By Dave Allen for Discount Gold & Silver
Another bank down. How many more to go?
Last week, it was Silicon Valley and Signature Banks down, with an almost-gone to First Republic.
And now, too big to fail Credit Suisse almost failed this past weekend. Instead, fellow Swiss bank UBS is buying its former rival for negative $14 billion. Say what?
Yes, UBS is paying $3.2 billion to Credit Suisse shareholders, but only because Swiss banking regulators are eliminating $17.2 billion of the bank’s liabilities, leaving its bondholders with nothing but worthless paper.
Global regulators have determined that 30 megabanks – Global Systemically Important Banks, as they’re known – are too big to fail.
You know the usual suspects – Citibank, JPMorgan Chase, Barclay’s, Deutsche, UBS and the like.
Because of their designation as G-SIB, they operate under stricter capital standards and regulatory scrutiny than their smaller peers.
Nevertheless, with Credit Suisse propped up as Exhibit #1, they can still end up being worth a negative amount of money.
Emily Peck and Matt Phillips write today that in the normal world of mergers and acquisitions, that wouldn’t be possible.
“Bondholders are senior to shareholders, meaning that they get paid first, and only once they’re paid out in full do shareholders get anything.
“In the real world of rescuing a too-big-to-fail bank, however, such niceties can end up being sacrificed for the sake of managing to get a deal done.”
Wow! Turns out that senior UBS management and its major shareholders didn’t particularly want to buy Credit Suisse, while Credit Suisse management and shareholders reportedly didn’t want to be caught holding an empty bag.
It’s unlikely this deal would have gotten shareholder approval – from either side – which is one reason why Swiss authorities changed the law to permit the deal.
The interests of international financial stability ended up overriding the interests of shareholders. Justice prevails, right? Well, kinda or something like that.
Swiss regulators sort of forced the two banks together, threw Credit Suisse shareholders a $3.2 billion bone, and zeroed out a bunch of junior contingent convertible bonds that are supposed to convert into equity when a bank gets into trouble.
Credit Suisse shareholders ended up losing about $17 billion in equity value over the past year. At that point, Peck and Phillips point out, there wasn’t another $17 billion left to lose, “so the next tier up had to take a hit.”
In the interests of expedience, it was easier to just zero out the convertible bonds and leave shareholders with $3.2 billion than it would have been to convert them to equity and then pay them out at pennies on the dollar.
Apparently, just finding a conversion price would have been incredibly a big burden.
Bank balance sheets comprise one pile of assets offsetting another pile of liabilities. Shareholders only own the slice in between, which in the case of Credit Suisse was nothing.
When a bank is failing, they generally have no say in what happens to it. The convertible bondholders have more reason to feel betrayed. But they were going to lose most of their money anyway — and besides, convertible bonds are supposed to behave like equity in a crisis.
In that sense, it shouldn’t come as a complete surprise that they’ve been wiped out to keep Credit Suisse alive – or now embedded as part of a new UBS.
Meanwhile…
While this was going on, the world’s leading central banks jointly announced new action intended to keep U.S. dollars flowing through the global banking system – returning to a tool used in past financial crises.
Neil Irwin reports that the Federal Reserve, the European Central Bank, Bank of England, Bank of Canada, Bank of Japan, and Swiss National Bank, all spent their Sunday evenings trying to make dollar swap lines more readily available.
As Irwin points out, in stressful financial times, much like these, banks around the globe often are more reluctant to lend dollars to each other, creating additional tightening of global credit.
Swap lines, which were used extensively during the Great Recession and again in the early days of the pandemic in 2020, allow overseas central banks to access dollars directly from the Fed.
Then, in turn, they make dollar loans to their own domestic banks. The Fed essentially becomes a global lender of last resort.
Notably, these swap lines are now part of a standing liquidity arrangement between the Fed and major foreign central banks.
But last night’s announcement is aimed at increasing the lines’ effectiveness by making the liquidity available daily instead of weekly.
The move comes after UBS took over Credit Suisse with substantial financial guarantees from the Swiss government and its central bank earlier yesterday.
Irwin says it’s a sure sign of the severity of the risk that global central banks see from the growing strains in the global banking system since Silicon Valley Bank imploded nine days ago.
Which Brings Us to the “Guarantee”
Under federal law, the FDIC guarantees customers’ bank deposits up to $250,000.
Emily Peck says it’s a figure most of us weren’t thinking about until ten days ago, when regulators guaranteed all customer deposits at two failed banks – even those above a quarter-million dollars.
Now, the water cooler talk (or the kitchen table, for those remote workers) is debating whether the FDIC limit, which hasn’t been raised since 2008, needs to be increased or abolished altogether.
Over the weekend, four different members of congress said they’d consider raising the limit.
Separately, a coalition of midsize banks is asking the FDIC to insure all deposits for at least two years
Regulators ruffled some feathers when they recently decided to protect all depositors at Silicon Valley Bank and Signature Bank, aiming to stem a serious risk to the financial system.
Peck argues that on one hand, their actions sent the message that if you deposit more than $250,000 at an important-enough bank, it’s safe.
On the other hand, she points out, no one has actually said that; i.e., the limit still exists and uninsured deposits are still technically uninsured.
Perhaps more importantly, Peck says it’s unclear what makes a bank important enough.
As she points out, First Republic Bank, SVB’s similarly sized peer, continued to experience withdrawals of uninsured deposits after SVB’s rescue.
So, what are we left with, other than a lot of confusion? “At this point, the $250,000 cap is illusory,” write Lev Menand and Morgan Ricks in a piece for the Washington Post. They argue that the limit should be scrapped.
Otherwise, they add, the official cap remaining in place means that “much of the nation’s money is unsound and unstable — an ever-present sword of Damocles hanging over the U.S. economy.”
Happy first day of Spring! Do you know the status of your bank’s balance sheet?