When Insolvent Banks Are Worth Billions

Discussion in 'Economics' started by ByLoSellHi, Aug 14, 2009.

  1. When Insolvent Banks Are Worth Billions

    by: Felix Salmon August 13, 2009 |


    Jonathan Weil has a good column today leading with the fact that Regions Financial (RF) is insolvent, if you mark its assets to market; it’s not the only one. But stock-market investors don’t seem to mind — they’re valuing the equity in the company at more than $6 billion. The true market measure of how risky the bank is can be found in its credit default swaps: five-year protection written on RF’s tier-2 debt is currently trading at a spread of 722bp over swaps.

    What that says to me is that bonds are the new stocks, and stocks are the new call options. Bonds give you a high return for high risk, while with stocks you’re really levering up, running the risk of being wiped out entirely in return for the possibility that your investment could multiply in value in a matter of months.

    That’s not healthy. The stock market should be a way for investors to allocate their capital over the long term in fundamentally healthy companies. Right now, however, it’s a casino. And the slightly safer market, in corporate bonds, is exactly the market we want to discourage from coming back: systemically speaking, equity markets are much less dangerous than debt markets.

    In any case, we’re certainly nowhere near the point at which you can judge the health of a bank by looking at its share price. Which means that we’re nowhere near the point at which requiring large shareholdings is the best way to give management a strong incentive to make their bank healthier. Maybe we should require that top executives start buying a lot of preferred stock instead.