April 2, 2014
By Mike Dolan and Hugh Lawson
LONDON (Reuters) – Five years after Lehman Brothers’ seismic bust and just two years after euro member Greece defaulted, the concept of being too big or too strategic to fail is alive and well.
Although unwritten government guarantees of big banks have been at the heart of taxpayer outrage over being left on the hook for the missteps of giant corporations, few politicians or voters are keen to embrace another ‘Lehman moment’ or the global economic implosion that ensued.
Tighter regulation on capital buffers and risk-taking, the insistence that banks have ‘living wills’ for any future workout procedure, creditor ‘bail-in’ bonds and even the ring-fencing of certain operations within banks have all been preferred routes to limit the exposure of both society and shareholders.
Yet, as an International Monetary Fund study detailed this week, there’s still a running assumption that governments would again rescue the biggest banks in the event of another panic.
The IMF found that at least through 2012 the euro zone’s biggest banks still benefited from an implicit taxpayer subsidy of $90 billion to $300 billion. Subsidies for UK and Japanese banks may have been as high as $110 billion and they ranged from $20 billion to $70 billion in the United States.
So the risk, you might assume, is still loaded on the government’s tab.
Yet government borrowing costs across the western world and beyond have rarely, if ever, been lower.
Even far out on the risk spectrum, Greece – whose 2010 bailout and 2012 debt default has traumatized the euro zone for four years – looks set for the quickest and arguably most dramatic return in history of a sovereign bond defaulter to capital markets. A new public debt sale is expected by many later this year.
While new debt issued by euro zone governments will from now on contain some form of workout prescription, or so-called Collective Action Clauses, the assumption of broad international support remains intact.
Prospective bond buyers reckon the chances of Greek government, IMF or euro zone officials contemplating another private sector default by Athens in the foreseeable future are slim – for domestic political as well as bloc-wide stability reasons.
There may well be further rescheduling or restructuring of official sector loans to Greece, but this would likely be seen as preferable to another protracted private creditor workout with little material relief to the long-term Athens debt load.
And that’s why some are saying Greece – a single B credit at best – could well borrow for five years at less than 6 percent.
Fully funded for the next 12 months, Greece does not want another EU/IMF bailout either. “I have taken note of the optimism or let’s say the ambition of the Greek government not to have another programme,” euro group chair Jeroen Dijsselbloem said on Tuesday.
And yet again – emboldened by the European Central Bank’s landmark commitment to do ‘whatever it takes’ to keep the euro zone intact – Germany and the highly indebted euro zone sovereigns are enjoying multi-year lows in borrowing costs.
So if political, systematic or strategic significance renders borrowers “too important to fail”, as the IMF study described it, then how far does the calculation extend?
Ukraine is a classic case in point.
Despite horrendous public finances, a contracting economy, dwindling currency reserves and the annexation of part of its territory by a neighboring superpower, few now see Ukraine defaulting. Its bonds trade above 90 cents in the dollar – now more than 10 percent up from the nadir of the Crimea crisis.
Perhaps the original deduction by Ukraine’s biggest bondholders, such as Templeton Franklin’s Michael Hasenstab – was that its strategic importance played out in sequential financial rescues, as first Russia and then the IMF swapped promises to keep the country from defaulting with giant bailout programmes.
Hasenstab, now famous for making similarly strategic and contrarian bond bets on both Irish and Hungarian government paper, has seen his funds suffer redemptions of late but what looks like another ‘too big to fail’ bet could well come good.
“I wouldn’t say exactly that (Ukraine was) too important to fail, but it’s a very important geopolitical situation and that means backstops will appear from unexpected places,” said Exotix economist Gabriel Sterne.
Moral hazard or not then, governments will still likely stand by key banks and countries considered critical to financial, economic or political stability. And – thanks largely to the power of central bank printing presses – the guarantors appear to pay little or no additional price for that support.
For investors channeling ever larger amounts of savings to fixed income as prospective retirees “de-risk”, the temptation of these well-chosen yield plays seems clear. So high yields may signal ‘buyer beware’, but only up to a point.
And yet the more money that floods to relatively risky bond markets, the bigger the fear of just one miscalculation.
“I don’t think you can ever eliminate the possibility of another Lehman moment – all you can do is try to reduce the chances,” said Chris Probyn, Chief Economist at State Street Global Advisors.
(Editing by Hugh Lawson)