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By Oliver Hart and Luigi Zingales
Published: February 7 2010 18:47 | Last updated: February 7 2010 18:47
In the struggle to identify how to avoid a repeat of last year's financial crisis there is an emerging consensus among regulators, academics and practitioners that contingent convertible (Coco) bonds are the way to go. The idea is to have some debt in the capital structure of banks that converts into equity when a bank faces financial distress.
These bonds have some benefits. If, in an extreme downturn, the conversion were triggered, debt-holders would be forced to absorb some losses without dragging other obligations (derivatives or repurchase agreement contracts, for instance) into a bankruptcy process, an event that could trigger a systemic panic. This would save taxpayers large amounts and create incentives for creditors to monitor the issuers, instead of lending freely under the assumption that the government would bail them out.
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