Should Bondholders Be Insulated from Risk?

New York Times columnist Floyd Norris has the story of Japanese bankers balking at the prospect of taking a loss on loans to Tepco:

The president of Japan’s largest bank, Mitsubishi UFJ Financial, was shocked by the very idea that a bank should lose money if it lent to a company that could not meet its obligations. Mr. Edano’s remarks “came out of the blue,” said the executive, Katsunori Nagayasu. “I felt there was something wrong about them.”

To Yasuchika Hasgawa, the chief executive of the Takeda Pharmaceutical Company and chairman of the Japanese Association of Corporate Executives, the idea violated basic tenets of society. Mr. Hasgawa said he “cannot help but question how this country’s democracy can be made to work with free-market-based capitalism.”

His definition of “free-market-based capitalism” seems to assume that lenders should escape without pain, at least if they are lending to major institutions. It is an idea that has become remarkably pervasive.

“We consider banks and Tepco systemically important institutions,” wrote Tetsuya Yamamoto, a Moody’s analyst based in Tokyo. “Debt forgiveness undermines the systemic importance of the bank and utility sectors in the national economy.” These are, he added, “developments we did not anticipate.”

While we might shake our heads in wonder at the wacky Japanese, I can think of two examples closer to home of bondholders arguing for immunity from risk.

In 2009 investors complained that their contractual rights were being violated in the Chrysler and GM bankruptcy proceedings. Some, including Indiana state treasurer Richard Mourdock, sued to halt the proceedings, based on the belief that their rights as bondholders trumped the contractual rights of workers and suppliers.

With a debt crisis at hand, a significant portion of Republican lawmakers are arguing that the U.S. can avoid default for a time by paying bondholders and delaying the payment of other obligations such as Social Security. Talking Points Memo reports that Senator Pat Toomey, a former bond trader, thinks we can avoid a crisis by "prioritizing" the government's obligations:

Toomey's preference would be for the Treasury to avoid defaulting altogether by prioritizing outlays of incoming revenue on interest payment to U.S. debt holders -- thus slashing spending on a host of other obligations, including, perhaps, Social Security benefits, vendor reimbursements, and the military.

Prioritizing is what bankruptcy courts do. In each case, we see the argument that investors should be immune to risks that everyone else should bear.