A “long-yearned-for shock of liberation” for taxpayers.

Hypo Alpe-Adria bank, when it was still owned by the small Austrian state of Carinthia, was a cesspool of corruption. It involved bankers, politicians, and powerbrokers in Austria and the Balkans. It was the perfect union of money and power. Investigators found 160 instances of suspected fraud, amounting to €1.6 billion, of which €890 million occurred in Austria, €250 million in Croatia, €164 million in Bosnia and Herzegovina, among others. Six of the bank’s former executives have been convicted of crimes.

“I’m not aware of a criminal case bigger than this one,” explained Christian Böhler, whose forensics team started investigating the bank in 2011. “It was a mix of greed, criminal energy, and utter chaos.”

The sheen started to come off in 2006. The Austrian banking supervisor determined that executives had buried over €300 million in losses. And Hypo’s business model fell apart: it had been issuing bonds guaranteed by Carinthia that gave it access to cheap money to fund it shady activities. But the EU prohibition against state guarantees was kicking in. So it was time for Carinthia to sell the bank.

Sure enough, in 2007, state-owned Bavarian bank, BayernLB, despite warnings from its own analysts – a “squeezed-out lemon,” they called Hypo – bought a majority stake for €1.66 billion. Within months, BayernLB had to bail out its crown jewel with a capital injection of €441.3 million.

In 2008, BayernLB itself toppled and was bailed out by the German and Bavarian taxpayers to the tune of €10 billion, of which €700 million went to prop up Hypo, along with €900 million from the Austrian government. In 2009, Bavaria shuffled its Hypo jewel off to Austria, which nationalized it. The deal left Bavaria as one of Hypo’s creditors. It has since sued Austria, which has countersued, and more suits and countersuits followed.

Other notable Hypo bondholders include the World Bank and Aurelius Capital Management, which was one of the hedge funds that chased Argentina all the way to the US Supreme Court.

A year ago, Austria’s central bank governor Ewald Nowotny and his task force recommended that Hypo’s toxic assets of €17.8 billion should be put into a “bad bank.” But to stop the drag on public finances, the federal government should not guarantee Hypo’s bonds. At the time, Austrian taxpayers had already plowed €4.8 billion into Hypo to bail out these bondholders.

He then explained on TV to incredulous Austrians that this deal would nudge the budget deficit over the 3% limit set by the Maastricht Treaty and push the government’s debt from 74.4% of GDP to 80% of GDP. This one rotten, state-owned bank in Carinthia was causing this much damage to the country’s finances!

Nowotny exhorted the government to not let Hypo become insolvent because the €12.5 billion in guarantees that Carinthia had issued would then push the state itself into bankruptcy.

But to the consternation of bank bondholders around the world, Finance Minister Michael Spindelegger dug in his heals and refused to rule out letting Hypo become insolvent; bondholders, instead of taxpayers, would then get to eat the losses.

Now the moment has come. Another audit discovered a new financial hole of €7.6 billion. And that was it.

On March 1, the exasperated Financial Markets Authority (FMA) announced a moratorium of debt payments by the renamed Heta Asset Resolution AG, under the “new European regime of winding down banks” that calls for bondholders to take a hit and for taxpayers to be largely spared.

In order to formulate this wind-down plan that “conforms to the goals of the new regimes,” the bad bank would make neither principal nor interest payments on the affected debts, which include the bonds guaranteed by Carinthia, senior bonds that had been spared so far, and some unquantified debt to BayernLB. Effective till May 31, 2016, the debt moratorium was designed to spare Austria’s taxpayers additional costs beyond the €5.6 billion they’d forked over so far. The FMA added later that even bankruptcy was not excluded.

“The government won’t pay another euro in taxpayer money into Heta,” Schelling told his ORF radio audience on Monday. Bondholders would take steep losses, even on bonds guaranteed by Carinthia. It would be up to Carinthia to bail them out, but Carinthia with its 560,000 souls, wouldn’t be big enough to do so. “Everyone who bought a bond should have known that there is a risk to any bond, no matter where you buy it,” he said.

On cue, those bonds plunged, trading for less than half their face value. Capital markets work if you let them.

And what if Heta becomes insolvent?

It’s likely “that Carinthia will go bankrupt,” constitutional lawyer and former Dean of the Faculty of Vienna, Heinz Mayer, told the German paper FAZ, echoing what Nowotny had warned about a year ago. But unlike Nowotny, he considered it “manageable.”

Heta’s bankruptcy, despite what it means for Carinthia, “would be the only way to finally relieve the taxpayer who has already paid billions,” he said; Heta was a “bottomless pit that could consume up to €20 billion,” or about 6% of Austria’s economic output.

A “long-yearned-for shock of liberation” for taxpayers, that’s what Franz Schellhorn, director of economics think tank Agenda Austria, called Schelling’s announcement that the “federal government won’t save irresponsibly acting states at all costs.”

“That would mean that Carinthia slithers into bankruptcy in one year,” he said. Otherwise, given the ever expanding extent of the debacle, “whole generations” would probably have to pay for it. “And the good thing is that the government, to protect the taxpayers, finally pulled the ripcord.”

Throughout the Financial Crisis, and since, there has been one rule: bank bondholders will always be bailed out at the expense of everyone else. The sanctity of bank bonds reigned supreme, no matter what government and central banks had to do to keep it that way. Bank bonds weren’t allowed to be judged by the capital markets. They were simply untouchable. Underpaid and overtaxed workers would have to bail out bank bondholders when these recklessly managed banks collapsed.

That was the rule in the US when the Fed, and to a lesser extent the federal government, bailed out the banks. And that was the rule during the debt crisis in Europe.

But cracks appeared more recently. When SNS Reaal, fourth largest bank in the Netherlands, re-collapsed and was nationalized in early 2013, stockholders got wiped out, as were holders of junior bonds. That was new. It sent tremors through the system. It was the needle that pricked the Eurozone bailout bubble.

But holders of senior bonds were made whole. The bailout cost Dutch taxpayers €3.7 billion. The sanctity of senior bank bonds and their implicit taxpayer guarantees were maintained.

Austria now changed that. Banks would be allowed to go bankrupt. Even senior bondholders would get to eat the losses. And even states that had guaranteed these bonds would be allowed to go bankrupt to protect their taxpayers. A monumental change! What a novel idea to let bank bondholders relearn the notion of risk, and price it in.

But in Greece, where the new government is struggling to line up more bailout money, there is another solution. Read tongue-in-cheek…  If Greeks Did This, the Terrible Crisis Would Be Over

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