Jim Armitage: This bond-market lunacy can only
end in tears, and we’ll be the losers
Jim Armitage is the City editor of The Independent and London Evening Standard group of newspapers. He has been a reporter and editor for more than 20 years and was recently shortlisted for the Press Gazette financial journalist of the year and The Society of Editors financial journalist of the year awards. He contributes news, investigative reports and comment to the Independent titles plus a daily column in the Evening Standard.
Saturday 04 May 2013
If your mind was boggled by the fact that a business barely registering on the map a couple of decades ago just borrowed $17bn (£11bn) from investors, wait ’til you hear who else has been squeezing money out of our pension funds.
Despite the concerns looming about Apple’s pricey products and competition from Samsung, the company is getting pretty much free money — 0.5 per cent for three-year loans and 3.9 per cent for 30 years. Not only that, there was such a stampede to lend that it could have raised three times as much.
But don’t read those super-low rates, or that level of demand, as a marker of the highest credit score the world ever witnessed. See them instead as signs the markets are totally dysfunctional. For all Apple’s famous lack of debt, no private company is that much of a safe bet.
Examples of lunatic bond markets abound. Look at the little African state of Rwanda. Less than 20 years ago, it was the scene of the most horrific genocide seen on the planet since Hitler. Its jungle economy consists of subsistence farming and tourism. Yet Rwanda just raised $400m from the bond markets, paying a mere 6.8 per cent a year for 10 years.
Or take Mongolia, the world’s most sparsely populated country, famed for Genghis Khan and nose-flutes, where a third of the population are nomadic herders. I’m as big a fan of the nose flute as the next man, but I’d think twice about lending too much of my hard-earned to Ulan Bator. However, Mongolia recently sold a 10-year bond at just 5.1 per cent.
Everywhere you look, countries we used to call Third or Second World, from the Dominican Republic to Paraguay, Romania to Mexico, are borrowing at stupidly low interest rates. Some have a growth story to sell, of course. Mongolia has started exploiting its natural resources, Rwanda has kept a lid on the violence for a while now. But the reality is that, just like Apple’s Tim Cook, these countries have the money-printing policies of Ben Bernanke, Sir Mervyn King and now Haruhiko Kuroda to thank for the lending largesse.
With Mr Bernanke alone pumping $85bn a month into the system to keep borrowing rates at near zero, money managers are forced to make ever more desperate investment choices with our money.
But who loses? Cheap, long-term debt brings stability to troubled states. It allows companies like Apple to return cash to shareholders or finance their businesses at a time when conventional bank loans are hard to find.
The losers will as ever be us investors. How are we going to fund those 30-year, 3.9 per cent Apple loans when base rates return to normal levels? Even the most pessimistic doomsters aren’t predicting we will be on QE-driven zero percent Bank rates for three decades.
And how easy will it be for those troubled states to go cold turkey on their debt habits in 10 years when the holders of that 5 per cent bond demand an unaffordable 12 per cent or 15 per cent for the next one?
Making things safer is full of danger, too
The dangers building up in the bond markets of super-easy monetary policy are colliding with another aspect of modern finance – the ill-thought-out regulations of banks. Bond markets only work well when banks are prepared to act as intermediaries, readily buying from and selling to investors. To do this, they have to hold large amounts of loan stock at any one time.
Now, faced with hefty new regulations aimed at getting banks “safer” by making it more expensive for them to hold on to assets, the banks are not prepared to act as debt warehouses any more. The market for buying and selling bonds after their original issuance, known as the secondary market, risks seizing up.
If – or, as some bankers are saying, when – that happens, our pension funds will end up holding on to all these bonds whether we like it or not. The $20m of Apple bonds your fund manager managed to get hold of this week could be falling like a stone, but he wouldn’t be able to sell them.
And there you have the trouble with dramatic legislation. You never quite know what the consequences might be.
A simple solution the big banks are bound to veto
Speaking of dramatic legislation, a couple of senators – one Republican, one Democrat – are proposing a novel way of dealing with the issue. They point out that those new rules punishing banks for warehousing assets like bonds wouldn’t actually prevent another financial crisis.
The rules, known as Basel III, state that banks must have enough capital on hand to cover the riskiness of the assets they are holding. It’s done on a sliding scale according to how risky the loans or investments are.
The trouble is, as Ohio Democrat Sherrod Brown and Louisiana Republican David Vitter point out, it wouldn’t have helped prevent the last crisis, let alone the next one. Sub-prime mortgage manure was, as we all recall, scored as low-risk by the credit rating agencies.
Better, argue Mr Brown and Mr Vitter, to scrap Basel III and force the too-big-to-fail banks to hold a straight 15 per cent of all their consolidated assets as a capital buffer. Simple. Straightforward. Safe.
Cue pleas of poverty from the Wall Street behemoths: lobbyists for the likes of JPMorgan and Citi shriek that they would have to rein in their lending, dragging the whole US economy back into recession.
They have a point: 15 per cent is almost double the capital requirement under Basel III. It is punitive for the mega banks. But the Brown-Vitter plan offers them an alternative: slim down, become not-too-big-to-fail (with less than $500bn of assets), and you only need an 8 per cent buffer.
That’s the bit I like most about the plan. One of the many awful consequences of the financial crisis is that the too-big-to-fail banks have become even bigger as they bought up their sickliest rivals. How messed up is that? They’re now so huge they’re even more certain to be bailed out by the taxpayer if they get into trouble. That means they pay artificially low interest rates on their borrowing, making it harder for smaller banks to compete. They just get bigger and bigger, riskier and riskier.
But they also get more and more powerful in Washington. Watch now how they exert that power to get this bill killed off in its infancy.
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