Loan Modification

Such things are normally straightforward. Equity is wiped out, assets are revalued and the gap in the balance sheet is uncovered. Bondholders take a ?haircut? ? meaning a lower than expected return ? or a principal reduction. Some principal converts to equity, management is replaced; voilà, life goes on.

But for Fannie and Freddie none of that happened. Both institutions were bankrupt. Today their stock trades at a steep discount, but it still trades. Those who held their debt took no haircut at all. Their assets were never fairly revalued and the balance sheet was replenished with taxpayer funds. Why the different treatment?

One reason is that Russia and China were among the largest holders of Fannie and Freddie bonds.

From there the trend continued. In 2009, during the Chrysler bail-out, hedge funds holding Chrysler debt wanted a normal bankruptcy, but were brushed aside by the Obama administration in its rush to accommodate trade union allies. One could have imagined a completely different outcome, if the company in distress had been non-union, or if Chrysler?s bonds had been more heavily owned by union pension funds instead of hedge funds. But the pattern remained, namely that it is the holder?s identity that mattered.

Moral hazard is only the most obvious threat. More insidious is what economists call ?regime uncertainty?. This ungainly phrase refers not to a political regime, but to laws that allow all players in a market to follow the same rules. Price discovery is difficult in normal markets. But when geopolitics, expediency and short-term concerns overlay them, it is little wonder that equity inflows are drying up, corporations are hoarding cash and mergers and acquisitions have ground to a halt.