24 December 2008

We Will See More of This

We are now starting to see the breakdown of customs in the financial community that would have been unthinkable only a year ago.

Case in point, Deutsche Bank refusing to execute a call option on €1 of subordinated debt, which has the Bank of China ready to cut off all contact with them.

Here is the short version of what just happened:
  • The bank has been offering a bond of relatively low quality which has a maturity date at some point in the future.
  • Typically, at some portion of that maturity date, the bank can call in the bond, i.e. pay off the loan and roll over the loan by selling new loans.
  • Deutsche Bank has decided that money is too expensive right now, and is refusing to call in the bonds.
  • This means people who, for example, bought a 5 year bond with a 1 year call option, now cannot get their money back at the 1 year mark, and have to wait to the 5 year mark.
  • Thus, the investors are very are pissed off.
The thing is that while Deutsche is under no legal obligation to call in the bonds, this sort of rollover has been a routine way of doing business for a very long time.

In some ways these conventions are at least as important in international finance as the actual laws and regulations under which these institutions operate, and we are seeing them break down in significant ways.


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