Sunday, Jan 31, 2010
What banks are cooking up for us…
Greg Pytel: Davos 2010: a "cunning" plan how we will all pay for "the largest heist in history"
Bail-outs did not work. Quantitative easing did not work either and extending it looks controversial. Time for “debt to equity conversion”. Pytel explains what that would mean in practice.
Posted by ant @ 11:25 AM (2003 views) Add Comment
20 Comments
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1. icarus said...
What's the difference between an 'individual depositor' (with government guarantees) and 'depositors' (who will have to accept shares instead of cash)?
2. drewster said...
It's not a new idea, at all. As Greg points out Roubini mentioned it nearly a year ago. A quick internet search for "debt-to-equity swaps" will uncover a world of discussion on the topic.
Fundamentally, debt is problematic because of its black-or-white nature. A borrower is either able to pay interest on time, or unable (in default) - there is no middle ground. By contrast equity is far more flexible than debt. The world needs less debt and more equity, in my humble opinion. Unfortunately debt has tax advantages compared to equity, hence its enduring appeal.
3. techieman said...
For an explanation of this see
http://www.youtube.com/watch?v=6uB1eWJz9jI
But the question is why would anyone vote for this? Unless 1. They were forced to (eg by Government) 2. Things got so dire that they had to.
Mark W loves this stuff but i have always been sceptical. In effect this may be a death spiral because some loans (bonds) are collateral for other loans elsewhere. Do you keep on swapping debt for equity or is it a one off??? Dilution of the equity - as the video shows is another topic.
Smugdog - the video might help you understand what gearing is ;-).
Mark?
4. icarus said...
Another problem with debt-for-equity is the difficulty of issuing new bonds if the would-be buyers suspect they too may have to accept equity instead of their money back.
5. techieman said...
"The world needs less debt and more equity, in my humble opinion". - you have to qualify that a bit, well quite a lot. There is a difference between loans / overdrafts / bonds in terms of debt. Bonds are included in many portfolios and pension funds because of their relative safety, in terms of payout priority should the unthinkable happen. Bond-holders will be reluctant to swap for the very reason you say... unless they have to.
6. ant said...
@icarus:
I presume that the difference between 'individual depositor' (with government guarantees) and just 'depositors is that the former one like individuals enjoy government guarnatees (at least in the UK up to £50,000), the latter are simply the ones that are not covered by such a guarantee (for example higher amounts and institutions). A fate of some British councils suffering from Iclandic banks collapse is a good example (although as I understand the government eventually stepped in with som help, but it was not guaranteed).
Debt to equity conversion is not a new stuff. The difference is whether you are forced to accept equity rather than cash for the debt.
7. doahh said...
"Whilst it may not apply to individual depositors who have government guarantees (although this is also far from being certain as it is not known how the system may be developed in the future), in practice it would mean that a depositor or a creditor may receive in return a bunch of bank's shares having demanded a payment in cash"
So, Joe Soap with £100 in his account may one day go to a cash machine to get money to buy his dinner and end up with a band spanking new share certificate instead? This may be a sensationalist view but that is how I am reading it from the information in that article. I must have the wrong end of the stick surely?
8. ant said...
@drewster: "The world needs less debt and more equity, in my humble opinion." Could you clarify who is going to control "equity" so minority holders are not diluted (i.e. robbed)?
9. ant said...
@doahh: you may be correct in your sensationalist view. (Although I think there is an element of technical simplification in a Pytel's article). Mind you if Pytel (or whoever) wrote two years ago that goevrnments would be rescuing banks with trillions of dollars that would have been even more sensationalist. So it is worthwhile to keep this in mind.
10. drewster said...
techie @ 5 - "Bonds are included in many portfolios and pension funds because of their relative safety, in terms of payout priority should the unthinkable happen."
Bonds aren't the only option. For a business, shares can be issued in different classes with different categories; e.g. cat A could have payment priority over cat B in the event of collapse.
It gets murkier with government bonds. Governments don't issue equity, only debt. In the U.S. interest payments on government debt amount to nearly 10% of government spending; of which half goes to foreign lenders. Can you imagine if Britain were to sell a 5% (and rising) share of its tax revenues to foreign investors?
(LVTers might argue that owning land in the UK amounts to the same thing as owning equity in a country.)
@ant,
My point about more equity / less debt is more relevant to the business world. I don't know how it would play out for individuals. In theory equity holders should have voting rights in the business, but in practice that's not always feasible. It's easier if the bank is a local operation rather than a global megabank.
In particular I was referring to so-called private equity, whereby a group of individuals borrow huge amounts of money to buy up companies. At a stroke, the company's volatile equity is transformed into non-volatile debt, capable of churning out stable returns year after year. As we've seen from the collapse and restructuring of many such deals, they don't work out well.
@Doahh,
I think you're more-or-less right. If a d4e swap happens, it will be announced as a sudden overnight decision, most likely at a weekend. Any person (or business, charity, local authority, NHS trust) with more than £50,000 in their account finds e.g. 20% of their cash turned into bank shares.
11. markj69 str05 said...
@drewster... 'Any person (or business, charity, local authority, NHS trust) with more than £50,000 in their account finds e.g. 20% of their cash turned into bank shares.'
Surely this is illegal? When I deposit my 'hard earn't' into a bank or savings account, I expect it to be 'no risk', and (when set up as such), instantly accessible.
12. drewster said...
markj69,
If your money in the bank is no-risk, why were savers queueing up outside Northern Rock branches in September 2007 ?
Just because the government was able to bail it out that time, doesn't mean it will always be able to.
13. stillthinking said...
In our case though, the UK government bought shares as well as pumping money in the banks, so share dilution would also wipe out the governments investment. Which looks very similar to taxpayer again, because what is the difference between the government providing a loan that they don't get back, as opposed to buying shares that then lose all their value. Just different methods that both end up with an equivalent loss, and both represent the taxpayer making goods the losses of the banks. Back to square one.
Or on techiemans link about capital structure, the government is at the front and the back of the plane, and is 70% or whatever of the passengers, so surely it doesn't make any difference where they sit. So presumably this is a just an emergency plan which allows the sharing of losses between the 50K+ deposit holders and taxpayers.
14. stillthinking said...
Also, one more thing, although Pytel looks at this with an admirable sympathy for the middle class noble savers, who have diligently paid into their pension funds, I think the reality is different. His idea is that wealth that existed in 2007 will be taken, but I don't see it like that at all. There was no wealth in 2007, it was all smoke and mirrors. What is happening is a belated discovery of our true position.
These savers have spent the last decade constructing a huge turd hotdog company, and they have diligently squirrelled away their shares to provide for their future. But -the company is no good-(UK economy)... they wasted their time and in reality their work and their savings are of no value. This is different from ripping off IMO.
15. greenshootsandleaves said...
doahh @ 7(12.14 pm): 'So, Joe Soap with £100 in his account may one day go to a cash machine to get money to buy his dinner and end up with a band spanking new share certificate instead?'
Does this not remind anyone of Milo Minderbinder's certificates in M&M Enterprises in Joseph Heller's Catch-22?
16. mander said...
It takes a lot of guts for Mr. Pytel to talk against the trillions that people at Davos have created.
17. icarus said...
greenshoots 15. Milo M said anything good for business was pro-American, including bombing American bases. He'd have been at home on Wall Street.
18. Carol said...
I don't think even the most idiotic would consider "debt" to equity swaps for depositors. Do it at one bank, and you will cause a run on every other bank in the country (probably several countries). Try to do it at all banks, and you'll have riots.
In fact, just considering this possibility has made me decide to hold even more cash than I'm holding already (which is substantially more than I was two years ago).
19. techieman said...
Drewster - "Bonds aren't the only option. For a business, shares can be issued in different classes with different categories; e.g. cat A could have payment priority over cat B in the event of collapse." true, i was trying to simplify it. Yes there could be preference shares and convertibles, both of which blur the edges, and other types of security.
However at the end of the day, the debt for equity would be exactly that, and preference shares would be swapped for common stock and convertibles would erm be forced to convert rather than having the option to convert.
As for STs comment "Or on techiemans link about capital structure, the government is at the front and the back of the plane, and is 70% or whatever of the passengers, so surely it doesn't make any difference where they sit". I would agree - the video i posted was to explain the concept. To where we are how would the government divest itself of the shares? No - its already made the choice so i would agree the argument is a little academic. However if we have more problems like before then what happens to the rest of the banks debts?
I think Flashman says they go into the market and place a rights issue.... or three.... (and by differentiating between some banks and others he may be right) but that assumes they are able to place a rights issue into the market....that aint necessarily so!
20. mark wadsworth said...
@ Techie, debt-for-equity swaps sort out most of the few economic problems that Land Value Tax won't.
Whatever problems are left over after we've replaced all existing taxes with land value tax; and sorted out banks and over-leveraged businesses/mortgage borrowers with debt-for-equity swaps* will either be ameliorated by Citizen's Income or be quite simply insoluble, and hence not worth worrying about.
* In the case of a borrower in nequity, what d-for-e means is "hand over the title deeds to the bank". In the case of banks, it means that bonds get coverted to equity and shareholders get wiped out. In the case of "private equity" firms it means that the lenders take over from the shareholders, and so on. It can mean different things in different contexts. It just means 'letting the markets take their course', really.
D-for-e is what happens in the absence of taxpayer bailouts and government guarantees, and anything must be better than letting the taxpayer pick up the tab or trying to inflate the problem away.
And of course there are limits to this - if the government has said that individual deposits of up to £50,000 are guaranteed so be it, that just means that bondholders get hit slightly harder to the benefit of depositors.
But there again, I always like to look at both sides of the equation, most politicians just look at one side of it - but they are the b*ggers getting elected, and not me.