C’mon folks.
First, it’s illegal for the German government to bail out Deutsche Bank. That’s one of the (few) changes made in the EU post-2008, and it has gone into effect.
However, they can be bailed in.
Now let’s talk about what that means, and why in fact it’s worthless in a situation like this.
A bail-in would destroy the stockholder equity (first), then bondholder equity which is converted to stock. That sounds ok but there’s a problem with it.
It works roughly like this: There are multiple “tranches” of bonds with various seniority associated with them. This is done so the institution pays less to borrow on the “higher” (or “Senior”) tranches, because the lower ones are wiped out first before the Senior bonds take any loss.
The issue that arises is that all these institutions “engineer” their tranching through various machinations (including default swaps and similar) so that most of their debt issue is “Senior” or “Super-Senior.” They do this to reduce their borrowing costs but the question becomes whether that “protection” is actually effective, and the only way it is effective is if the mathematical models used to derive that alleged risk are accurate.
This is exactly what was done with the various securitized mortgages from “subprime” lenders, incidentally — and we know how accurate those models were, right?
This post was published at Market-Ticker on 2016-09-29.
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