A couple of the papers mentioned an NAO report, which praised the UK government for having saved money by buying back outstanding debt in Bradford & Bingley and Northern Rock, which is a variation on the general theme of debt-for-equity-swaps. The NAO report summarises as follows:
4.1 Over the course of 2010 Northern Rock (Asset Management) and Bradford & Bingley [after they had been taken over by the UK government] bought back £2.4 billion of their outstanding subordinated debt for £821 million in cash.
4.2 The debt was trading at substantially below its nominal value (i.e. the amount originally advanced by the investors), principally because:
a. It is not known if and when the principal and accumulated interest will eventually be paid. This makes it difficult for investors to value the debt and makes the bonds particularly unattractive to investors who seek a short-term investment.
b. Although the debt continues to accumulate suspended interest into a sum to be paid once the providers had returned all the taxpayer support, the terms of the debt do not allow interest on the interest (it is non-compound). Consequently the value of the debt and its interest falls with inflation and the money value of time.
c. There is still uncertainty regarding possible future government intervention and the potential for the Government to remove its loans, guarantees and assurances.
d. More generally, market risk remains high for the mortgage sector, and in particular there continue to be concerns about the quality of the mortgages in the mortgage providers’ books.
All good stuff, but it's a pity they didn't just do this years ago when the banks first became insolvent (in the sense that their liabilities, including bonds, exceeded the value of their assets).
Think about it:
1. By and large, the market price of the bonds would be the original principal amount minus all the potential losses of the bank (assuming share capital already wiped out).
2. So if somebody comes along and buys all the bonds and takes over the bank, that person doesn't actually lose a penny if he continues to run the bank, because the losses were all borne by the previous owners.
3. That new owner can cheerfully write down the balance sheet value of the bonds to the amount he paid for them, or convert some of the bonds into equity, it doesn't really matter. If you own all the shares and all the bonds in the bank, the total value of your holdings is much the same however you account for them.
4. As it happens, the total losses suffered by even the worst-run UK banks (B&B and NR), mainly on irrecoverable mortgages, were nowhere near as much as the amount of bonds in issue; therefore the bonds/bondholders could absorb the whole loss and the bonds always had some value (a third of their original issue price, in the above case).
5. Conversely, depositors' money was never really at risk (the UK government has always guaranteed deposits up to a certain level, it was just over £30,000 per person at the time), provided of course the government was prepared to take a firm stance and rank depositors ahead of bond holders in order of priority on a liquidation (and it is the government which writes the insolvency laws...)
6. Therefore... the government (or indeed anybody with sufficient billions to play with and the nerve to see it through) could have sorted out NR and B&B without losing a penny, or needing to actually invest any money directly into those banks, possibly even making a profit if they timed things right.
People used to tell me that I was mad to believe that you could sort out banks using debt-for-equity swaps. I think history is proving me right.
Friday, 18 March 2011
If only they'd thought of this sooner!
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12 comments:
"People used to tell me that I was mad to believe that you could sort out banks using debt-for-equity swaps." Then said people are chumps. It was the obvious right thing to do. Instead our wonderful socialist PM cocked everything up.
Your presentation of debt for equity swaps has always been totally convincing.No need to labour the point!As you must know from LVT ,lack of acceptance of an idea is often a sign that it is inconveniently right.
D, thanks, but even some people who know (or claim to know) about banking have told me it can't possibly work. I suspect that they've never looked at a bank balance sheet, but hey.
DBC, I'm not so much 'labouring the point' as 'giving myself a pat on the back'.
I've been saying this for a while now, not in relation to banks but sovereign debt. We just need a downgrade and normalised IRs and we could purchase them back for snip.
It is not known if and when the principal and accumulated interest will eventually be paid. This makes it difficult for investors to value the debt and makes the bonds particularly unattractive to investors who seek a short-term investment.
As it's all contrived anyway, it hardly matters.
CD, I've pondered that and to be honest it wouldn't work. What governments do is just inflate debts away. As a taxpayer I applaud that, as a saver I'm pretty disgusted.
JH, "it hardly matters" Exactly, this would have all sorted itself out.
So, being thick, especially when it comes to "money" and "sums" does this mean that NR(AM)- the bit of the previous Northern Rock that was split off from it to leave behind a "nice healthy BANK with no nasty skeletons sitting in the accounts" called Northern Rock and was then bundled together with B & B to form ARL (UK) basically to look after "all the toxic stuff that brought NR down and that no BANK in its right mind would want on the books" has gone through with a cunning plan whereby it approached people holding bits of paper saying effectively "IOU megabucks" and signed Northern Rock and has now purchased back some of those IOUs at prices somewhat considerably lower than they might have been, principally because the holders of the IUOs could forsee a situation where their only value might indeed be the paper the IOUs were written on and took the chance to cash them in and grab what they could ?
Anon, broadly speaking, yes, that's a fair summary.
Agreed.
On the other hand, I'm far from convinced that RBS and Lloyds were insolvent at all, as opposed to simply having liquidity difficulties.
AC, let's not split hairs. I've been an accountant for most of my life and can't be bothered explaining the subtle - and possibly meaningless - distinction between those two concepts.
Banks are actually much simpler than most people think, provided you can be bothered to look at actual balance sheets, which 99.9% of the country clearly have not done.
MW, I'm really not splitting hairs.
Lots of bad loans resulting in zero capital = insolvent.
Withdrawal of funding (either by everyone withdrawing their deposits, i.e. a run on the bank, or the money markets drying up) = illiquid.
The difference is crucial. The right response in the first instance might be a debt for equity swap. The right response in the second case, especially if it is retail deposits being withdrawn that are the problem, is surely for the Bank of England to lend money to the bank (at a penal rate).
AC,
No, insolvent is if losses are sufficient to wipe out share capital and for the bank to be in a position where it can not fully repay deposits and bonds - even if they can still repay 90% or 95%. This can be sorted out by debt-for-equity, we are agreed on that.
With NR, depositors were only running on the bank because they feared that 'money market funds' would withdraw their money and 'money market funds' only wanted to withdraw their money because they though that NR had made huge losses and become insolvent. So the illiquidity was a result of the insolvency.
CONVERSELY if the bank run (and resulting illiquidity) were for entirely irrational reasons (because the CEO had been outed as a paedophile drug addict, let's say), then it would be good and proper for the BoE to lend it money to tide it over.
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