Thursday, 23 June 2011

Protect the Bondholders?

The latest twists and turns in the Greek bailout fiasco have combined with a disturbing insight into FSA attitudes here in the UK to make me concerned that the system may now be distorted beyond peaceful reform. In fact, the danger of harmful destabilisation may be much worse because supervisor actions reinforce poor outcomes.

I am told that the primary objective of the ECB in Greece and the FSA in the UK is the same: Protect the bondholders.

Perhaps I am naive, but I did not realise that the FSA saw this as its primary mission until someone at the FSA bluntly told me so and someone in the markets confirmed it independently as only just and proper that this should be so.

If protecting bondholders from bad debt really is the primary objective of the supervisors, then the supervisors have become the problem. Capitalism does not work when capitalists are shielded from the economic risks that they freely undertake for profit when they enter into private contracts for debt finance. If bondholders know that they can get the ECB and the FSA to tilt the field in their direction, they have no incentive to balance yield against risk. They should just go for yield wherever they find it, and trust the ECB and FSA to ensure that they get their money whatever happens to the company, the depositor, the employee or the taxpayer who foots the ultimate bill for their yield.

If the objective of current official interaction with the markets is to prevent market determined outcomes, then we are in for a very ugly period of instability. The market is going to force a market outcome. The officials standing in the way can influence who profits from the market clearing, but the market is going to clear. If the officials have decided that the bondholders always win, then the rest of us will always lose. And once the rest of us - the companies, depositors, employees and taxpayers - remember that we have political power, then we will change the system.

This is what we are seeing in Greece on the streets. The Greek people have realised that the government works for the bondholders; the ECB works for the bondholders; the IMF works for the bondholders. They now understand what was not clear before: No one works for the people.

Strangely, this is also the realisation taking hold in Germany too. People are waking up to the fact that their national economic self-interest is subordinate to the claims of the bondholders. The German government's priority is to protect the bondholders. Germans should know better than most that stuffing the bondholders is sometimes the best policy - having defaulted three times in the last century to lay the ground in each case for economic resurgence.

What scares me is that I naively believed the UK was different. I believed that the FSA was a market regulator that understood market operations. I am now under no such illusion. They have told me their job is to protect the bondholders. If that is true, then the UK is no different than Greece, just slightly behind Greece on the arc of history.

It used to be that the role of the state in financial market regulation was to ensure efficient market operations, promote transparency of prices and liquidity, protect consumers from abusive practices, and to resolve failed companies according to principles of equitable distribution of assets among like classes of creditors. If the role of the state now is to shield HFT, dark pool and OTC markets from transparency, provide liquidity where the market fails, oversee the orderly fleecing of consumers, and to ensure that some creditors of failing firms always win while others always lose, then we no longer have a market economy. And as virtually all these regulatory policies have evolved in the absence of public debate and legislative scrutiny, we also no longer have democratic governance of markets.

Perhaps this is what tiny Iceland realised when it determined that it would default rather than protect the bondholders. Perhaps in a small country in a big ocean it is easier to perceive a common interest in economic and political adaptation to protect the future of your children and your neighbours, rejecting the claims of the faceless, pitiless and stateless bondholders.

I suddenly have a lot more sympathy for the Greek people than I did a fortnight ago. Come the revolution here, I may be in the streets too.

Some will say that the Greeks are hard line communists pining for generous state benefits and pensions they haven't earned. Maybe so. But there is more economic justice in such a system with such objectives determined in a democratic process than in any system with a secret primary imperative to Protect the Bondholders.

The FSA is being broken up as institutional punishment for its many failings in the run up to the financial crisis. I was skeptical of breaking the FSA along prudential supervision and consumer protection lines, but now think that may be a good thing. It may draw a sharp distinction between maintaining resilient banks and tilting the playing field toward institutional players like bondholders. A consumer protection authority will have a more direct interest in countering the Protect the Bondholders mindset where it robs the consumers or risks the taxpayers to achieve its ends.

As many long time readers know, I try to remain optimistic. There is hard work to be done, but the ground is fertile for those who will make the effort to seed and nurture the reforms required. The Vickers/Indepdendent Commission on Banking review and various efforts by HM Treasury and the Bank of England are all moving in the right direction: toward getting the state out of private financial transactions except as regards the setting and enforcing of reasonable rules. Hopefully they will succeed and the bondholder bias will be curbed with the break up of the FSA and long before we Britons hit the streets under the weight of an unsustainable debt.


zeeteekiwi said...

> Come the revolution here, I may be in the streets too.

Be careful what you wish for. The crowds might decide that hanging the bankers by their ties is an appropriate thing to do.

David Merkel said...

As Psalm 37:21 says, "The wicked borrow and do not repay."

Who are you siding with?

Anonymous said...

Explain this to me, Merkel
Devil his self will quote scripture when it serves his purpose.
When I see the wickedness and corruption that has taken over my country,as well as my government,and "banksters"who see me as nothing but as krill ,is it not my right,IS IT NOT MY DUTY,to take whatever actions as a citizen I may need "Restore""law and order?."
London banker,
Sir,you have a very well defined sense of justice.The system is broken past fixing,as well you understand.
This "situation" will not end well,as,thanks to the net, and modern communications.Way,way too many of the "Citizens who pay attention",understand exactly how we got into this mess.And who is responsible
Good Luck sir.

Bee good,or
Bee Careful


Anonymous said...

This is an extremely important development, and you really need to report this to the mainstream media--or at least to a trade publication. If what you say is true (and I don't doubt it), the regulators are no longer working as regulators, but as brokers. The conflict of interest is obvious.

Would you be willing to tell us who told this to you or at least where this order came from, and if it is explicit? I wouldn't be surprised if this was stated somewhat vaguely on an internal memo from an executive somewhere, and I'd love more info.

Lee said...

We know this is self evidently true on a global basis from the behaviour of 'bailing out' Goldman Sachs by paying them 100cents in the dollar with their AIG bonds.

I'm guessing with the FSA they would put this under their remit of ensuring financial stability.

London Banker said...

@ seeteekiwi
I shall don a poncho for the march - possibly a waterproof one, depending on the weather.

@ Merkel
Perhaps it is wicked to borrow and not repay, but how much more wicked to turn to the state and have it rob the taxpayers to pay your debts instead of liquidating your assets to pay the creditors?

@ Snuffy - I am old enough to see dangers the young cannot, and content enough to take risks the young avoid, so careful is less important than vigilant.

@ Yhellothar - The context was conversational and I cannot say more.

@ Lee
I begin to think that "financial stablity" like "national security" masks a lot of activity that threatens the social fabric and principles of an open, market society.

Jo said...

London Banker

Great piece.

I sometimes wonder why any sov bond pays more than any other - given, as you've laid-out here, that there's no risk.

Keep up the good work and ignore the regime thugs.

Anonymous said...

@ LB

Maybe I am just naiv but:

ECB et al. are not protecting the bondholders, they try to maintain stability.

And as long as european politicians do not realize, that an orderly restructuring of Greece requires an awful lot of money to prevent contagion and to recapitalize banks, I don't see how this should work.

Paul said...

Of course they are. Welcome to 2008. If anyone was willing to let a bondholder take a haircut, this mess would have all been resolved 2 years ago.

macfly said...

Wonderful post and great follow ups too.

I also wish this was something discussed on a much broader platform, and my suspicious mind instantly wants to know...

Who are these regulators?
Why is their mandate to protect capitalists from the consequences of investing their capital?
Where did they work before the became regulators?
Are they being bribed? (ie: is someone funneling funds into Cayman Island or Swiss bank accounts for their futures?)

tv said...

No one put a gun to the head of the debt issuer to loan money.

Moral/Ethical/Societal Onus on the issuer.

Both feel pain. One loses alot of money, the other gets to experience sudden economic stop.

Everyone gets scathed.

Quoting scripture is cool. I wonder how David feels about the passages that involve stoning children.

Deuteronomy 21:18-21
New International Version (NIV)
A Rebellious Son

18 If someone has a stubborn and rebellious son who does not obey his father and mother and will not listen to them when they discipline him, 19 his father and mother shall take hold of him and bring him to the elders at the gate of his town. 20 They shall say to the elders, “This son of ours is stubborn and rebellious. He will not obey us. He is a glutton and a drunkard.” 21 Then all the men of his town are to stone him to death. You must purge the evil from among you.

Maybe we can compromise and stone certain portions of the banking sector and certain financial "regulators."

London Banker said...

@ All
I want to make very clear that I am not suggesting malfeasance or corruption at the FSA, ECB or anywhere else. These are good people - for the most part - who are struggling to do a difficult job well. The system is set up to self-reinforce the interests of those with the most assets and power, and that leaves the rest of us on the sidelines. It is the self-reinforcing dynamic of the system as it works in practice that is the problem, not the people in it.

For example, when regulations are put out for comment, it is the banks with the biggest compliance departments and most pricey lawyers who make the most compelling case for regulations that favour their narrow interest. They will almost always prefer regulations that create a competitive bias by imposing higher costs or complexity on smaller players. Over time, the system reinforces them, and freezes everyone else out. When their self-interest becomes parasitical, unbalanced and dangerous to the rest of the economy, there is no adequate representation or sophisticated player with sufficient interest to counter the threat and prevent harm.

Similarly, when there is a job opening, it will be most appealling to someone already established and experienced in the industry. He or she will find it difficult to resist the social pressure to accommodate what seems like reasonable pressure to relieve present pain that is easily measured at the cost of future, theoretical social gain that will always remain difficult to substantiate.

Especially in a crisis, when many regulators have been struggling to contain damage for three years, it will always be easier to go along with assurances from the bankers that "a little more time" will help them put their balance sheets in order and prepare for a default. Since the EU periphery has been on the verge of default for quite long enough now that everyone gets it, even China, that story seems a bit dog-earred. But if you are the regulator who will have to face the BBC or the Parliamentary inquiry or even resign in disgrace for any losses actually realised in black and red, maybe it might still be compelling to "extend and pretend" just a bit more.

Anonymous said...

London Banker,

You have just described what happens in virtually any regulatory entity,or organization.I suppose you could describe it as systemic entropy,as every "organism" grows old and ineffective...or loses focus to its founders intent,although many times the "regulatory body" agenda begins to be designed to prevent market forces from upsetting currently profitable enterprise.[I have watched it happen.]
I would imagine things will continue to get "papered over",and the kabuki dance will continue...until it cant.power and influence will be washed away by forces so powerful that they will shake the foundations of western civilization.
I believe we are heading into a phase-change that will fundamentally change the way our world works.This dramatic popular uprising starting in Greece might well be the "Lighting of the fuse"that signals the start of this phase-change.
I am not near wise enough to understand where it will lead,but the concentration of wealth to the degree that has occurred,and the manner in which it was done,as well as blatant "crony-capitalism"where the state decides who wins and who[the taxpayer] pays, strikes at the heart of the system.It destroys the fundamental belief that one lives under a rule of law.And that WILL destroy a system of governance.

I need to be productive[g]

Bee good,or
Bee careful


mohala said...

Not sure what the difference is between your post, that paints a pretty convincing picture of corruption, and your comment, that then denies that the supervisors have become corrupt. Sure they are good people doing a terribly difficult job, but does that preclude them from falling into the definition of corrupt?

Anonymous said...

Many people have known for several years that there's just too much debt.

Economic growth will not come. The factors of production are not in place.

If the FSA is subconsciously protecting bondholders, it must understand that the game is over in the medium-term. Maybe even in the short-term.

If the man on the street is able to perceive the above, why can't the FSA? Are they not competent enough?

Best wishes,

Accidental Ecologist

PeterJB said...

It is good to hear that you begin to see reality, so, in celebration I sought and deliver here some wise words from before yet:

"The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks."

John Dalberg Lord Acton

You see LB, there is nothing new going on here that hasn't gone on for almost 3 millennia, or so, which is course the symbiotic relationships between political, bureaucratic and banking "leadership" which is etched as human behaviour into written history; nothing.

It is not merely a probability that today's circumstances will lead to revolution and civil unrest, it now appears mandatory that the global system - demographically expressed - must destroy itself in order to purge the excesses of dishonest and corrupt policy and regulation that has been injected into Law, as heroin into the veins.

The problems are well known, to some, but the solution is neigh impossible without the experiences of the ultimate pain being shared amongst all and sundry; humility will be necessary for the next step.

Anonymous said...

I'm not an expert but I'm not sure what role the FSA has in the Greek sovereign debt crisis. Does the FSA hold Greek debt? Does it regulate international finance?

I can understand the ECB wanting to protect bondholders as it has a very large exposure itself. I have read that when Greece defaults, the ECB immediately becomes insolvent. Hence their actions may have nothing to do with protecting wicked capitalists and everything to do with saving their own skin.

Sure we have the democratic right to change the rules of international finance, but the financiers also have the right to exact heavy interest payments for their loans - if they lend at all. What would have happened if the UK government had not been able to sell £4.75bn of debt earlier this week?

Also I think that your analogy with Iceland is a little off. The Icelandic government did not default on its debts. Before the crisis its debt was under 30% of GDP and it was running a healthy budget surplus. Now its credit rating is just above junk, its currency and stock market have collapsed (along with the major banks) and it has had to appeal to the IMF, ECB and the Russian government for loans. A fine way to "...protect the future of your children and your neighbours...". And the losers may have been "...faceless, pitiless and stateless bondholders." but they were also local governments, police services etc. in the UK.

MarcoPolo said...

"There is hard work to be done, but the ground is fertile for those who will make the effort to seed and nurture the reforms required. The Vickers/Indepdendent Commission on Banking review and various efforts by HM Treasury and the Bank of England are all moving in the right direction..."

The heavy lifting is being done by Los Indignatos and in Syntagma Square. When Papandreou, for example, can change his government to produce his desired vote outcome, democracy is a sham. Still there are political limits to economic maneuver. As was shown in Argentina. Our question is, how does this end? I don't share your optimism.

Anonymous said...

Who are the bondholders and why need they be protected?

Sure, some are "rich" guys who need no sympathy re haircuts.

How many are aggregated "little" poeple?

Do we have a social system worth saving?

dearieme said...

It's the Blair-Brown bequest, innit?

My fear is that the Coalition government has not really appreciated the scale of the problem. In which case we're a' doomed, ah tell ye, doomed.

MegaSpeculator said...

The system will not reset until it has failed for various psychological and greed from the politicians and the citizenry alike.
Until then, work to improve your putting and short game and maybe, just MAYBE, if your lucky, you will die in your sleep peacefully.

Matt said...

And so it is across the globe and undoubtedly throughout the ages. widespread default is far too disruptive to be accepted, as it shows the flaws inherent in the system and by the actions of its operators.

We only forsake the economy for the monetary unit when it is politically expediant to do so. That is, when the debt is primarily owed to outside parties and there exists a general anymosity to those parties. Much better to debase the underlying unit and pretend that the system is functioning than allow default and prove otherwise. We're only human after all.

In a world of financial predation and expontntial debt, default is our last defense left against slavery.

Anonymous said...

Yep had this conversation at a dinner party last night, thanks LB

Matt, your last sentence is right on.


Harry said...

"Protect the bondholders.

Perhaps I am naive, but I did not realise that the FSA saw this as its primary mission until someone at the FSA bluntly told me so"

Can this be true? A group of UK retail bondholders has been trying to interest FSA in protecting them against what is in effect a fraudulent and, under English law, illegal tender by Bank of Ireland for some of its PIBS. We have been unable to get past a form letter from the august institution telling us to get lost. Could you please put us in touch with the person at FSA who told you that protecting bondholders is their mission?

here's a link to our last attempt to communicate with the FSA:

Juno Moneta said...

You have to have an exit strategy in any deal or scheme and I fear we are experiencing their exit strategy. At last count, we have had at least four monetary systems in the past 100 years and the ECB could lay claim as a fifth- a central bank without democratic control or sovereign treasury.

Bondholders are taking control of real assets at real prices and the Dutch plan for a Greek asset privatisation commission is a sign of things to come.

Unfortunately, I am not too optimistic we will see “blood in the streets”; too many are dependent upon the teat of government largesse.

And don’t forget Eastenders is on 86 times a week and, we can’t miss that.

Anonymous said...

what happens if Greek pension funds are among the largest holders of GGBs...??

Richard said...

I find it very interesting that the FSA would describe itself as protecting the bondholders. I would have thought "banks" might have been a more accurate descriptor.

Since your post, both David Cameron and Mervyn King have come out requesting that banks disclose their exposure (gross and net) to Greece as well as their exposure to other banks. This is the first chink in the armor of protect the banks.

Anonymous said...

You lost me when you veered off into a gratuitous shot at HFT and dark pools (btw, dark pools were invented to counter information leakage to HFT, they are the OPPOSITE of HFT. Unfortunately, they have the word "dark" in their name, so they sound evil, though not quite as evil as "naked access"). I'll bet you 5 pounds that HFT, in its entirety last year, made less than 1/20th of the profits of just one
TBTF bank's OTC trading profits at fat protected spreads. HFT has been a wonderful cover for the OTC markets during this crisis, deflecting attention from them. Speaking of market clearing events, if the Tobin tax is passed, it will generate exactly zero additional taxes from HFT, as the politicians discover that HFT margins per trade are about 5% of the proposed tax. Spreads will widen considerably, trading will be more expensive, market makers will get a windfall, HFT will disappear, Vanguard will lose the 40% reduction in trading costs they've been publicizing. HFT has become a pathetic innocent bystander, defenseless against the populist steamroller. There are going to be a lot of casualties as the market "clears". C'est la vie. But you, of all people, are capable of understanding what's really going on here.

Anonymous said...

All that you have summarized is true. But, the harsh reality is that the ability to protest will be growingly hampered in countries where they are most developed or "mature" (this is somewhat facetious). I have no doubt that if the greek protests were taking place in the US, the protesters would most likely be killed or severely injured by the police. This is why it is so crucial that this is first taking place in Europe where there is a tiny bit of citizenship rights left for those that are being affected the most... unfortunate, governments and congresses are useless representatives when they are called on to show their courage to stand up and represent the people they are supposed to be representing. The police is just part of the theater as they are also in cahoots with the government and congresses. Seeing these heads of sate standing and advocating democratic values and principles is abhorring...

nilys said...

Hey Merkel,

The full Psalm is:The wicked borrow and do not repay, but the righteous give generously. In King James translation it is: The wicked borroweth, and payeth not again: but the righteous sheweth mercy, and giveth.

How about this random selection:
Psalm 37:26:They are always generous and lend freely; their children will be blessed.
Psalm 112:5: Good will come to him who is generous and lends freely, who conducts his affairs with justice.
Proverd 21:26: All day long he craves for more, but the righteous give without sparing.
Mathew 6:12: And forgive us our debts, as we forgive our debtors.
Romans 13:8: Let no debt remain outstanding, except the continuing debt to love one another, for he who loves his fellowman has fulfilled the law.
Luke 6:34: And if you lend to those from whom you expect repayment, what credit is that to you? Even 'sinners' lend to 'sinners,' expecting to be repaid in full.

How about this one:

Ecclesiastes 5: There is another serious problem I have seen under the sun. Hoarding riches harms the saver. Money is put into risky investments that turn sour, and everything is lost. In the end, there is nothing left to pass on to one’s children. We all come to the end of our lives as naked and empty-handed as on the day we were born. We can’t take our riches with us.

So, who's side are you on?

scandia said...

@Nils and Merkel, Your preaching here is not helpful. Do you have a voice and thought of your own?

Anonymous said...

Ah, LB, it's great to see some fire returning.

I haven't got a login per the list, but I followed your posts avidly back when RGE was free.

I like your new site.



PeterJB said...

@ LB

Summary: the Banking system cannot and will not be reformed, a priori, until it burns and burns beyond the roots. It is predatory and sycophantic criminal organization that cannot lose as it has eliminated Risk through corrupt influences of captured "leadership".

Here is an interesting conversation for you to read, if you will:

My summary:

1. Usury is a rotten system - when put in the hands of lesser men -
as it invariably occurs.

2. Natural Bankers demands a Risk Free environment so he captures
political "leadership" and just tells them what to do

3. The political "leadership" are eager to do the bidding of Banks
as it allows them to appear elite and washed while warmly draped in
wealth and power.



1. Banks are given the privilege of being Commercial Private

2. Banks are given the privilege of being protected by Government
by all means even by the Military as well as receiving wealth as a
transfer from the people

3. Banks have the privilege of having Policy written for them so
suit the protection of their asset values as well as to increase
their asset accumulations.

4. Banks are privileged in all matters and are rated as a priority
to all other matters.

5. Usury centralizes wealth to a singularity or to the Banks, by
function and design.

6. Usury has been declared illegal many times and banned by Many
Nation States over the past ~3 millennium.

8. Banks, political "leadership" and bureaucracy is a sycophantic

9. Banks, political "leadership" and bureaucracy are a predator and
criminal organization.

10. Banks, political "leadership" and bureaucracy are also agents
of the socio-economic oxidization processes.

Summary: Banks cannot be reformed. Banks can only be closed".

And, the current Banking system must be shut down and replaced with a credit distribution system that does not centralizes wealth through debt.

This can easily be initiated by removing all the privileges granted to them through Policy and Access.

A good start but I am not holding my breathe.

Wolf in the WIlds said...

Thank you for an excellent post. If you don't mind, I have linked the post to my blog. I believe that without political and social awareness of the issues at hand today, change will be hard to come by.

Knute Rife said...

"Blessed are the bondholders?"

"Well, you can't take these things literally. He's obviously referring to any obscenely wealthy holder of excessively risky financial products."

Andy said...

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