Own up, who didn’t know what an AT1 bond was!
AT1 (or ‘Additional Tier 1’) bonds are a sort of Schrodinger’s security. They embody equity-bond duality (like wave-particle duality in quantum mechanics). They pay a coupon and (for all I know) treated as a bond for tax purposes (i.e. interest cost is deducted to compute taxable profit), but are at the back of the seniority queue when it comes to paying out to those who have funded the business (i.e. creditors and shareholders).
If you want to know more about how they work, read Matt Levine. You get an authoritative explanation with laughs thrown in. A lot of people are upset about what happened to Crédit Suisse’s AT1 bonds. They are in the news. Read more here.
I’m not concerned with what happened. I’m more concerned that laws are passed that 99.9% of the population doesn’t know anything about, that they cannot imagine being affected by. (When I say laws, I include all regulations put out by regulatory authorities, which are extremely numerous.) AT1 bonds exist only because some banker lobbied for them to have the properties they have. How exactly they behave, to the extent that it differs from regular bonds or equity, creates winners and losers. Given the invisibility of these regulations to the general public, one can be fairly certain that the set of losers is equivalent to the set that is labeled “the general public.”
Another regulation was introduced this week. It’s called the Bank Term Funding Program. It sounds extremely innocuous. Who could object to a program whose function is to provide funding to banks? ‘Term funding’ sounds complicated (long or short?), but funding a bank makes the depositors better off, so all good, right? The Fed thinks so: it’s website states: “The Bank Term Funding Program (BTFP) was created to support American businesses and households [my emphasis] by making additional funding available to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.” It’s nothing to do with bailing out the banks, OK?
As someone once said, capitalism with bankruptcy is like religion without sin. The Fed does what it does best: it rewarded bankers who took more risks than their peers, it saved those banks from failing and as a consequence denied the other banks an opportunity to grow their business. The end result is worse-run banks and a bigger appetite for risk-taking. It’s moral hazard as they term it in the insurance business. (You may be less careful about leaving your gas on because if your house is blown up the insurance company pays for it to be rebuilt. In practice, you are probably fairly careful because of considerations which go beyond the purely financial.)
Why does this happen, again and again? Because the rational voter knows that even if he makes the effort to understand, his voice will be drowned by the amplified voices of a very concentrated group of beneficiaries shouting into the law-makers ear (and pouring money into their campaign fund).
What is to be done? I’m not sure that anything would make a big difference. We cannot turn the clock back to the time when bankers considered that any asset beyond short-term commercial paper was unacceptably risky, but we should definitely reconsider the fiction that government bonds are risk free. In a time of interest rate volatility, a thirty-year bond is not safe for a bank to hold, even if it does pay a term premium via its yield.
Obligatory explanation of obscure title
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