01 March 2011
Contingent Convertible
(1957 Ford Skyliner, dropping the top in front of the Glass House, Dearborn, Michigan. Photo courtesy FoMoCo.)
“Beware the Ides of March. The bastards are at it again.”
- Punk Playwright Bill Shakespeare, Act 1, Scene 2, from Julie-the-Caesar
I had not quite forgotten why I was in the office. I had decided it was bronchitis that had driven the malaria-like symptoms of the First (and hopefully last) Big Cold of the Year.
It might all be connected with the vertigo that ushered in the frigid month of February, and it was the endless cold of Michigan at the end of the month that finally caused my usually reliable autoimmune system to collapse in confusion. I knew I had driven the pony hard and put it away wet, between travel and emotions. Oh well.
Having no choice, I decided to enjoy the free disorientation, which normally costs me a lot more to acquire at Willow.
I was thinking that age, or illness, made me much prefer the idea of going back to Big Pink and crawling back to bed than going to the bar. I was attempting to update a spreadsheet to forecast potential take-away work and not doing that well in the out-years when the cell phone went off.
It flashed at me from the mousepad. My pal Mac had been to see the doctor that morning and I was hoping for an update. It was not Mac, and it was not an emergency from the Northland, or at least my northland. It was an investment banker in Sweden, riding on a subway under the streets of Stockholm.
“Hej,” said the disembodied voice.
“Hej, right back at you,” I responded. “How the hell are you keeping a cell call in the subway?”
“You forget this is the home of Erikson. They have this all worked out. Swedes have had cell phones since they carved the first ones out of Elk horns.”
“I imagine you are right. I finally watched the DVD of “Girl Who Kicked the Hornet’s Nest. I can imagine the darkness there, and the cold.”
“I did not call for the weather report. I am here. I know. I have a question for you.”
I am a little uncomfortable about my depth in anything beyond looking out the window and predicting what just happened, but I am game for anything.
“Shoot,” I said.
“I have been telling my clients that the rise in the stock market is totally dependent on the Quantitative Easing that Ben Bernanke is doing to your money supply. When he turns off the spigot in the third quarter of the calendar year, your 4th Quarter of FY-11, the bubble is going to come out of the market.”
“Seems reasonable. I have been happy with the recovery in the market even if it doesn’t make any sense.”
“It doesn’t, or maybe it does, and is just designed to show economic recovery, though it actually just represents more smoke and mirrors out of the Fed. When the Fed money stops there will be a very sharp sell-off. The Fed has only pledged to keep the flow going until early fall, and the Smart guys already know when that is. It is a game of chicken to see when it will tip over.”
“So, I should be making plans to get out ahead of the bubble? Or should I be planning to expand holdings and reinvest when it deflates? Is this a bubble engineered by Bernanke, or Goldman Sachs.”
“Both, I imagine,” said the banker.
“Crap. At some point I have to know what I have so I can retire. And since you know all this, what on earth can I tell you? I have questions for you…”
“Hej- gotta call you back. My station.” I looked at the phone blankly as it disconnected, and I went back to evaluating whether I should build a wedge into my plan for additional Libyan contract analysts with Maghreb social skills into FY-11.
The phone went off a few minutes later. “I am driving a nice Volvo that belongs to my stepson. He is unemployed and on a ski vacation. The car is nicer than mine, and he thinks this is right.”
“There is a lot of that going around,” I said. “So what was the question?”
“What do you know about Contingent Convertibles?”
“That’s easy. Ford introduced the Skyliner in 1957. It was the first mass-produced hardtop convertible. It was cool. Really sleek bodyworks and the hardtop was segmented so it could fold down into the trunk.”
“No…”
“Oh, yeah. Ford said it offered the motoring the carefree, open-top motoring of convertible with the safety and security of a hardtop. My little SLK-320 had one. Pity, since the top takes up the whole trunk, and you can’t store a damn thing in it except maybe a Dopp kit.”
“No, that is not what I meant. You Detroit kids are all the same. I mean a CoCo- a Contingent convertible bond that Credit Suisse is pushing here in Europe. There was a new release today.”
“Wait,” I said. The name tickled a memory though I confess my first thoughts were of the dark-side version of Kellog’s corn-puffs. “Hang on, let me Google it.”
I tapped the keyboard. I recalled that Barkley’s bank was talking about an innovative way for banks to raise capital while simultaneously rewarding management for responsible risk taking that doesn’t drive the institutions into the ground in exchange for obscene personal profits, enabling the crooks to walk away from the wreckage with their personal fortunes intact.
I looked at the search results for something relevant. “I thought it was tied to a two-tiered bonus compensation scheme.”
“Well, that is one aspect of it. I was hoping you knew what was going on.”
“I don’t have anything more than the usual dread I feel when a new ‘creative’ security is launched by those buccaneering bastards.” I looked at the Google results on my screen. “Here is what I know now, and it doesn’t make me feel good, or secure.” I scrolled down the screen. “Says here that a convertible bond is one in which the price of the underlying stock on which it is based must reach a certain level before conversion is permitted.”
“How is that supposed to be connected to responsible risk taking by the institution?”
“I dunno. Says here as an example that the conversion price for a CoCo may be $10 bucks a share, but if the stock price is below $20, the owner can’t convert. I guess it means the smart guy is supposed to get stuck with it, and this public offering is a way to get us chumps to share the risk.” There was silence on the line.
“Hej- gotta go. I have had a glass of wine, well, two, and I have to watch for Polisen. If you get caught here, it is one strike and out. Call you from the land-line.”
“Hej då,” I said, and put my chin in my hand.
I tried to puzzle it through. Traditionally, banks had two sources of capital: debt they incurred by issuing bonds, and equity, which is real and permanent. That was the whole deal with the housing melt-down. The Goldman Sachs smart guys and their quants figured out a way to get everything confused, and created a huge incentive for the banker to raise capital from debt to avoid having their own private money at risk. They coopted the regulators, part of the cozy inside group, to let them have much less than sufficient equity to cover the company obligations, which is why Bear Stearns and Merrill Lynch had to be sold, cents on the dollar, and why Lehman Brothers was allowed to die.
Regulators and bankers are aware of the current perception that they are unrepentant thieves, and the CoCo bonds appear to be a creative way to avoid a repeat of the recent meltdown. One thing is pretty clear about reality: human nature has not changed a whit. The Rules of Business may be constantly mutable, but when people smell collapse, they panic. The CoCo actually has a trigger at which point the debt must automatically be converted to equity- which says the bank is in trouble and the run on it begins.
The phone rang, an unfamiliar number showing on the screen. “Hej, home. Time for one last glass of wine.”
“I am glad you called. Here is the deal. The Industry is saying the CoCo bonds are the most concrete new idea for solving the inherent conflict between management and investor greed, though they don’t quite use that word. Merrill Lynch says they are going to include the bonds in some of their investment offerings, which means some index-following investors are going to buy them.”
“I would check your portfolio to see if you are going to be one of them.”
“If the past is prologue, I am betting that is true. I want to get out of the market.”
“There is no way out,” said my Swedish banker. “It is a lot like the old Irish Republican Army.”
“You mean, ‘Once in, Never out?”
“Ni har helt rätt,” said the banker. “You got that right.”
“Crap.”
Copyright 2011 Vic Socotra
www.vicsocotra.com