The left, led by Senator Elizabeth Warren, is now gunning for the bond markets. It isn’t a surprise that all markets, including bond markets, move and change with supply and demand. This is a simple principle that guides businesses, investors, and markets around the world. However, much of the left seems either completely oblivious to this fact or actually intent on leveraging their power to fully disrupt our economy. While political games like this can be entertaining when it is over something simple, playing political games with a market that has a worldwide footprint of over $90 trillion and a U.S. footprint of over $30 trillion is appalling.
The attack is aimed at the Trust Indenture Act (TIA), an obscure law that enacted in 1939. It largely goes unnoticed, but it is the underlying legislation that provides the transaction rules for bond markets. More than a trillion dollars or corporate debt is issued under TIA annually. According to Professor Kenneth Klee, discussing the bill in the Wall Street Journal, TIA was passed “to protect small bondholders from having their rights bargained away out of court by well-heeled insiders.” TIA forces bond issuers to get majorities of bond-holders to agree to changes in conditions of the loan and requires super-majorities for larger decisions like postponing interest payments altogether. Decisions to reduce principal or interest require unanimous consent. Changes in loan conditions or delays in interest payments can help businesses stay afloat and protect the long term investments of bondholders. If an issuer goes out of business, bond-holders only receive pennies on the dollar.
TIA does two things for the bond market. First, it provides reasonable assurance that a few bad actors wouldn’t issue debt and then rewrite the rules and disappear with the investor’s money. Second, and arguably more importantly, it provides a structure that allows bond issuers and bond-holders to adapt the structure of their agreement, so that companies could be saved from going out of business.
However, some recent court rulings are challenging TIA and the ability for restructuring of these relationships outside of the courtroom. In fact, depending on the interpretation of the recent rulings, it might take 100 percent agreement from bond-holders to restructure loan conditions such as covenants or guarantees. What this could mean in the short run is that an activist investor could stop a bond Issuer from making any changes regardless of the ramifications to the business or the value of the bonds. In the long run, that would mean that fewer investors would be willing to buy corporate debt, and fewer buyers would be willing to buy old debt, which would bring a big chill over the bond market. That would be very bad news for the economy.
Congress, doing its job, is attempting to fix TIA, but Senator Warren is attempting to derail the fix and therefore the bond market at large. The “Solvency and Restructuring Efficiency Act of 2015” is designed to return the market that has effectively worked for both bond-holders and issuers for 75 years. It does this by maintaining the needle that was threaded back in 1939: bond-holder rights and bond Issuer flexibility. If both aspects aren’t present, the bond market will disappear as both supply and demand decrease. The proposed law does this by continuing to prevent amendments to principal, interest, or maturity dates without consent of the bond-holder, while also providing issuers the flexibility to manage the structure without unnecessary bankruptcies or the need to go to court for resolution.
Charles Sauer, an economist, is the president of the Market Institute.
