Prophets

The EU and U.S. Want to Change the Rules of the Bond Market

European officials think voters are more important than the institutions that buy their bonds, but that's a costly error.

Bond market rules are being tested.

Photographer: Jean Ayissi

What are the powers that be at the European Union and European Central Bank thinking? They have now concocted a very dangerous scheme to buy back junior bank bonds that were “mis-sold” to retail investors and “voiding” -- yes, “voiding” -- EU bank indentures in the process. I suppose they think voters are more important than the institutions that buy their bonds, but that's a costly error.

A number of large financial institutions are angry at what the Europeans have done, which is create a whole new class of bondholder that is not found in any indenture. In doing so, they have not only likely violated EU bank regulations, but made a mockery of them in the process. EU officials may applaud their ingenuity and publicly congratulate each other for their political partisanship, but there will be a price to pay. Whether it was the banks in Spain or Italy, no bonds were “mis-sold.” Nothing of the sort happened. They just used political expediency -- chicanery -- to protect the people in power.

You should not invest in what you cannot trust. If you own European bank bonds, then I would recommend taking a serious look at your holdings -- Tier I, Tier II, contingent convertibles, subordinated debt, senior debt -- all of it. If one category of bonds can be “mis-sold” today, then another category, if politically expedient, can be “mis-sold” tomorrow. If the Europeans can do this with bank debt then they can certainly do it with other bonds. What is to prevent some telephone company from “mis-selling” bonds? The answer is nothing. Europe has become a very unsafe place for bondholders.

There was a headline in the Wall Street Journal this morning that made me wince, but I’ll bet that many readers glossed over it without a thought. The headline was “U.S. Weighs Restricting Trades in Venezuelan Debt to Punish Maduro,” and the article went on to say that the “move would ban U.S.-regulated institutions from dealing in bonds from government and state oil company.”  

Whoa! Your first take may be that this is all about Venezuela, but that’s the least of it. The bigger takeaway is that the U.S. might upend the bond markets, by fiat, for political reasons. This is not good.

First, if you own Venezuelan bonds, or their oil company bonds, then I would consider heading to the hills. If the restriction occurs they will lose significant value. My bigger fear is that if the U.S. can restrict trading in bonds here, then they can restrict trading in bonds elsewhere for political reasons. This would be a very dangerous precedent and a clear negative for our bond markets. Who might be next if politics alone determines what can and cannot be traded?

The Trump administration may wish to punish Venezuela, and that is understandable, given their ministrations, but this punishment has implications way beyond the crime. They will also be punishing the American bond markets in the process. A re-think is necessary.

Bloomberg Prophets Professionals offering actionable insights on markets, the economy and monetary policy. Contributors may have a stake in the areas they write about.

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    Mark Grant at mjgrant@bloomberg.net

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