Topsy-turvy bank rescues bring a whole new area of risk

Banking authorities on both sides of the pond are being commended for learning from the great financial crisis of 2007-2009.

Rather than letting troubled institutions go bankrupt – as was the case when Lehman Brothers went under in September 2008 – they have acted to keep them afloat by arranging mergers with more solid rivals and by making it easier for banks in the US. make it easier to exchange loss-making assets for Federal Reserve money.

Such measures are designed to contain the unprecedented shock waves pulsing through the global banking system as investment funds, other banks and ordinary savers seek safer havens.

That goes against some moves by the Financial Stability Board, which was created after the collapse 15 years ago.

The rules, passed by state regulators, were designed to prevent the same thing from happening again, putting taxpayers’ money at risk.

One of the much-discussed reforms was that no bank should be ‘too big to fail’. Endless discussions took place about creating so-called ‘living wills’ so that when the next major bank got into trouble, it could be run down in an orderly manner without disrupting the apple cart.

Moreover, if something goes wrong, it is mainly the shareholders who are in the line of fire.

None of this seems to have happened. Instead, central banks have made frantic weekend efforts to prop up floundering institutions rather than have shareholders and bosses pay a heavy price.

In Switzerland, the Swiss National Bank, which had failed to stabilize Credit Suisse with large cash injections, finally decided that the only solution was a merger with its rival UBS.

In the end, it could prove to be a big payday for UBS, though it can never be sure of what it’s buying until it’s been under the hood.

Similar acquisitions were orchestrated in 2008 when Lloyds acquired HBOS and JP Morgan in the US bought first Bear Stearns and later Washington Mutual.

Technically, such aided deals — and others being orchestrated for Signature and First Republic in the US — preclude the need to invoke an advance directive.

But that’s not the full picture. In America, the agreement of Treasury Secretary Janet Yellen and Jay Powell of the Fed to offer to trade underwater assets for cash is effectively a bailout.

The Fed may be independent, but the money belongs to the taxpayers. The same goes for the Swiss National Bank’s initial reaction to Credit Suisse’s problems.

A huge idiosyncrasy is the treatment of what are technically called Additional Tier 1 (AT1) or Coco bonds created after the financial crisis to bridge capital shortfalls.

Such bonds have provided better returns than traditional securities and have therefore been attractive to fund managers.

The theory was that such bonds would convert to equity in the event of trouble, creating a better capital buffer.

That did not happen in Zurich. Under Credit Suisse’s UBS bailout, existing shareholders will get massively devalued shares in the expanded institution and wipe out the roughly £14bn worth of Cocos, or additional bonds.

This has led to consternation at the European Central Bank and anger among Coco investors, who are threatening legal action. It led the Bank of England to point out that this form of instrument is behind core equity.

The way the UBS bailout is structured has added a whole new area of ​​risk to the financial system. Rather than coordinated, predictable actions by regulators, it was first a case of national concern.

Sparring partners

How fast things change. In a recent conversation, John Lewis chairman Sharon White sounded confident that despite last year’s loss of £1.5bn in liquidity, the department store and supermarket conglomerate had all the means to do what it wants.

It had signed a £500 million deal with Abrdn to build houses on retail sites in Bromley and Ealing, and there wasn’t even a hint that the reciprocity would end.

Before getting into anything, White must remember the horrors that befell building societies that sacrificed reciprocity, the collapse at the Co-op Bank, and the humiliation at LV when it tried to sell itself to private equity.

There can be a middle ground by, for example, releasing pension fund funds. But the partners should be careful about what they wish for.