Credit Suisse

The longer this goes on, the worse it gets for the banks and central banks.

Credit Suisse and European financials are in the crosshairs today because (as is tradition) whatever the sins of US banks, Europe is worse.

Here's a telling quote on the sentiment:

“Credit Suisse is an isolated case,” said Charles-Henry Monchau, chief investment officer at Syz Bank. “But banks in Europe, because of regulatory pressure, had to load up on negative-yielding bonds at the worst time and now they are facing major unrealised losses.”

The situation has too many similarities to the financial crisis for comfort. But the a key difference is that last time it was US housing debt and derivatives while this time it's government-backed debt -- the underlying collateral isn't in question.

To illustrate, there are 30-year US bonds trading at 60-cents right now because they were issued at such low yields in May 2020. So $1 billion in notional is worth only $600m if sold today. The thing is, that bond will mature at 100, so the $1 billion will be there. In general, the debt is shorter duration than 30-years and usually shorter than 10-years but you can see the problem.

The regulatory rules are also clear, you can hold these at 100 for capital ratios.

The problem is that the market is no longer treating them like that, or at least not entirely. In a bank run, the bank needs to sell those bonds and take the loss to fund outflows. They go from held-to-maturity to held-for-sale and it means big real losses. That's what broke the back of Silicon Valley Bank.

As an investor, what do you do?

If you treat everything as a mark-to-market loss, then there's a huge problem. The hole in Bank of America, for instance, is 50% of equity. And if BAC tried to raise equity to fill that gap, it would quickly be 100% of equity, if not more.

The window for anyone to raise capital right now is narrow.

At the same time, how do you ignore held-to-maturity losses now?

I thought after SVB and the Fed actions, the market could move on but now everyone is looking at banks around the world and they all have the same problem. Insurers do as well. Right now the market is merciless and something might need to change to fix it.

The next step will be for central banks to stop tightening. Even tightening 25 bps each from the Fed and ECB is playing with fire. If we assume they both hold, is that enough?

The next step would be to extend the kind of program the Fed put in place and make it more generous. Charging banks the repo rate -- near 5% in the US -- to take the bonds at par for one year doesn't really solve the issue and simply bleeds the bank more slowly. In Europe, TLTROs can help but a similar program to the US might not even be legally possible.

Then you look out at the rest of the world and no one could possibly know where all the risk is or who will be hit next.

The first line of defense has to be keeping deposits where they are but in the social media age, it's easy to stir up fears. What's been done so far isn't working.