Saturday, May 26, 2012

Bail-in provisions will exacerbate run on banks, drive German asset inflation

This Sober Look post discusses the reality of unsecured EU bank bonds that are expected to have zero recovery due to the so-called "bail-in" provisions. Should a bank were to become "insolvent", these provisions will allow the regulators to force orderly defaults, subordinating these bonds behind any government bailout funds. But because most bank assets that would have value in a liquidation are already pledged (particularly in the periphery) to the ECB under the LTRO programs, there will be nothing to recover under these unsecured claims. Unsecured bank bonds have basically become equity with no up-side. The provisions will essentially put an end to most EU banks' ability to issue anything but covered bonds.
FT: - Sweeping reforms to shift the burden of rescuing failing banks from taxpayers to bondholders are to be unveiled by the European Commission, despite fears it will further rattle nervous bank investors.

When a bank is deemed to be failing, regulators will win extensive powers to write down non-guaranteed deposits and senior unsecured bondholders, according to draft proposals obtained by the Financial Times.

While the broad thrust of EU bank resolution reforms are well known, its publication has been delayed for more than a year over fears the so-called “bail-in” tools would make it even harder and more expensive for banks to raise money.
What's more, large depositors such as corporations, trusts, pensions, asset managers, insurance firms, etc. will have to view their cash at banks as unsecured lending to these institutions.

Within the euro area these bail-in provisions will simply drive bank clients to move balances to German banks and into German government paper, further exacerbating TARGET2 imbalances and run on periphery banks. This flight of capital is even starting to drive German asset price inflation.
Pimco: Evidence so far points to accelerating asset price inflation in Germany rather than consumer price inflation. Capital flight and their “safe haven” status have inflated the prices of German government bonds. Concerned about the stability of the euro, Germany’s savers are shifting their money into real estate. German residential house prices and rents rose by 4.7% last year, the fastest increase since 1993’s reunification boom. So far, Germans are not leveraging to buy houses. Growth in German mortgages is paltry at just 1.2% per annum according to the ECB as of December 2011, but in our view all ingredients for a debt-financed house price boom are there. Distrust in the euro is rising, German households’ debt level is low, as are interest rates and unemployment. The ECB’s monetary policy is too loose for Germany’s domestic conditions, just as it was too loose for Spain and Ireland in the early years of monetary union when Germany’s economy was weak.
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