Mrs. Johnson cuts straight to the heart of the problem in the financial markets when she observes
But the reality is that the Santander deal is emblematic of a much wider – and in my view permanent – disruption to fixed income markets.
Banks are now clients of state. States own bank equity and banks own state debt. Banks depend on the state, by way of monetary authorities, for their liquidity.
What has developed is an intense, introverted, inter-dependent patron-client relationship. States and banks have become equivalent, and equally distressed.
For bond investors, the outcome is brutal. Santander is not alone. Other banks are also keen to make their bond-holders offers they can’t refuse. It is being called by the euphemism ‘liability management’ but in essence it is a form of default.
The rules that once applied are no longer relevant. Once the state is involved regulation can be re-written, as can the law. Where politics is concerned, etiquette is soon brushed aside....
The conclusion should not be hard to draw, though it is quite different to the one we are used to hearing. Neither governments nor banks are capable of providing a safe-haven in the challenging times we face. They are not the solution. They are the problem.
Over the last several months, this blog has documented how the relationship between banks, regulators and sovereigns has perpetuated the financial crisis to the detriment of investors and society.
I know I have said this before, but requiring the banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details is the only way to solve the problems created by the relationship between banks, regulators and sovereigns.
Ultra transparency ends, at a minimum:
- regulators hiding a bank's condition from the market while they try to stabilize the bank (think extend and pretend). Instead, it substitutes market discipline with the idea being to prevent the bank from becoming a problem in the first place;
- the focus on meaningless, highly manipulated bank book capital. Instead, it substitutes the combination of a bank's solvency (the market value of its assets less the book value of its liabilities) with the reality that so long as depositors trust in the guarantee of their deposits, they will keep their money in the bank regardless of its solvency. With this combination, banks can spend the next several years retaining earnings to restore their solvency; and
- regulators, and by extension sovereigns, incurring the moral obligation to bailout investors when the regulators announce that a bank has passed a stress test. Instead, investors know that they are responsible for all gains and losses which gives them the incentive to assess the risk of each bank independently using the data disclosed under ultra transparency.