Monday, 21 February 2011

Well they would say that, wouldn't they?

The FT gave a fair bit of coverage today to the concept of the debt-for-equity swap (now referred to as a 'bail-in') as an alternative to taxpayer funded bank bails outs. They get marked down for crediting the idea to the European Union (who had no qualms about bailing out French and German banks at the expense of Irish and Greek taxpayers) or the bald (and grammatically incorrect) lie that "Bail-ins is a novel concept...", but let's get to the nub:

... bondholders and many bank executives warn that such moves could have negative consequences for the wider economy. (1) Banks finance most of their customer lending through bonds. (2) Raise the risks of bond investors losing money, and they will charge more in interest. (3) If banks’ borrowing costs rise, that in turn will be priced into the costs of mortgages and other customer loans. (4) Regulatory efforts to protect taxpayers could unintentionally expose them to a permanent rise in the cost of credit.(5)

1) Well they would say that, wouldn't they?

2) That is simply not true. I've looked at bank balance sheets and the correct figure is approx. one-third (if you consider both 'customer deposits' and 'bonds' to be 'finance'). Of course, if you count bond holders as owners rather than as creditors, then it is true, but once you count them as owners, a debt-for-equity swap seems like the obvious next step.

3) Yes, they probably would. But we are starting from a position where the whole credit-bubble-Ponzi-scheme has yet again turned out to be built on sand. Had there not been an implicit government guarantee for bond holders (or easy political capital to be made from rising house prices), then investors simply wouldn't have lent so much money so cheaply to banks in the first place; so there wouldn't have been credit and house price bubbles; and so bank bonds would have been a far less risky bet.

4) The wider public has a choice: pay extra taxes to subsidise other people's risky behaviour or accept that interest rates might go up a bit. But wasn't it artificially low interest rates that got us into this mess in the first place? For savers, higher interest rates are A Good Thing anyway, and for future home buyers, higher interests are (counter intuitively) also A Good Thing - if interest rates rise then the price of houses will come down to compensate, and in the medium term, they will end up paying less in total mortgage repayments out of a marginally higher net income.

5) Oh wow... *head spins*... are they really saying that taxpayers have to be forced to bail out - i.e. subsidise* - bond holders in order to protect the self same taxpayers from a "permanent rise in the cost of credit"? What happens if you're a saver or a taxpayer who lives within his means and doesn't want or need 'credit'? What if you're a potential first time buyer who's being forced to pay extra taxes in order to push down borrowing costs in order to prop up house prices in order to increase your total mortgage repayments? And that out of a lower net income?

* Never forget The Golden Rule - subsidies don't make things cheaper, they make them more expensive.


CityUnslicker said...

all correct Mark. The scam is on.

dearieme said...

language watch: should the verb be to bale out or to bail out? And why?

Mark Wadsworth said...

CU, ta, I've been banging on about this for over three years, maybe one day it will sink* in.

D, "bail out", as in "water from a boat"*, not "bale" as in "of hay".

* sink, bail.

DBC Reed said...

Your reaction to the weird statement @2 "Banks finance most of their lending through bonds" is admirably restained.
The modern authority on "Financial markets and institutions", Prof Jeff Madura who wrote the book with that title, downgrades bonds even further than you in the lending process:
"Like other corporations banks own fixed assets such as land, buildings and equipment.These assets often have an expected life of twenty years or more and are usually financed with long-term sources of funds ,such as through the issuance of bonds.Common purchasers of such bonds are households and various financial institutions,including life insurance companies and pension funds.Banks do not finnace with bonds as much as most other corporations because they have fewer fixed assets than corporations that use...equipmentand machinery for production.Therefore banks have less need for long -term funds"
Bank lending relying on bonds does not make any sense ,since the bond money does n't enter the same orbit.
I really think you should fire off a broadside at the FT letters column:you have steadfastly recommended debt-for-equity transfers since the big unravelling of 2008.I have not commented because I am in complete agreement and don't have anything to say on the matter.You are really out on your own on this one ( a bit of support from the likes of Worstall and Redwood would not have come amiss ) and nobody has ever been able to lay a glove on your argument.They have preferred to ignore it ,proving that you really can have an elephant in a room which if nobody mentions it ,can be said not to exist.

Mark Wadsworth said...

DBC, thanks for back up.

As to "not laying a glove", the second half of that FT article is a long list of special pleading from 'insolvency experts', bankers and the like, all explaining why "it won't work" and why it will "hurt the economy". They even play the Poor Widow Bogey!

PS, I have been recommending D4E swaps since since 26/9/2007, two weeks after NR bank-run, i.e. once I'd taken the time to print off their balance sheet and look at the actual numbers to check whether it is feasible.

Lola said...

Wot DBC Reed says. Plus, they forgot to add that doing D for E and the rest of it may just hammer their margins and hence their profits. Oh, poor dears.

Bayard said...

"Well they would say that, wouldn't they?"

It's amazing just how many newspaper articles can be summed up in those few words and how very infequently (i.e. never) those words are employed in said article.