FURTHER DOWN THE FINANCIAL RABBIT HOLE

4/6/13

A page B14 article in this weekend’s (4/6/12-4/7/13’s) Wall Street Journal once again prompted those of us who thought we knew how markets work to scratch our heads at how much things have changed since the wunderkinds of international finance have been put in charge.   See, for background, my 3/27/13 post JEROEN DIJSSELBLOEM’S COMMENTS ON CYPRUS:   “THE DUTCHMAN’S NOT THE KIND OF MAN WHO KEEPS HIS THUMB JAMMED IN THE DAM THE WHOLE DAY THROUGH.”

In this weekend’s article, Richard Barley discusses the “bail-in” of banks in Cyprus, i.e., the process by which senior bank debt and, in Cyprus’s case, uninsured deposits, are made to take hits as part of restructurings of troubled banks.   (See my 3/20/13 piece, CYPRUS AND THE “RIDDLE, WRAPPED IN A MYSTERY, INSIDE AN ENIGMA,” and the prior posts to which it will refer you, for some discussion on the evolving Cyprus situation.)   Now that senior debt holders have been made to take losses in Cyprus, the thinking is that the same could, and probably will, happen should other banks in Europe need to bailed out.   Mr. Barley states

That raises the question of who will be willing to buy senior instruments that are officially seen as available to take losses but which don’t provide stock-like returns.

Hmm…

Doesn’t this means of financing take place all the time in both the bank and non-bank sectors?   Haven’t corporations in all sectors been selling senior bonds, which are “available to take losses but which don’t provide stock-like returns” since the dawn of finance?   Clearly, banking is a special sector, but is Mr. Barley arguing that all senior debt holders in all banks bought their bonds with the assurance that they would never take a loss?  If this were the case, why would there be any spread between the senior debt of banks and treasury debt?

Mr. Barley goes on to say that

Mainstream investors are likely now to buy senior debt from only the safest banks backed by strong sovereigns.

And he laments

For weaker banks, or those based in countries with troubled public finances, access to markets may be limited or at a higher price.  (Emphasis mine)

Huh?

In my apparent dotage (Thank you, sainted Sister Monica, for that expression!), yours truly thought that was the way the markets were supposed to work, i.e., investors who took more risk did so because they could expect a higher return.  In the case of senior debt, this return came primarily in the form of a higher yield on the debt of riskier issues.   But in what must be described as the “new world order of finance (NWOF),” troubled banks should be entitled to pay the same rates on their uninsured debt as safe banks.  (According to this logic, one supposes, when I was buying junk bonds for clients back in the benighted ‘80s, I was supposed to accept for my investors the same rates as they could earn on treasuries, right?   Banks must be a very special case!  But I digress.)   Not only do insured depositors not have any responsibility for assessing the safety of the institution into which they put their funds; neither do investors in senior debt of banks.  It’s all good; it’s backed by the taxpayers!  Apparently, quaint old concepts like “moral hazard” have no place in the NWOF.  

Brave new world, or NWOF, indeed; or should we call it Alice in Wonderland finance?