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TOO MANY LAWYERS AND NOT ENOUGH ECONOMISTS IN BERN.

 Banks failing: Lessons learnt from Credit Sussie collapse. Part 2.

WRITTEN BY
Dr Giuliano Bianchi. 

Two bailouts in just 15 years

UBS in 2008 and now Credit Sussie.

"“Never again” was the mantra and the goal was to bring Swiss laws in line with other frameworks (namely the U.S. and the EU) and to follow international financial recommendations (i.e., the Basel accords). The Swiss regulator sought to shore up the stability of the system and bring it in line with international capital market standards, in hopes of bolstering the attractiveness of the Swiss financial marketplace."

The bank takeover and its consequences

How did FINMA orchestrate UBS’ absorption of Credit Suisse? FINMA decided to write off Tier 1 capital, tout simplement. This financial instrument was created by the international regulatory community after the 2008 financial meltdown to guarantee banks would have access to capital in case of distress.

The idea is quite simple: Tier 1 works as a bond, but if and when the bank needs capital, they get converted into shares. This conversion carries extra risk that is compensated by a risk premium. The market expected Tier 1 bonds (dubbed “CoCos” for ‘contingent convertible bonds’) to be—in one way or another—converted into stock or compensated in some other way. Nein! FINMA decided to write the bonds off instead, with two lasting repercussions.

First, the decision might sound the death knell for CoCos (or Tier 1) as an asset class. Who’s going to trust them now? Conventional wisdom says that investing in shares of stock is riskier than holding bonds. But FINMA just unilaterally decided to wipe out $100 billion in bondholder wealth. So a tenet of investing wisdom has been turned on its head.

Second, the Swiss authority has put national interests ahead of international credibility. Finance has another truism: “Banks are international in life, but national in death”. FINMA has sent a scary message to investors, which may cut the legs out of a market that has proven to be efficient in preventing bank failures. The decision, to its credit, seems to have halted (or at least slowed) the spread of bank failures that ignited in the United States with the collapse of Silicon Valley Bank. In a recent speech, President Biden’s response was unequivocal: “Investors in the banks will not be protected. They knowingly took a risk, and when the risk didn’t pay off, investors lose their money. That’s how capitalism works.”

"So FINMA has an army of fantastic lawyers to explain their way out of trouble. But what are economists saying about the deal? Is it good for the Swiss economy? Economists could provide a better understanding of the financial engineering, how markets operate and the dynamic behind it, which would help to predict and anticipate events in the future. Maybe there are too many lawyers and not enough economists in Bern. While law and economics is a well-established discipline in the U.S. and other countries, Switzerland seems to be clinging to an antiquated legal interpretation of events."

SOURCE:

https://hospitalityinsights.ehl.edu/banks-failing-lessons-learnt-credit-suisse-collapse-part-2



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