BANK DEBT & THE MARKETS: AN IDEA

Are we too easily assuming that eurobanks and markets should be on different sides?

Yesterday (as ever) I was posting on the game being played between banks in Europe on the one hand, and the bond/investment markets on the other.

I have little doubt this thought has occurred to others as well, but I mention it anyway – if only because the dearth of creative ideas about fixing our problems is so boring (and painful) to watch.

When I was a young entrepreneur borrowing money, there were two ways you could do it: from a  retail banker with your house on the line – or from an investment/private equity source – unsecured, but in return for stock. I always chose the latter, because I figured my family was more important than an entity ending in ‘Limited’.

The trick (I found) was to beat the Knight down to lowest possible equity stake at the start….and then if and when more investment was needed, give away a bit more stock  in return for it. I did this twice – the first time, poor old 3i lost the lot, and I lost £10,000. The second time, I wound up giving away 35% to  a private investor over three years – but the exit strategy was such that everyone won.

What this system did was create a culture of trust: everyone stood to benefit, so nobody swung the lead; and nobody foreclosed because Head Office got nervous.

The situation between the EU and the markets at the minute is one where the latter expect spin, are bored with it, and don’t trust  it. (They’re right not to). The typical uncommercial suggestion by politicians and eurocrats at both the bank and sovereign levels is that, as a compromise between welching and struggling, the markets and bond buyers should take a whopping discount on what they’re owed – thus probably losing any margin they stood to make. Not surprisingly, this idea trundled gently down the slipway, and sank.

But suppose sovereigns and banks – I’m thinking more particularly the latter here – changed tack and gave out with the following:

“Look, we’ve got something of an overlending bad debt problem right now – we know it and you suspect it. But if you pull the plug the whole thing goes down to the sewers. Why not buy lots of bonds to tide us over this problem, in return for which you get real stock in the bank?”

By doing this, you would effectively turn the credit markets into banking shareholders….with a vested interest in not playing games. Everyone really would be in the same boat.

This idea is a long way from being original: China made a huge investment in South Africa’s national (private) bank some five years ago, in return for an equity stake. My own view is that this was a geopolitically dumb thing for SA to do, but such a consideration doesn’t apply in Europe.

Of course, it does change the whole dynamic of EU/eurozone futures on the one hand, and the yield levels of bonds on the other. God forgive me and may Milt Friedman strike me down, but I think this is one of those cases where cooperation alongside competition would be a good thing: borrowing at this level would get cheaper, and the markets would be less nervous. This is, after all, the formula that accounts for our success as a species – whatever bollocks the neo-liberal free marketeers like to spout.

Cue lots of comment threads explaining why this wouldn’t work.