Interesting phenomenon: While bank stocks have rallied mightily over the past week — Citigroup (C) is at $2.45 this morning! — bank bonds have gone on a significant slump.
It’s been noted that at current bond price levels, the market assumes that equity will go back to being worthless and that bondholders will take a significant haircut (the end of civilisation!).
But Breakingviews thinks this view is hogwash for two reasons.
The first is that the government has said “No more Lehmans” and that it probably means it. A bank failure that would involve zeroing the equity and forcing some kind of haircut or debt-for-equity swap would be a wrenching process that regulators have no appetite for.
And second, consider how much cash the government has plowed into Citi. $45 billion of taxpayer money. Are they going to walk away from that and tear up the paper? Probably not. As long as they keep shoveling dollars on the coals, they can always keep up the illusion of staying the course and (ironically) looking out for taxpayers. Once they give up the pot, it’s all over.
Here’s our concern: These ideas seem more-or-less obvious. So what’s the bond market seeing that Breakingviews isn’t?