If there was ever a case to just sit back and watch, this is it. Let me explain…
Fed head Powell made it very clear on Tuesday and Wednesday that he was going to hike rates “faster, and higher, and longer” than Wall Street wanted. When the bell rang Wednesday afternoon to close the market show, I was convinced he was going to give us a 50 basis point rate hike in less than two weeks.
But then Thursday we started hearing about some big trouble at the Silicon Valley bank, and the stock was getting slaughtered. Like falling 50% and then some. The problem seemed to be that they were sort of experiencing a run on their bank, after there was some questions about their liquidity situation.
Friday morning we got hit with two things. First the jobs report hit and it was sort of mixed, giving a couple different signals. Now first off realize that NONE of the official numbers are real. None. There’s so many hands in the cookie jar, and so many adjustments, no one knows how much fudging the other guy has done. So all we can do is go by the official baloney. Well they say 311,000 jobs were created.
In a normal world, more jobs would be great. But in a Wall Street driven, fed fearing world, more jobs than expected is bad. Yes the supposed unemployment rate moved up a bit, but then so did Labor participation, so it was sort of a wash. The bottom line was that the jobs number did nothing to convince me that Powell wouldn’t be doing a 50 basis point hike on the 22nd.
But then more and more word came hitting the wires concerning Silicon Valley Bank, and the big questions started. Did Powell’s rapid rate hikes “break” the debt/bond market? Were other banks in trouble? Were past hikes finally catching up and crashing things?
Then the news hit that the bank had been shut down by the California banking regulators and the FDIC was going to be in control of things. That sent panic waves across the market and the stock indexes were whipping around like a loose water hose. For instance at one point the DOW was green by 50 points, and not long after it was red by 400.
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.