Friday 30 November 2012

They're softening us up for another taxpayer-funded bank bail out

From City AM: UK banks must raise tens of billions in extra capital.

Sky News: UK's Banks 'Could Need Billions More Capital'

BBC: Major UK banks may need to raise more capital as protection against possible future losses

and so on and so forth. This all goes back to the Bank of England's Financial Stability Report:

The Committee recommends that the Financial Services Authority (FSA) takes action to ensure that the capital of UK banks and building societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights.

Where such action reveals that capital buffers need to be strengthened to absorb losses and sustain credit availability in the event of stress, the FSA should ensure that firms either raise capital or take steps to restructure their business and balance sheets in ways that do not hinder lending to the real economy.


Oh dear, thinks the man in the street who only reads the headline, where are they going to get that money from? Fact is, they don't have to raise a single penny from outside the banking system, that's the bit in bold after the "or": UK banks have already raised that money, only they have treated it as bonds and not as share capital.

If the shortfall really is £35 billion, all the banks have to do is reclassify about one-tenth of the bonds (maybe it's one-fifth, who cares) they have already issued as share capital, hey presto, problem solved. The total value of all shares and bonds in issue will not change, and it might even increase slightly if you do the swap properly.

As it happens, banks bonds are trading below par and bank shares are trading at a discount to net assets, so whether you hold a £1 face value bond with a market value of 70p or shares worth 70p for every £1 of net assets is neither here nor there.

But no, the newspapers are already softening people up for the next taxpayer-funded bail out.

As to "sustaining credit availability", that is quite a separate topic. Ultimately, it is the borrower who prints the money, not the bank. Consider, if government borrowing is much the same as the government printing money printing (and it is), then so is private borrowing.

7 comments:

Lola said...

Didn't I just see that the latest bailout for Spain so it could bail out four of its banks had also required debt for equity swaps?

Mark Wadsworth said...

L, yes you did, see e.g. here. It's all good stuff.

Derek said...

As a matter of interest vaguely related to the topic of this post, Steve Keen is in the UK just now and gave a presentation on monetary macroeconomic modelling to some of the economists at the Bank Of England last Monday. Dunno how much effect that will have on future policy but he's not a fan of bailing out the banks directly, so hopefully some.

Today he's in Germany talking to the FDP politicians and apparently he will be giving a presentation to the German Ministry of Finance on Monday. And apparently he will also be joining the panel for "Question Time" on BBC1 next Thursday. So he certainly seems to be gaining some traction.

Mark Wadsworth said...

D, top stuff. Only I can't bear to watch QT, it rams home just how stupid the general public is.

Unknown said...

Debt-to-equity swaps is obviously the best way to recapitalise banks. Pity we do not have a legal framework where it is possible to do it without the debt holders agreeing. The inability to convert bank bonds with trigger points to equity has been a glaring problem throughout the financial crisis.

I am sure the banks would love to reclassify their bonds. Who the hell would not like to reclassify their debt as not debt. Unfortunately, they can't because the bonds are a contract giving the holder specified seniority claims on the bank. Bonds covered under English common law give the bondholder most legal protection i.e. most bonds. The regulators are currently trying to develop a system of convertibles with the aforementioned trigger points that will convert to equity if a bank is undercapitalised. However, that framework especially in the UK does not yet exist. Even when it does exist, it will apply to the issue of new bonds not existing holders. Existing bondholders are not going to willingly agree to be subordinated.

The capital structure of a bank is like a pyramid. At the top of the pyramid are the secured bondholders who are senior to everyone including depositors. The bank goes bust and they have claims on the assets before anyone. At the very bottom of the pyramid are the equity holders. From the bottom to the top are different kinds of bondholders that represent different levels of liabilities for the bank depending on their legal entitlements. Hybrid or junior debt to senior unsecured debt etc. They all take losses depending on their seniority.

Why would they agree to be subordinated by willingly going to the bottom of the pyramid? They would easily win in court if you forced them to do something that was not in the bond contract. Building a framework to convert the bondholders that forces steep losses on them is the ideal, but we have no legal mechanism to do it at the moment. Therefore, rights issues or the disposal of assets is how things will proceed.

Mark Wadsworth said...

RW, well yes, but...

"Building a framework to convert the bondholders that forces steep losses on them is the ideal..."

Who said force losses, let alone steep ones?

Let us assume that the total 'enterprise value', the value of bonds + shares is a known and fairly fixed figure, call it £100 (which in current conditions is a lot less than net books value of assets less liabilities such as deposits, which might be £130 or £150).

Of this, £5 is current market cap of shares and £95 is current market cap of bonds. It cannot be beyond the wit of mankind to reclassify bonds with a market value of £10 to shares with a market value of £10, hey presto, sorted.

So now the total 'enterprise value' is still £100, bonds are worth £85 and shares are worth £15. Two thirds of those shares are owned by current bondholders, so current bondholders still end up with total value of holdings £95, it's just that they own £85 market value bonds and £10 market value shares,

Sorted.

Bayard said...

"Only I can't bear to watch QT, it rams home just how stupid the general public is."

Me, too. Or rather, not stupid, but narrow-minded and opinionated. There are some very intelligent people who hold very unintelligent opinions and believe complete and utter rubbish, but are prepared to defend said opinions and rubbish tooth and nail.