I should CoCo

As I have been pointing out for two years, the free-market way to fix the banks is via debt-for-equity swaps, i.e. this is exactly what happens if a bank is allowed to go 'bankrupt' - that doesn't mean that its payment system freezes up, all its loans are magically called in (which would be impossible) and that all branches are shut - all that happens is that debt-holders cancel some of their debt and issue themselves shares instead (as happened with CIT Group recently).

There are infinite kinds of debt-for-equity swaps, another good example is the idea of splitting Northern Rock into a 'good bank' (which takes over good loans, branch network and deposits) and a 'bad bank' (which is a closed fund which collects repayments on bad loans and pays off bondholders as and when the money comes in).

A more forward looking plan is for banks to issue "contingent convertible" or "CoCo" bonds, which Lloyds Group is now planning. The gimmick being, as soon as there is a shortfall in the banks shareholders' funds (i.e. if ordinary liabilities and customer deposits exceed the value of their assets - primarily mortgage advances to borrowers), the equivalent value of CoCo's is converted to share capital (i.e. the liability to repay is cancelled).

Sure, this means that banks will have to pay a higher interest rate to holders thereof to compensate them for their lose-lose position (they share in the downside but not in the upside), but so what? There has to be a balance between the return on finance paid to depositors, bondholders and shareholders and the free market is the best way of finding that balance.

If all non-deposit finance raised by banks were in the form of CoCo's, we'd never really have to worry about bank failures again.