The sovereign wealth funds have played a critical role; some $69 billion of pure capital came from such funds into the Western financial system. In the future they’ll be important providers of recapitalization because they know the sector [banking] well.
So what does this mean for investors?
If you are a bond holder, you want to be ahead of a recapitalization. If you are an equity holder, you always want to come in after. When people have been pushing the financial sector, they haven’t made the distinction between what is good for the bondholder and what is good for the equity holder. The equity holder wanted to buy emerging markets after they recapitalized in the late 1990s, U.S. corporate after they recapitalized in 2002 and 2003 on the back of Enron, Worldcom, etc. The timing is critical. For the bondholder, it’s the other way around because a recapitalization lowers risk and therefore brings in spreads. And the people who are diluted are the equity holders.
This could be an important rule for owning equities in industries where the big players are “too big to fail.”