Sometime between attending the high school graduation party for the son of one of my high school classmates, and waiting for the temperature to drop a little so I might mow the lawn in comfort, I spent an hour reading more about this weekend’s Spanish bank bailout.
But before I comment on that… I have to say that, in the event gray hair doesn’t make one conscious of his age, attending a graduation party for the offspring of a peer will remedy that in short order! That, and finding out, at that same party, that Bruce Springsteen signed his initial recording contract 40 years ago this week.
I tried to rationalize my feelings by recalling a line from a song by Jethro Tull: “You’re never too old to rock and roll.” Then someone pointed out that the song was released 36 years ago.
Back to Spain. In the hour I had allotted to reading, I read a piece by DeutcheBank detailing how the Spanish bailout would work within the framework of the existing Euro-zone treaties. I also read an analysis of the weekend’s events written by Bruce Krasting. Finally, I hopped over to Bloomberg to look at the equity market futures and the EUR/USD exchange rates. What follows are my observations in no particular order:
- As of this writing, the Euro has strengthened by 1.02% over the USD. Forex seems to think the bailout has legs.
- US stock futures (DJIA) were up 141 points. The bulls are back.
- The Nikkei Index is trading up 60 points while Singapore has thus far added 38 points to its index.
- Other markets have yet to open.
All-in-all, the weekend’s developments have brought back evidence of the “animal spirits.”
I hope the rally truly has legs and the bailout is a meaningful step towards removing the Sword of Damocles that has hung over the market’s head for the past 5 years. But here’s the problem. It’s not a bailout. Having read the documents (the DB doc in particular since it referenced this term twice), what is occurring is known as a bail-in. A bail-in! Sounds nice.
The thing about a bail-in, is that it really is (as is known in bankruptcy parlance) a cramdown. I mean, if someone came up to me and asked if I’d rather be “bailed-in” or “crammed down, ” my gut would say “Bail me in!”
But they are one in the same. And this is where the Krasting article makes its finest point.
In a bail-in (or cramdown), positions in the capital structure that had previously been senior get “crammed down” into subordinate positions. Spanish bank loans that were subordinate only to the actual depositor’s money will likely be moved to the third position, as the bailout loans take the second spot – essentially cramming down the senior loan holders. Sorry, I mean bailing them in.
On the surface, that sounds dandy. The bondholders knew the risks when they bought the bonds, so knocking them down a notch in the capital structure is fair and just.
If you wanted to be fair and just, the entire capital structure all the way up to, but not including, depositor accounts should be wiped out until the bank has adequate capital. That’s a different argument to be made another time.
But we live in a world of unintended consequences. We presently have the luxury of witnessing these consequences much more frequently, since governments can’t seem to take their hands of the knobs for even a second.
My reticence about this bail-in, is that senior bank loan holders in other countries (like Italy, France, and maybe even Germany) might decide that it’s too risky to hold these loans. Should things go poorly in those countries, might they be bailed-in too? Could fear of this (unintended consequence) create mass liquidation of senior loans in Europe, akin to those we saw in the US in 1998 (you could buy $1 worth of senior floating bank debt for about $0.50 at the time)?
If I were long the senior loans of banks in the above-mentioned countries, it would certainly give me something to consider.
But… I’m not long those loans, and it looks like it’s time to cut some grass.
This has been my 3rd blog in as many days, and I thank you for your indulgence. I find living in this period of history to be fascinating. And I enjoy sharing that enthusiasm via the blog. What strikes me as funny, though, is through all the troubling big-picture discussions, there are still parties where we celebrate fine young men graduating from high school. And weed-riddled grass that needs to be mowed. It’s that small-picture stuff that makes life so enjoyable.
Whether or not some Spanish bank is getting bailed-in.