. It’s a bizarro world when the buyer of a bond is the one who decides whether there’s an “implicit” guarantee or not.The Agencies were bailed out and the U.S. taxpayer was slammed because the Treasury and Fed were beholden to asset holders, not to taxpayers. Apparently Dubai and Abu Dhabi are more responsible, and less corrupt, than our own government. That is what is truly sad.

Posted by a | Report as abusive

“In general, a government has the right — but emphatically not the obligation — to bail out absolutely any company it wants, anywhere in the world.”That’s only somewhat true. In Europe, for instance, state aid rules place strict limits on the form and scale of bailouts – they can’t give the bailed out company an unfair competitive advantage. So, for instance, when ING was bailed out by the Dutch government, the EU forced them to increase the fee for the state guarantee and to sell off half their balance sheet. All the bailed out banks have been forbidden from paying discretionary coupons on their hybrid capital instruments.

Posted by Ginger Yellow | Report as abusive

a, I think you’re confusing “amoral” with “immoral.”Captialism is an amoral system because it’s based on letting buisnesses choose their own path to success (or failure), not dictating that path.

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