Donal O’Mahoney on Senior Bank Bonds Post author By Philip Lane Post date February 28, 2011 His article in today’s IT is here. Categories In Banking Crisis Tags senior bank bonds 96 Comments on Donal O’Mahoney on Senior Bank Bonds ← Moving Deposits → Ireland Revolts for Stability 96 replies on “Donal O’Mahoney on Senior Bank Bonds” Excellent article. As the Vox Pop or more especially the Prof Pop gathered crescendo I started to wonder was I naive? Maybe we should be burning bondholders? Can it be that Gerry Adams is right after all? And then a sheer piece of common sense from someone who actually knows what they are talking about assures me that just because I am in a dwindling minority doesn’t mean I am wrong. @Donal da_spinner So old_hat at this stage – we have bigger fish to fry – no time to waste on small fry! http://community.nytimes.com/comments/krugman.blogs.nytimes.com/2011/02/26/iceland-ireland-again/?permid=40#comment40 Bank bonds are of course risk capital, saying otherwise is nonsense and lumping them together with deposits is deeply misleading. This argument hinges on a seriously flawed premise: DOM contends (correctly) that senior bank bonds are not, generally, “risk capital” – but this is no argument for the taxpayer to bear the risk ahead of senior bondholders, as the taxpayer is not “capital” of any sort! The only reason that the taxpayer is on the hook here is that the State, foolishly, guaranteed the banks – a decision which should now be unwound. Even if the argument that senior bondholders should be protected because they are analogous to depositors is accepted, DOM points inadvertantly to another gap in his logic: at a minimum, the “real” risk capital, including subordinated bonds, should be wiped out before the taxpayer is asked to bear loses. This has not happened. Finally, there are strong political, social and economic reasons for protecting bank depositors – but this is ordinarily done up to a reasonable cap, eg the first €50k of an individual’s deposits are insured or guaranteed by the State or wider banking system. This was extended (in many countries) during the financial crisis on the basis that the systemic risk was so great that the normal rules did not apply. If there is an argument that the taxpayer should bear some burden of protecting larger depositors and the roughly analogous senior bondholders on the basis of systemic risk, then this should be strictly confined to those institutions that are genuinely systemically important. At the very most, this includes only AIB and BOI – and possibly not even both of these. “It was a similar perception of systemic support loss for senior subordinated paper in early October that contributed to a vicious contagion of junked credit ratings, surging bond yields, seized-up funding markets and dramatic deposit flight, all of which culminating in the EU/IMF interventions of late-November. ” Was it really? I thought it was M Trichet pulling the plug on the banks that was the coup de grace. Wasn’t DOM spinning abut 20bn in cash and a quick return to an NTMA roadshow around now back in October? DOM seems to be in denial about the banks. He must have nothing to do now that nobody is buying Irish bonds of any description. “However, the moral justification for State burden sharing (over and above financial stability issues) lies in the acute failings of domestic regulators (Central Bank, FR).” The lax regulation was as a result of the consensus that the market would regulate itself. Germany abandoned its historical aversion to derivatives trading and so forth. Of course the chief culprits in pushing for lax regulation were bankers and financial experts. ” Far from being the reckless high risk/high reward speculators characterised in various dispatches, senior bondholders are the most risk-averse of species. “ Of course, the most cautious and more risk averse investors engaged experienced and expensive financial advisers to help them avoid putting their money into risky banks. As Michael Somers has pointed out, the evidence of the fragility of the Irish banking sector was there for experienced financial experts to spot. Mr. O’Mahoney may know some of those advisers. One wonders what their own liability to investors might be. Did they fulfil their duty of care or did they act negligently? There is a lot to come out in the wash. Initial calls for the imposition of “haircuts” on subordinated bank debt have now given way to more aggressive demands for burden sharing among the senior bondholders. Mr. O’Mahoney consistently fails to distinguish between guaranteed senior debt and unguaranteed senior debt. Why is this?? Irish default risk premia (per market pricing) remain highly elevated, and this increasingly reflects as much investor concern over Ireland’s “willingness” to pay as “ability” to pay.” Mr. O’Mahoney does not addres the point that willingness to pay too much could adversely affect our ability to pay in the future. Whereas one can recover from a perceived unwillingness to pay by knuckling down and paying one’s way, one can only recover from an inability to pay by default and/or bonded labour. Mr. O’Mohoney’s article will provide grist to the mill of the hard left. Maybe it is the editor’s fault, but the focus on the psychology of the cautious wealthy, rather than on the mechanics of credit creation (which is briefly touched upon), frames his core argument in the worst way politically imho. If any academics want to pick up some dosh as expert witnesses then a good paper to publish might be: “The foreseeability of the Irish banking crisis – What financial adviser knew and what they should have known” @Philip lane It’s bad enough the IT printing this self-serving garbage – but does IE blog really have to waste time debating the views of obvious vested interests? As Mandy Rice-Davies so shrewdly observed “He would say that wouldn’t he?” Interesting that Donal posts in the section where there aint any comments available. Meanwhile, in the real world http://ftalphaville.ft.com/blog/2011/02/28/499556/its-an-irish-bank-eat-irish-bank-world/ Plenty to disagree with here, as usual and not worth arguing with. That said, let me point out something I agree with “Clearly, some concession on the non-IMF portion of Ireland’s bailout interest cost may soon materialise, albeit more likely in the generalised context of an EFSF revamp for the system as a whole. However, can I point out one place where he is correct However, a much more important concession may await during the requisite downsizing of the Irish banking system. Any further asset sales at firesale prices will only further imburden the sovereign via stepped-up recapitalisation injections.” If the “deleveraging” proposals coming from the ECB are as radical as is being reported, then they present a danger of huge cost to the sovereign. If the ECB wants to be paid back so quickly, then some alternative EU vehicle may have to be the way, e.g. EFSF lends to the Irish banks to pay back ECB and then decides what its going to do with €100 billion in loans to banks nobody likes. @Karl Whelan €100 billion! You goin soft? €150 billion …. let it ‘rest’ around here for a ‘sound’ while …. @ Karl i assume that some sort of vehicle will be formed whereby the ECB will continue to fund a TrackerNama set up for the Irish tracker mortgage books. They’ll transfer over at par, or with only a modest discount, and the ECB will continue to fund it at base rate, and the profit margins on the loans are used to create a loss buffer, with the government (or EFSF) either putting on an additional guarantee or some start up equity. Eventually, in a few years as the economy slowly recovers, the vehicle could actually start to sell off bonds to the markets and finally unwind the ECB liquidity (albeit they would be ECB elligble assets anyway). It would also mark an attempt at completely reformatting the Irish mortgage market into something similar to the Scandinavian or German covered/mortgage bond markets. http://www.centralbank.ie/data/site/cmbs/Money%20and%20Banking%20Statistics%20January%202011.pdf The Central Bank’s January Banking Stats are out. They contain a nice new surprise- a new category, namely ELG banks The tables now come in three flavours: – All institutions – Domestic Market Credit Institutions – Covered (ELG) Institutions We can now see, among other things, that 93bn of the cash borrowed from the ECB is down to the six banks. @Rob S ELG – European Liquidity Gas – is the nEU_fuel which is to be used to slow_burn the Irish citizen_serfs. The savvy turf_cutters have spotted the flaw_in_the_inferno …. something to do with the local refinery (-; I won’t spoil the fun …. savvy high-infants graduates could figure it out! A paid-for infomercial by a tenured schill. Thankfully enough sane (principled) folks here to recognise it as such. Turkey attempts to stave off Christmas with “who will eat all the turkey feed” argument… PS Still, it is clearly fine to stop paying all coupons on bank bonds, since it is return of cash, not return on it. As such, if we also prorogue all maturities to 2030… Underlying this and previous articles is the notion that there is some kind of technical fix that will avoid taking pain for particular interests (that Liam and zhou_enlai also refer to in their way). For example “notwithstanding painful efforts to improve the solvency of both sovereign (fiscal consolidation) and banks (over-capitalisation), expected improvements in funding costs have failed to materialise”. The “improvements in funding costs” failed to materialize, as most of the pain was imposed on the Irish taxpayer, and not other interests. That in turn weakened the State’s solvency. So “efforts to improve the solvency of … banks (over-capitalisation)” (and let’s not forget the socialization of bank debt), undermined the solvency of the sovereign. Meanwhile the “fiscal consolidation” referred to by the author is a 10% + deficit / GDP ratio for 2011, a third year in a row. As for the solutions, a function of yet more “attractive long-term funding provided by Europe”,… well the ECB is showing signs of wanting to disengage. However like Karl, I’d see some other body as taking over the outstanding risk, but increasing it further? Europe, like Japan before it, has tried to solve its repeated financial and fiscal crises by sweeping them under the carpet. The taxpayer – and probably long term economic prosperity – is the victim by default. The banking crisis has cost the Irish taxpayer 36bn. A lotta dosh, maybe even more than the illusory stamp duties, VAT, CGT etc. etc. that the taxpayer enjoyed during the bubble, but absolutely manageable. There is of course the contingent possiblility that the banks will lose 100s of billions. That is always the case in a modern economy where long term assets of the banking system are a multiple of GDP and backed by short funding. It seems that most of the populace now believe that this contingency is all too possible. Indeed those on this blog seem to think it an inevitability and get positivley agitated when this conviction is confronted as it has been by DOM. And of course FT observers are positively salivating at the prospect of a rerun of the Famine. Thankfully, the ECB does not believe in the inevitable complete meltdown of Ireland. DOM is right about senior debt not being risk capital. It’s long term funding, hence why its on the same level of the capital structure as the deposits. But he’s wrong about the whole “burning subbies created the vicious circle where we now find ourselves”, or rather he doesn’t allow for the potential that we could have ended up here even if we had paid subbies back every cent they were owed. I think D O’M makes a good point in “..the moral justification for State burden sharing (over and above financial stability issues) lies in the acute failings of domestic regulators (Central Bank, FR).” But the people have punished those who oversaw these ‘acute failings’ and there has to be a limit to this burden-sharing. A consensus seems to be emerging that extended EFSF support might be used to shift the burden from the ECB. I think we’ll have to wait and see. @BW2 Do you remember Batt O’Keeffe’s speech at the London embassy on 15 November? The ECB didn’t buy all the spin about 20bn in cash then and pulled the plug, inviting the IMF in . The subsequent turnaround by Lenihan and Cowen broke FF. “Any taxpayer burden sticks in the craw in current circumstances. However, the moral justification for State burden sharing (over and above financial stability issues) lies in the acute failings of domestic regulators (Central Bank, FR). It is the implicit acceptance of across-the-board regulatory failure during the credit bubble that has now focused the attention of euroland authorities on “bail-in” considerations for future (post-2013) bond contracts only.” This is the most annoying section No, wait this one is “It was a similar perception of systemic support loss for senior subordinated paper in early October that contributed to a vicious contagion of junked credit ratings, surging bond yields, seized-up funding markets and dramatic deposit flight, all of which culminating in the EU/IMF interventions of late-November. Then, as now, the amount of relevant debt outstanding was relatively small, particularly in relation to the two failed entities most at risk of a coercive burden sharing arrangement. Then, as now, the risk/reward associated with such withdrawal of systemic support may have seemed attractive politically; however, it was to prove financially disastrous first time around, and this remains the threat today.” @BondE Sure senior debt may not have been seen as risk capital in the sense that it was widely believed that it was too high up the capital structure to get burned, but as a matter of fact and as a matter of law it was capital that was available to take losses in a wind up. Any definition of “risk capital” that doesn’t take into account this basic fact, (i.e. that it is at risk), is not a good or useful definition. Therefore, investors in such debt (and their advisors) ought to have known that a melt down (albeit only a meltdown) left them exposed. If they did not in fact know they were potentially exposed then they were poorly informed. Eoin, “DOM is right about senior debt not being risk capital” This might be something that gets taught on accountancy courses but in the fund management business ALL assets including sovereign bonds are regarded as having some risk associated with them. If this were not the case why would I or anyone else buy anything that yielded less than an unsecured senior bank bond? Why would different names have different market yields? Donal I presume represents himself as an asset manager not an accountant? Sorry for multiple posts “Senior debt provides term financing for bank credit creation that stretches well beyond the limits of ordinary deposit maturities. Continuous repayment of this debt, alongside that of the pari passu depositor, is the confidence glue which sustains the “maturity transformation” process of modern commercial banking.” Would higher levels of equity not perform this “confidence gluing” more satisfactorily than senior debt. Senior debt must be repaid. Equity is ever lasting. I can see how the transformation of maturity from deposits to say mortgages is valuable indeed vital. However, the maturity transformation inherent from a bank senior bond to a mortgage seems less so. If this is is the case, and equity would act as a better confidence glue for depositors than senior debt, should senior debt just be removed from the balance sheet of banks and be replaced with equity in the future? DOM in this article is no different to an estate agent claiming that the housing market has bottomed out and that there is great value to be had by buying a house today. @ Grumpy “ALL assets including sovereign bonds are regarded as having some risk associated with them” Yes, in theory correct. However, as we know, “the risk free rate” generally referred to sovereign debt, and if you dont have a risk free rate of return, you can never calculate a risk adjusted rate of return. If you can’t do that, then its somewhat difficult to gauge how risky any investment truely is. For senior bank debt, it was a liquidity premium as much as anything that let them yield 20bps or so more than sovereigns. @Eoin Bond By definition a bond is risky, but I can see that Christy and Grumpy already answered on that. The fact that they’re on the same level as deposits is not a real problem. Laws can be changed. That’s what a government is for. Rating agencies for example rate bank deposits and bank bonds separately. Hang on…so a 20bp premium was for liquidity? Across the term structure? Back in say 2008 was irish sov debt illiquid? blasted thing “if you dont have a risk free rate of return, you can never calculate a risk adjusted rate of return.” But, we did, for the best part of half a decade, have one for ireland. And it wasnt that different to the Bund – it should have been in retrospect but it wasnt. Sorry, dont buy the “sure they didnt know it was risky” idea. If they didnt then they deserve to be punished for being as foolish as the shareholders. If they did then they deserve to be haircut for taking on risk. Senior debt is not “risk capital”, eh? Sounds like a convenient excuse for foolish investment management. Regardless, I suppose I can live with the argument that the senior bondholders must be speared for the good of all provided all are to chip in to make them whole. As such, the Irish taxpayer should not be expected to carry the whole burden – Mr. Martin Wolf so rightly points out. @ anon (a) ratings agencies rate them seperately, but they typically rate them the same. Its only in the last few weeks that the Irish banks have seen a differentiation occur between senior debt and deposit ratings. (b) on laws being changed – thats a different argument, as to whether we can impose losses legally. The argument DOM is putting forward is that bonds should not be considered risk capital, and therefore it is not appropriate to impose losses on them if you’re also going to protect the other “non risk capital” ie deposits.. The answer may be that we should still impose losses on seniors, but its a fair argument to put forth by him. @ Lucey Anglo has some Jan 2012 senior unsecured debt that was issued in Jan 2007 (ie close to, but pre-crisis). It issued at Libor +12.5bps. I know Joan Burton and Michael Lewis and many many others reckon even the dogs in the street knew Anglo was toast back then, but evidentally they could find 1.25bn in funds to invest at incredibly low rates back then. For comparison, around the same date, an Irish 2013 govvie yielded around L-20bps, and a 2013 German Bund was basically identical with the Irish govvie, so also L-20bps. So, for 5 year senior Anglo paper you got a 32bps premium over the two risk free rates available for Ireland. But yeah, even the dogs in the street knew Anglo was fecked back then, it was only risk junkie hedge funds buying it i’m sure… ‘On behalf of the esteemed members of ‘Giftopia’ I wish to commend DOM for his learned contribution to the – in his words – ‘bank stabilisation debate’……………….. @Eoin Nobody is doubting that senior debt was priced at a level that is consistent with it being seen as an asset whose riskiness was similar to that of Irish or German sovereign debt. What they are saying is that this is irrelevant. It is surprising to still see people claim that senior debt is not risk capital – as the situations at that danish bank – Lehmans brothers – Washington Mutual – (and now Anglo?) – has shown is that as a matter of law and as a matter of fact (ie senior debt has actually incurred losses) senior debt is risk capital. Whether or not investors viewed it as risk capital ex ante is now largely irrelevant – if they did they have been shown to be wrong – and it is clear that in the future it will be viewed as being risk capital. @ Christy we have seen depositors lose cash in some of those situations as well. I suppose my point is that you can only really consider senior debt to be risk capital if you consider deposits to be risk capital as well? Making such a belief an explicit function of the financial system will rather markedly change the cost of capital for the banking system, and so for consumers. Maybe thats what is required for a more honest gauge of risk in the financial system, but we’re gonna have a pretty messed up system while everyone adjusts to that reality. As for your suggestion that “Nobody is doubting that senior debt was priced at a level that is consistent with it being seen as an asset whose riskiness was similar to that of Irish or German sovereign debt”, well the right honourable Professor from Trinity College would seem to at least somewhat disagree with you… 😀 @ Eoin B, “For comparison, around the same date, an Irish 2013 govvie yielded around L-20bps, and a 2013 German Bund was basically identical with the Irish govvie, so also L-20bps. So, for 5 year senior Anglo paper you got a 32bps premium over the two risk free rates available for Ireland. But yeah, even the dogs in the street knew Anglo was fecked back then, it was only risk junkie hedge funds buying it i’m sure…” All that demonstrates is the underpricing of risk at the time. Less liquid AA-rated European rmbs notes were being placed at 30bps back in 2007. Just because someone is willing to take a low risk premium doesn’t exempt them from losses. I wouldn’t disagree with the claim that senior bank debt ranks equal to interbank deposits; IANAL but AFAIK that’s a fair statement of the legal position. but it is quite misleading to say that they “are placed alongside rank and file depositors at the very top of the creditor pecking order, where return of capital rather than return on capital is the absolute byword.” The natural interpretation of “rank and file depositors” is small savers. Donal O’Mahoney is misleading his readers there, I think. Does anyone dispute that? Eoin, “For comparison, around the same date, an Irish 2013 govvie yielded around L-20bps, and a 2013 German Bund was basically identical with the Irish govvie, so also L-20bps. So, for 5 year senior Anglo paper you got a 32bps premium over the two risk free rates available for Ireland. But yeah, even the dogs in the street knew Anglo was fecked back then, it was only risk junkie hedge funds buying it i’m sure…” If you were allocating funds in a portfolio you had a choice – to take a yield premium over the sov bond or not. There was a craze at the time, probably enthusiastically encouraged by Donal, that the risk in the financial system was now so small that you were a fool to not take the extra yield – you were getting a free lunch. That view was wrong. Some of us looked at the yields on things that had risk – like bonds in Irish banks, factored in the property bubble and concluded the yield spread was ridiculously low and either took the sov bond or just went ex-Ireland completely. The fact that the market had priced the risk too low does not change the fact that the risk was there. @Christy “Whether or not investors viewed it as risk capital ex ante is now largely irrelevant” well, unless you advised someone at the time that it was not risk capital and they stand to lose a packet… that might sharpen your view that it is not risk capital. @Kevin Donoghue The whole article is an attempt to lead in a particular direction. “It’s not my fault, it was the bold children on Dame Street and they’ve already been punished by being retired on huge payouts…” @Kevin Donoghue They are equal in a winding up. They are not equal in that if a bank starts to look dodgy, while a bank can still access liquidity, depositors (demand or near) can withdraw 100% of their money. Bond owners cannot do that – they can only sell at the market price befor redemption. Retail depositors generally have little idea how the system works. Senior bondholders – or the Donal types advising them are supposed to understand that their capital was only as safe as the bank. “The argument DOM is putting forward is that bonds should not be considered risk capital, and therefore it is not appropriate to impose losses on them if you’re also going to protect the other “non risk capital” ie deposits.. The answer may be that we should still impose losses on seniors, but its a fair argument to put forth by him.” I don’t see this as a fair argument at all – I can’t see any sense in it. We are bailing out depositors for practical reasons – we think it is in our interest to do so. The fact that bondholders believed they would be bailed out in a meltdown does not make it “appropriate” to actually bail them out. I don’t know what you mean by “appropriate” here. The legal structure was clear ex ante – seniors and depositors are creditors of the bank. They thought they could hide beside depositors – but if they wanted to do that they should have ensured they were senior to depositors and then they could have hid behind them. Furthermore, its surprising to hear investors talk of fair and appropriate – talking about whether it is legal or illegal to impose losses is fair enough – but seeing DOM STILL believing that senior debt is not risk capital annoys me because it tends to show that he still has not learnt the lessons of the crisis The regulatory system in which banks operated, operate and will operate did, does and will provide for the possibility of seniors suffering losses. Moreover, seniors have in fact suffered losses. On any reasonable view these facts show that senior debt is in fact risk capital. Whether or not it ought to be risk capital and whether or not investors believed it to be risk capital are questions that are separate to this discussion. I hope he isn’t, as we speak, buying senior debt at some bank and pricing it on the basis that it is not risk capital because to do so flies in the face of reality. Our Minister sans mandate (as he might say to Mme Lagarde) has published resolution legislation http://www.merrionstreet.ie/wp-content/uploads/2011/02/b1111s.pdf Grumpy is right, however in most countries there is a specific retail deposit guarantee to prevent bank runs, so in the case of a default the money on deposits is lost but depositors are made whole by the government (or some government-backed entity). In Ireland the deposit guarantee was increased from €20,000 to €100,000 in September 2008 so technically until 2008 people could have lost any savings above €20,000 that they had on deposit. @BWII “The banking crisis has cost the Irish taxpayer 36bn.” What are you basing the €36bn on, and do you really think that is going to be the extent of the state’s losses? @ KOD Depositors rank pari passu with Senior Bondholders, no matter how small or how humble the former may be – that is the legal position and so DOM is absolutely correct. Now if a bank goes bust it is a totally separate matter whether some other agency be it the State or an Insurance Company or whatever then steps in to replace some or all of the lost moneys for some or all of the losers. @ All Why are people being deliberately obtuse on the meaning of “capital”? Capital can of course be interpreted very broadly even encompassing Human Resources. I would have thought that by now most on this blog would be familiar with the term as it applies to banking. Senior Bonds are NOT capital. Right up until Blanket Guarantee day our Regulator was insisting that Anglo was totally solvent. It went as far as to blame Hedge Funds for bad mouthing that venerable pillar of the Irish financial establishment. I am not one for arguing the moral case for honouring Seniors. We are doing that because the EU/ECB demand it as the price for saving us from economic Armageddon. In making those demands they also have the comfort that they have a very strong moral case for doing so. “Right up until Blanket Guarantee day our Regulator was insisting that Anglo was totally solvent. It went as far as to blame Hedge Funds for bad mouthing that venerable pillar of the Irish financial establishment.” A regulator saying a financial institution is sound is like a board affirming their confidence in a premiership manager. But more basically, such assurances do not give rise to a legal entitlement to be repaid. Donning a “Global Strategy” hat for a mo. Do not underestimate what is resting on the creaking prop that is the Irish taxpayer underneath the senior bonds, In Europe and elsewhere there is widespread acceptance in the investing community that many banks are at least under capitalised and some are only pretending to be solvent – a bit like CitiBank during the Mexican fiasco. There is a belief among many, that there is a wink wink – nudge nudge agreement among all the grown-ups in the system, that an implicit guarantee exists that no senior bondholder will take a loss. Just like Fannie and Freddie in the ‘states. Lots of people in that community think that is bonkers and that it is just a way of trying to continue the underpricing of risk as a can-kicking exercise that will result in a Zombie-Japan type scenario – without the US consumer boom to export into. The lack of a guarantee obliging Ireland to pay off in full the senior unsecured unguaranteed bonds is a big deal for banking interests around Europe because if the logical course of action is taken by Ireland and haircuts are taken by the complacent investors, then the whole question opens up of “er, why was it again that we think an unsecured bank creditor cannot take a loss?” If the prop breaks – or creaks so loudly that some of the believers scarper, then the act of faith that goes into bank financing will be harder to sustain and bank investors of all sorts will have to start taking a closer interest in the actual business the banks are doing. That would be a good idea. But as I have tried to point out before you can’t have it both ways. You cannot continue to have Beverly Hills style charges embedded in the economy, pay the state payroll money that is so far out of line internationally and at the same time threaten anybody with anything much. You have to make a choice. Paul Hunt: “But the people have punished those who oversaw these ‘acute failings’” ~~ Not all of them – we don’t elect civil servants. When is the haircut coming to DoF, CBI, FR? I have no problem in seeing Senior bondholders in core banks as being a similar risk profile to depositors, but to be so there has to be serious supervision since failure of these levels of investment in one institution throws doubt in all similar investments in the same jurisdiction – that these investments would be targeted by risk-seeking investors should be a tripwire in a rational oversight system. There can be no argument from core banks as to need for this since it’s not like BoI and AIB hadn’t provided ample evidence over the previous decades that their internal systems were unfit to be trusted. In addition to rebuilding the existing we have to look at how we prevent such collapses, and for me it comes back (sorry for being tiresome on this) to loan insurance. Loan insurers, whether State backed like Canada’s CMHC or private sector insert a conservative bias into a system which pre-2007 had all the players – State, financial, investor and borrowers (developer and buyer) – determined to keep the bubble inflating. If the loan insurer is State backed then that transforms the State interest from indirect (lobbying from the insurers) to direct (if insurer collapses taxpayers on hook). Obviously given lack of capital to build such a body this would take a while to build out but the scope of insurance could be expanded over time. @BWII That’s playing with words. Bonds are not equity, everybody is well aware of that. When an investor puts his money in a bank, whether under the form of equity or bonds, he’s got to know he can lose it. From the point of view of the bank it’s not capital but from the point of view of the investor it is definitely “risk capital”. In Ireland the deposit guarantee was increased from €20,000 to €100,000 in September 2008 so technically until 2008 people could have lost any savings above €20,000 that they had on deposit. Personally I wouldn’t describe savers with over 100k on deposit as “rank and file depositors” but YMMV. Obviously that particular phrase is vague, which may be why DOM chose it — he can be quite precise when it suits him. BW2 “Senior Bonds are NOT capital” Try explaining that you did not use your client’s capital to buy those bonds. The capital invested in them is at risk. The trick Donal is trying to pull off is to use an accounting type interpretation of a phrase “risk capital” and then apply it in an alien environment (fund management) where where it is at best very misleading if not meaningless. grumpy: “Some of us looked at the yields on things that had risk – like bonds in Irish banks, factored in the property bubble and concluded the yield spread was ridiculously low and either took the sov bond or just went ex-Ireland completely.” The people who put their hands up in public (as opposed to merely redeploying theirs or their clients investments, as well they should) and said “there may be trouble ahead” got said hands chopped off by The Powers That Be. How do we create a system where such warning signs are heeded rather than dismissed as scaremongering without a fair hearing? How does such information get introduced to the public without causing cascade effects? @Mark Dowling First, it wouldn’t cause cascade effects because it was by definition, a minority view. Second, “How do we create a system where such warning signs are heeded rather than dismissed as scaremongering without a fair hearing?”, change human nature probably. Very few wanted to know, that’s why sneering at dissenters was such an apparently good option for politicians and their entourage. @grumpy I dunno about that. The venom directed at people like Morgan Kelly seemed to be motivated by the notion that one little guy could cause all sorts of mayhem and thus had to be beaten down. To my mind the way to make warning signs heeded is self-interest/consequences – but removal of moral hazard by the current failout operations will do nothing to promote the notion that holders of senior instruments or those who would normally so hold be confident in being heard without retribution if they asked questions. Instead we see politicians leaning on civil servants who tried to manage risk of *public* monies by refusing to deposit in Anglo. In a rational system that incident should have led to an investigation of Anglo, not NTMA being bludgeoned into changing course. How can we rely on the private sector acting rationally in the course of their greed (sorry, slipped into Joe Higgins mode there) when the public sector behaves equally irrationally? “How do we create a system where such warning signs are heeded rather than dismissed as scaremongering without a fair hearing? How does such information get introduced to the public without causing cascade effects” Well, I would argue a better way to proceed is to assume that these mistakes will continue to be made and therefore increase equity requirements substantially so as to reduce the severity of the consequences of this happening. @christy – probably. The only thing is, that seems to me to create a system which resembles rugby players (or professional ice hockey players) between 1980s and now. Smaller players, less padding vs larger/stronger players, more padding. Injuries can be just as serious because human nature seems to assume that more padding allows more risk taking. @Mark Dowling Not quite sure how he managed it but David McW got a programme broadcast during the boom 2006 ish I think, which considered the possibility that the property market might be a bubble and that the Euro/Dollar might move against the country – and what might be the consequences. There was, later, another that discussed the idea of Ireland being a one-trick pony and coming a cropper. The RTE in-studio sneering that followed was something to behold. I recall one business columnist on RTE daring to suggest that it was possible, – just possible mind you, that house prices might not rise in the following quarter. They could even fall 1%. This was subjected to the sort of reaction that Fox News presenters would normally reserve for an interviewee who said anything suggestive of anti- Israeli views. Quinn and Anglo stuffed the country with an apparently illegal share support scheme. The regulator reacted by investigating people who thought there was a problem at Anglo and therefore sold the shares short. All of these actions would have been supported by the public at the time. The only way it will change is if you eliminate moral hazard and incentivise people to give a shlt. Here is what Donal wrote in April 2010, just around the time the government was signing up to a strategy that depended entirely on a V – shaped GDP path; Croke Park. Spot the sneering near the end. “Courtesy of Nama and the stepped-up prudential requirements of a new and vigorous financial regulator, Ireland will soon find itself with two of the most strongly capitalised banks in Europe (AIB and Bank of Ireland). This realisation is already playing out in Irish bank funding markets, where credit spreads are now tightening appreciably against European peers. For example, subordinated debt spreads for Bank of Ireland have tightened by as much as 120 basis points over the past five weeks. As with the experience of Irish sovereign bond spreads over the past 12 months, which have fallen by as much as 180 basis points against their German benchmark, the implementation of credible policy solutions to our fiscal and banking challenges will be rewarded by substantial improvements in our funding capabilities. In as much as Ireland has recently been transformed from pariah to poster-child in the fiscal consolidation stakes, a similar re-rating now awaits our quoted financial institutions. This is a key ingredient towards the much-needed revival in credit creation as economic recovery takes hold. Domestically, malcontents continue to vent their spleen against the Government’s stabilisation policies, in stark contrast to the increasingly receptive audiences overseas, including an endorsement from the International Monetary Fund last week. Of course, continued political opposition is the obligatory stock-in-trade, but the relentless criticisms of both media and academia is more bemusing at this juncture, not least given the paucity of credible alternatives proffered to date.” @Mark That’s a fair point – equity increases are not sufficient. But they are a good starting point. I suppose a bad outcome would be slightly/inadequatly higher equity requirements at the same time as financial “innovation” that develops instruments that are akin to senior debt but are classified as deposits and are amenable to a run through some sort of trigger or acceleration clause. Alternatively we could just see banks funded more and more by deposits. @grumpy I suppose, having written the above extract, DOM would have to either accept that he was as wrong about the post crisis situation as he was about the boom, or, blame the bail out on how we treated sub ordinated debt. I see he chose the latter “It was a similar perception of systemic support loss for senior subordinated paper in early October that contributed to a vicious contagion of junked credit ratings, surging bond yields, seized-up funding markets and dramatic deposit flight, all of which culminating in the EU/IMF interventions of late-November. Then, as now, the amount of relevant debt outstanding was relatively small, particularly in relation to the two failed entities most at risk of a coercive burden sharing arrangement. Then, as now, the risk/reward associated with such withdrawal of systemic support may have seemed attractive politically; however, it was to prove financially disastrous first time around, and this remains the threat today.” @ Christy “But more basically, such assurances do not give rise to a legal entitlement to be repaid.” Not sure about that. There has been talk that if seniors are torched there would be a case for legal action against the State. Certainly, if a life assurance company gave such assurances about the quality of one of its investment offerings and was subsequently found to be telling complete porkies it would be guilty of gross misrepresenetation and misselling and would have to make good any punters who accepted it assurances. @BW2 “Not sure about that. There has been talk that if seniors are torched there would be a case for legal action against the State.” I suppose that would depend on the manner and extent of their torching. But I can’t see a cause of action arising out of representations made by the financial regulator in the run up. Specifically, I don’t think you could ground a claim for legitimate expectation on the facts. “Certainly, if a life assurance company gave such assurances about the quality of one of its investment offerings and was subsequently found to be telling complete porkies it would be guilty of gross misrepresenetation and misselling and would have to make good any punters who accepted it assurances.” I don’t think this is a useful analogy as its the situation has too many fundamental differences. Most basically, you are dealing with a public authority exercising a public function in the interests of the state – damages are rarely available in these circumstances @grumpy DOM previously said. “Domestically, malcontents continue to vent their spleen against the Government’s stabilisation policies, in stark contrast to the increasingly receptive audiences overseas, including an endorsement from the International Monetary Fund last week. Of course, continued political opposition is the obligatory stock-in-trade, but the relentless criticisms of both media and academia is more bemusing at this juncture, not least given the paucity of credible alternatives proffered to date.” Anyone who considers someone with a different view from them to be a ‘malcontent’ deserves to be consigned to the dustbin of history. Investment advice? I wouldn’t even take directions from the man. @ christy ‘Well, I would argue a better way to proceed is to assume that these mistakes will continue to be made and therefore increase equity requirements substantially so as to reduce the severity of the consequences of this happening’ You are not the only one arguing for that. http://csi.gsb.stanford.edu/why-bank-equity-not-expensive Hogan, Grumpy. There is an issue to what you say re investment advice. Its quite one thing an academic, whos role it is to speculate, muse, think and generally get the brain overheated, when they go off the mark in predictions. Usually nobody is hurt, some pride mayby, and anyhow, any academic worth their salt is so inured to rejection from a multitude of editors that their skin is like rhino hide. But, when someone who has a fiduciary duty makes wrong bad call after wrong bad call, one wonders at the much vaunted market mechanism Who can forget the grandiloquent claims in 24 July 2009 “July is proving to be a pivotal month for the Irish market, given publication of those special reports on public expenditure and taxation reform, along with draft legislation on the establishment of Nama. In fleshing out their intentions for both the public finances and banking system, the Irish authorities have the chance to rollout a stabilisation programme that can succeed more rapidly and at a significantly lower fiscal cost than has been feared heretofore. If so, a substantial rerating of Irish government debt relative to its peer group will necessarily follow. Together with the continued healing in financial markets as the global economy revives, an opportunity will readily present itself for a substantial pre-funding of Ireland s 2010 borrowing requirement (EUR 20+ billion?) before the current year is out.”. Yes, the rerating began in earnest in 2009 we now know. Or the wonderful Of the same date “concerns have long since vaporised and, in tandem with a general revival in investor risk appetites, Euroland bond spreads are now fast reconverging on pre-crisis (Lehman Brothers) levels.” Something was vaporised all right.. And then we had the wonderful psychological balm of 13 April 2010 “History has shown that in the unfolding aftermath of all investment bubble-bursts, participants traverse the entire psychological spectrum from euphoria to despair. In this vein, one might characterise recent Irish economic history as reflecting the euphoria of 2007, the denial of 2008 and the anger of 2009. If past is prologue, then 2010 will prove to be the year of acceptance, wherein a chastened but substantially adjusted real economy and banking system can reclaim the recovery path.” What will 2011 bring? Resignation? Apathy? Depression? Then we whistled past the Hellenic graveyard on 24 april 2010 “Meanwhile, bond investors will eschew their recent indiscriminate selling of peripheral euro zone markets in favour of a more discerning approach, one in which the Irish government bond market will continue to rerate.” Re rate it did: from what now looks like a paltry 4.8% then for the ten year. Where is it now? What happens the value of bonds when the interest rate rises, remind me? Do they fall in value or rise…so easy to forget… It was all the fault of those pesky germans anyhow on 12 August 2010 when we were told that the widening spread on the bund was caused by “the relentless drive lower” of the germans. As the bond yield continued to rise and as the tide went out further on we swam, and we were told on 18 september 2010 that market reactions were “divorced from the reality on the ground” And then we had the clarion call to double down on Ireland, to go longer, to reject that mad fool Harry and his “diversification” , on 13 November 2010 “Thankfully, the economic prognosis begs to differ, with Ireland s twin-deficit vulnerabilities fast receding as the external sector rebalances.The corollary is that Ireland is moving increasingly towards self-help status, whereby the ongoing borrowing requirements of the public sector can, in principle, be absorbed by the accumulated surpluses of the private sector. Of course, practice can differ from principle in this regard; hence the need for more enlightened self-interest in the ways in which we disburse the investments of the pension fund and insurance industries, the National Pensions Reserve Fund, and indeed the domestic banks themselves.” A week later and the Germans were in charge. There is more, such as his poo-pooing of Ciaran O’Hagans fears in early 2010 that we could be locked out of the market, and his dismissal of Morgan Ks mortgage apocalypse as “Nihilistic . . . breathtaking . . . hubris . . . the upshot of such diatribes is to provide further cheap fodder to the Financial Times headliners and internet bloggers who are apt to display a schadenfreudian delight at Ireland’s current misfortunes.” DOM has a track record, but its not one that I would welcome if I were to have my monies managed by him. Still, its good to know that “In the international bond and currency arena, our global strategist, Donal O’ Mahony, has developed a broad-based following for his consistent and accurate commentary on macroeconomic and financial market trends.” Now who would have said that… @ Ahura/Grumpy the issue of low yields is important because it destroys the argument that investors in their bonds appreciated the additional risk they were taking because they were receiving the additional yield. If the additional yield amounted to 30bps over soveriegn, then you’re still very much in the risk adverse camp. We can still say, “tough luck, you messed up”, and impose losses, but you can’t do it whilst justifying in on the basis these guys got what they deserved cos they took on extra risk. Senior debt, even now, is still sometimes seen as a money market product as much as a corporate credit (though obviously for a smaller subset of banks and for shorter tenors). Secondly, for liquidity reasons, many investors can’t invest in term deposits, as, while almost every bank will give you your money back on demand, technically speaking a bank does not have to repay you your funds outside of the original agreed term. However, a senior bond is, obviously, a tradeable instrument, so liquidating ahead of maturity is relatively easy, albeit liquidity conditions can fluctaute, which is part of the reason you may receive a, for example, 30bps premium for the likes of an Anglo bond over an Irish govvie. Again, most of this premium over sovereign was about liquidity as much as credit, or due to the fact that some institutions could only hold government bonds etc. Please note that i am not getting into the arguments over whether we CAN legally impose losses, or over whether we SHOULD impose losses. I’m simply advancing the point that senior debt ranks equal to deposits for a reason, and it was priced incredibly tight to government debt. So legally this stuff was the same as deposits, and pricewise it was in the same ball park as the actual risk-free-rate. It was issued by banks as a way of increasing funding maturity profiles, not as a way of increasing capital to cover against potential losses. Regardless of the legalities, it has never been considered as risk capital in the capital structure of a bank, and it would be fair to say that almost all investors would not consider it as a risky investment. 2 trillion of it will be rolled over in the Eurozone in the next two years, and i think we are all well aware that the Eurozone banking system has nowhere near 2 trillion in risk capital and probably never will. Its importance for the funding structures of the banking system explain why the ECB is so unwilling to impose losses on it. This is a major problem with the banking system at the moment, and we will not have a proper resolution until we manage to figure out how to deal with it. @Eoin Bond Well, it’s not because bondholders were delusional and badly mispriced risk that they should be paid back. Corporate bonds are risky, bank bonds are risky, sovereign bonds are risky. We live in a risky world! It has sure always been considered risk capital, that’s why you have armies of bank analysts employed just for that. I have no pity for those analysts who didn’t do their jobs. @ Eoin “the issue of low yields is important because it destroys the argument that investors in their bonds appreciated the additional risk they were taking because they were receiving the additional yield.” No it doesn’t. Clearly they didn’t appreciate the additional risk – but they should have. Perhaps they are subscribers to Ol’ Baloney’s strategy notes. The underpricing of risk thanks to those dumb investors and their dumb advisers has decimated the Irish economy and nearly brought down the capitalist system a couple of years ago. They didn’t realise – so so they have to be bailed out? Are they going to return their bonuses and salaries? “Secondly, for liquidity reasons, many investors can’t invest in term deposits” And the reason they didn’t invest in sovereign bonds or bills instead is – they were too greedy and wanted that extra bit of coupon. @ Brian Lucey Well done. Maybe Madam should reconsider giving so much space to such drivel. @ Prof Lucey Good stuff. Did DOM say all of that? But think glass houses, how many of us would come out well from a dissection of our previous musings? Bw2 “Did DOM say all of that? ” Yes.Lexis nexis is your friend. As for glass houses, do read what I said , the first few sentences… @Eoin Bond “I’m simply advancing the point that senior debt ranks equal to deposits for a reason, and it was priced incredibly tight to government debt. So legally this stuff was the same as deposits, ” Eoin I am guessing you work in the business and I do not, so I am also guessing you are well aware that what you said above must be garbage. If “this stuff” was the same as deposits then it would have been covered under the oriiginal deposit guarantee scheme which it was not. If it didn’t need this guarantee scheme then clearly the deposits would not have needed it either. In the Marx Bros. movie ‘The Big Store,’ Martha Phelps hires private investigator Wolf J. Flywheel (Groucho) and he makes a proposal: WOLF: Martha, dear, there are many bonds that will hold us together through eternity. MARTHA: Really, Wolf? What are they? WOLF: Your Government Bonds, your Savings Bonds, your Liberty bonds. This debate is almost getting to the level of where to put the comma in the Nicene Creed… In The Irish Times today, Fintan O’Toole calls for ‘revolutionary transformation.’ Nothing to fear here for defenders of the conservative status quo; he’s not thinking of offering up one of his houses to the People’s Committee for Culling Sacred Cows of Left and Right! Simply it’s the tearing up of the EU-IMF bailout agreement. The Labour Party has been given 3 weeks to beat sense into the Europeans. We have an annual budget deficit; the oil price maybe heading for $150 a barrel; 200,000 net jobs have to be generated and there is a serious bank funding crisis with the ECB and CBI providing much more than bondholders. There are moves afoot on selling loans… I think it’s time for what could be termed a ‘holistic’ approach to this crisis. http://www.irishtimes.com/newspaper/opinion/2011/0301/1224291075972.html @ Anon Re priciing of risk. ‘I have no pity for those analysts who didn’t do their jobs’ The serial blowing of asset bubbles and subsequent busts are mechanisms for massive transfers of wealth towards those at the top of the pile. We had an old fashioned bubble in Ireland, but it was a big one. As Michael Pettis points out in the Volatility Machine (OUP 2001): ‘There is hierarchy of markets from the centre to the peripheral markets, and changes in the centre can be amplified as they move through the system to the periphery’ The underpricing of risk at the centre was conducted in conscious anticipation of the socialisation of losses. This was, in effect, a silent political coup. As with the rating agencies and the economists, those analysts who priced risk correctly were sidelined. The EZ banks duly swallowed the toxic derivatives from Wall St, and like Wall St, have made themselves TBTF. The Irish state , on the other hand, is not in that ‘safe’ category, and will probably be left to the vultures. @Bond Senior debt as a matter of fact can and has taken losses. I can’t see how this is consistent with a view that it is not “risk capital”. If it is at risk, (in situations where the sovereign doesn’t default) then to my mind it must be considered risk capital. any definition of risk capital that doesn’t account for this is not a useful one and is an abuse of language. To look at it another way, what you appear to be saying is that the financial system is at least in part built on and around the assumption that senior debt is implicitly guaranteed by the State. If senior debt is non risk, then it must follow that the state is bearing that risk. But that assumption has already been exposed as misplaced. The ship has sailed on that view as it turns out that not all senior debt is implicitly guaranteed by the State. This is not just a matter of legal possibility. It has actually happened. @ AMcGrath legally they ARE the same as deposits. That we choose to provide additional, seperate safeguards for deposits is a completely seperate issue. Please don’t take half of what i said and try to turn it back on me. @ Christy deposits have also taken losses. Are they risk capital? @Brian Lucey, “Its quite one thing an academic, whos role it is to speculate, muse, think and generally get the brain overheated, when they go off the mark in predictions. Usually nobody is hurt, some pride mayby, and anyhow, any academic worth their salt is so inured to rejection from a multitude of editors that their skin is like rhino hide.” Well put. It is the occasional adversarial contest of ideas between academics and practitioners here that lifts this board above all others. The fear – and, indeed, the suppression – of an adversaral contest of ideas in the major developed economies has, in my view, contributed much to the emergence of this ‘Great Recession’. Adversarial contests in the public policy sphere take place only at elections or in the courts – and the focus here is on securing victory or a result rather than a disputation that seeks to establish evidence and facts leading to better policy and regulation. In general, governments – usually exercising executive dominance (and often in hock to vested interests) – advance policies in ‘consultation’ with ‘stakeholders’. With the growth of Quangoland, regulators everywhere follow the same course. Every effort is made to avoid the adversarial contest of ideas and evidence. The result is a tidal wave of bullshit, PR and spin and the sustained triumph of vested interests at the expense of citizens and consumers. It should not be a surprise that we are in this mess and that it is proving difficult to chart a way out. And there seems to be no prospect of any changes in political governance, either here or throughout the EU, to remedy these failings. Paddy Power has just announced full support for the ‘DOM/Griftopian/Paul Hunt’ stance enunciated recently – he will from now on pay back on all losing bets over a €mill and recoup the revenue shortfall through a levy on all other punters…..this he believes is the fairest soluton as the failure of his staff to regulate the size of bets placed with his company is a direct reflection on the irresponsibility of all punters – and they must pay for this failure…and pay…..and pay….and pay…. BEB: legally they ARE the same as deposits. That we choose to provide additional, seperate safeguards for deposits is a completely seperate issue. If the additional safeguards are enforced by the courts then it is quite obvious that legally they are not the same at all. Your statement would only make sense if the additional safeguards were enforced by extra-legal methods, for example by gangsters who, for some reason, acted as enforcers for depositors but not for bond-holders. Perhaps what you are trying to say is that senior bonds and deposits rank equally under common law or the law of contract, but deposits have additional (statutory) protection. Once again, IANAL, but if that’s what you mean I think you’re quite right. But who cares? @ Kevin the additional safeguards are, as noted above, seperate to the rights of a bank creditor in the event of liquidation. So the depositors have no additional rights to the assets of a failed bank. The safeguards that we have promised, for reasons of financial stability, simply mean that we will make whole any losses, up to a limit, that they suffer from a failed institution. The guarantee is completely seperate to their normal creditor rights, not an addition to them. @Bond I suppose the logic of my position must imply that to the extent that deposits are available for losses they too are risk capital. However, clearly deposit holders benefit up to a point from explicit guarantees and this takes them out of the net. Moreover, they benefit from more reliable implicit guarantees. But yes if I was pushed I would have to agree that, because they have suffered losses, as a matter of fact they are risk capital. But to push the discussion further, the concept of non risk capital needs to be re appraised in my view. If the state guarantees a liability, all it really means is that the risk shifts from the creditor to the state. In other industries, when this happens, such funding is not given a label non – risk or funding capital. Now I recognize that there are unique features of the financial sector, not least of which is that banks often contribute to an insurance fund for depositors and a principal function of financial institutions is to bring short term savers together with long term borrowers. But the fact remains that allowing banks to benefit from implicit guarantees was and is ill advised and to an extent the language used to describe this funding is part of the problem. @vinny, You might find your attempt to pigeon-hole me is a bit off the mark. Following on from 9:40am comment, my concern is to ensure that amendments to the law of contract and those that might infringe property rights are properly thought through and applied. This is particularly the case for securing funding that matches the maturity of long-lived, often specific, assets that, in general, may not be very liquid. Threaten this and the cost of capital will go through the roof – or indeed there may be an investment strike. What the EU is proposing from 2013 will result in an increase in the cost of capital, but this should be a natural response to the irrational underpricing of risk during the bubble period. The difficult political problem now is to apply some haircuts judiciously, but, inevitably, retrospectively, that will not result in huge volatility in the cost of capital and a sustained increase in its cost. This must be applied in a co-ordinated manner thoughout the EU and over a period of time. I realise it is not happening quickly enough for us, but it will prove difficult to convince some EU member-states, which did not succumb to irrationality, of the urgency and of the extent of reform required. @ Christy “But to push the discussion further, the concept of non risk capital needs to be re appraised in my view.” Absolutely. And that was where i was going with this as well. I suppose in theory i’m agreeing 100% with you, but simply pointing out the practical realities, both in the past as well as in the present, and the fact that the ECB still doesn’t have a coherent plan to get us away from the current situation. These problems are exasperated by the fact that it was exceedingly difficult to impose losses on even the true risk capital embedded in the capital structure, and subordinated debt in particular. Basle III actually looks likely to erode the usage of subordinated capital, at a time when we clearly need more clearly defined risk capital overall. Unless equity does all the heavy lifting here, i’m not sure how we come up with a decent solution. @Bond What if deposits are super senior? @Eoin, I think where we’re ending up here is the inevitability of a big step increase in the cost of capital across the board. There is a huge demand for infrastructure investment throughout the EU, much, but not all, related to the climate change agenda. It will only be forthcoming at a very high cost of capital or, to reduce that, with government commitments and guarantees – which in turn will place pressure on sovereigns and up bond yields. Ireland is actually better placed than most in this respect (the bubbles weren’t all bad!) – but only if some of the Green madcap schemes are junked. Some judicious recycling of state assets could do a lot in the transport, communications and water areas (where some demand for investment exists). The real economy is not in bad shape – and would be even better if some of the deadweight costs were shifted. We can manage a certain amount of this bank resolution pain – but not too much. @Eoin “These problems are exasperated ” Poetically put. BEB: So the depositors have no additional rights to the assets of a failed bank. That’s a far cry from saying that they are legally in the same boat as bond-holders, which is what you claimed. As a depositor I’m not concerned whether I get my money back from a receiver or from some other agency. What matters is that I have rights which bond-holders do not have. The debate about risk/capital/reward has really become a bit surreal in this thread. What DOM is referring to is the Vox Pop and indeed Vox Prof and Vox Politic perception that senior bondholders are speculators who took a risk in the hope of enormous rewards. As DOM points out senior bondholders are even more risk averse than your average widow and orphans. And the massive rewards were non existent, any pick up in yield over sovereign was extremely modest and entirely explicable by a liquidity spread. @ christy ‘But the fact remains that allowing banks to benefit from implicit guarantees was and is ill advised and to an extent the language used to describe this funding is part of the problem’ + 1. If the arrangement were to be described accurately, it would be perceived for what it is, namely a systematic subsidy to wealthy individuals and corporations in the private sector. A reward for providing the appearance of risk taking without actually taking the risk. Nice work if you can get it. @BW2 “The debate about risk/capital/reward has really become a bit surreal in this thread. What DOM is referring to is the Vox Pop and indeed Vox Prof and Vox Politic perception that senior bondholders are speculators who took a risk in the hope of enormous rewards. As DOM points out senior bondholders are even more risk averse than your average widow and orphans. And the massive rewards were non existent, any pick up in yield over sovereign was extremely modest and entirely explicable by a liquidity spread.” You’re setting up a straw man there It makes no difference! Why should the public purse pick up the tab for their losses just because they were risk adverse but poor judges of risk. The only reason we should pick up the tab for their losses is if it is in our interest to do so the argument as to whether they are deserving of a bailout is nonsensical. Private creditors of a private institution bear the cost of losses at that institution irrespective of whether they are young or old, rich or poor. It is not the state’s role to bail out losers in private institutions. If they have a legal remedy against the state for its failure to meet its obligations through inadequate regulation let them pursue it. Whether or not they knew or wanted to take big risks is just not relevant. @ Christy I agree that the “moral” arguments are somewhat irrelevant to deciding the correct strategy. In a sense, even in normal times, we should always ask the question (in private of course) “Hey what if we just said stuff the National Debt we just ain’t paying”. Normally the utilitarian (i.e. amoral) balance would be against such a stance. These are not normal times and so the answer isn’t quite that clear cut. But DOM was challenging the “moral” consensus that these guys are foreign speculators who deserve everything that is coming to them. That is a valid challenge though I agree it does not follow immediately that ergo bondholders losing out is wrong. @ Kevin “That’s a far cry from saying that they are legally in the same boat as bond-holders” Kevin, you seem keen to mix up lots of different laws and issues into the same argument. Its cuts a confusing feel. We’re talking about the issue of where they sit in a capital strucuture, not whether you have a better chance of getting your money back via an alternative route. Buying CDS doesn’t change the legal position of your bond vis-a-vis the debtor bank, but they obviously safeguard your ability to get your money back. Ditto the position of depositors in terms the government guarantee. If nothing else this means that bank losses must be spread across all senior creditors at the same time, and then any losses for depositors made whole by the government. An comparable argument you, per your logic, would make, is that because ethnic minorities have additional statutory safeguards in place to prevent discrimination, they are therefore legally different to the rest of the population. They are not, they are equal, legally, under the law, in the same way that senior debt is equal under the law to depositors in the capital structure of a bank. Additional safeguards do not make you legally different, they simply grant you safeguards which are applicable under different statutes and laws. Eoin: We’re talking about the issue of where they sit in a capital strucuture, not whether you have a better chance of getting your money back via an alternative route. Maybe that’s what you’re talking about, but DOM is talking about the psychology of investors: Far from being the reckless high risk/high reward speculators characterised in various dispatches, senior bondholders are the most risk-averse of species. They are placed alongside rank and file depositors at the very top of the creditor pecking order, where return of capital rather than return on capital is the absolute byword. Senior bondholders are not as risk-averse as rank-and-file depositors. We know this because they take a significantly greater risk. Even if they buy only bonds issued by a reputable bank, they know that banks don’t always deserve their reputation. If they get bad news regarding the bank, depositors have two advantages over bondholders: (1) they can take their money and run, while at best the bondholders can only sell at a loss; and (2) the depositors can comfort themselves that while they may rank equally with the bondholders in a liquidation, they have a guarantee. You know this of course. Donal O’Mahoney knows it too. I think we both know what he’s playing at. @ Kevin “Senior bondholders are not as risk-averse as rank-and-file depositors. We know this because they take a significantly greater risk.” Well, the other way to consider this is that bondholders are more AT risk, so as such they will invest in a more risk averse manner. By your logic, depositors could invest in Bonkers Bank LLC tomorrow, safe in the knowledge that if things go bad, they can just withdraw their deposit in the morning, or wait for the government guarantee to kick in. As i said above, bondholders invest in bonds over deposits generally because they are, theoretically and for accounting and regulatory reasons, more liquid. Term deposits, legally, are not repayable on demand, though for practical purposes they usually are. Bonds can always, in theory, be sold into the market and converted into cash. So its the risk averse nature of bondholders and their eagerness to always legally, and in terms of regulatory reporting, be able to liquidate their holdings to cash, that they invest in bonds. Comments are closed.