Business

➚ BUY: Bail-outs. Credit Suisse was rescued, U.S. regulators found a buyer for Signature Bank, and the CEOs of the biggest banks are meeting today to find a private-market fix for First Republic, WSJ reported. (That bank’s shares, which have lost 90% this month, are up 19% premarket)

➘ SELL: Bail-ins. The wipeout of Credit Suisse’s “bail-in” bonds put a $250 billion market at risk as investors soured on similar assets at other banks meant to mop up losses in a crisis. Prices recovered slightly today after Europe and the U.K. pledged to respect bondholder rights.

Market value that investors have wiped from global banks this month as of yesterday, according to a Semafor analysis of S&P Capital IQ data. What began as a U.S. problem — maybe even uniquely American, with its roots in Silicon Valley’s hubris — quickly spread abroad.

Of course, banks don’t fail because their stock price goes down. But it’s a tangible symbol of unraveling confidence, and most depositors aren’t checking the prices of credit-default swaps.

Credit Suisse employees are bailing out the bank

THE SCOOP

For years, senior Credit Suisse employees were paid partly in a special bond that is now worth nothing, zeroed out as part of the bank’s fire sale to UBS, people familiar with the matter said.

Known as “contingent convertibles,” they function as regular bonds that receive interest — unless the bank’s capital falls below a certain level. Then they can be “bailed in” and their value wiped out to cover the hit.

That’s what happened over the weekend, when Credit Suisse, facing unraveling confidence and investor outflows, was sold for $3 billion to its bigger rival, UBS, in a deal that zeroes out the value of the 16 billion Swiss francs ($17 billion) worth of CoCo bonds the bank had issued in recent years.

STEP BACK

After the 2008 financial crisis, regulators pushed banks to better align pay with risk-taking. Big cash bonuses, the thinking went, encouraged traders and other executives to take all-or-nothing swings without any regard for the long-term consequences. Stock options, another perk with lopsided incentives, were phased out, replaced by plain vanilla shares that were subject to stiffer clawback policies.

Credit Suisse’s policy took that a step further, paying many senior executives in an instrument explicitly designed to shoulder any disastrous consequences of their decisions.

A spokeswoman for the bank declined to comment.

LIZ’S VIEW

On one hand, paying employees in a special piece of paper that puts them on the hook for catastrophic failure is the platonic ideal of compensation/risk management linkage.

On the other hand, it didn’t work! Much has been made in recent years of forcing bank executives to eat their own cooking. But Lehman Brothers employees owned about a third of the firm when it failed in 2008, and CEO Dick Fuld held onto 10 million shares until the end, losing about $1 billion. The era of traders taking home huge bags of cash and leaving a mess behind them is mostly over, and yet here we are in the middle of a mess.

Credit Suisse’s employees knew they would bear at least part of the cost of the firm’s failure and it failed anyway after years of excessive risk-taking. That should be a cautionary tale for the pay czars across Wall Street.

KNOW MORE

Paying employees in stock encourages a shoot-for-the-moon approach, especially if it isn’t tempered by long-term vesting schedules and clawback periods. But a bond is only ever going to be worth, at most, the face value plus the interest, capping the upside for Credit Suisse’s executives and giving them less incentive to swing for the fences on a given trade or strategy.

The problem is that this particular bond can be, and now is, worth less than stock. Credit Suisse stockholders are getting 0.76 Swiss francs, or about 82 cents, for each share of stock they own. The employees and other holders of the CoCo bonds (officially known as AT1 bonds for the additional Tier 1 — high quality — capital they provide) are getting nothing.

WHAT’S NEXT

Expect a legal fight here. The fine print of the CoCo bonds does allow them to be sent to the back in the bag-holding line, behind stockholders, but required Swiss regulators to make a legal determination that Credit Suisse would otherwise have been insolvent, which they did on Sunday.

It was a quick reversal from just a few days before, when they had believed that opening a financial lifeline might save the bank. That’s the kind of decision that gets second-guessed, as seen in the long-running court fight in the U.S. over the government’s decision to take over Fannie Mae and Freddie Mac, sweeping their profits away from private investors.

NOTABLE

• “Strengthening accountability is an important deterrent to prevent mismanagement,” President Joe Biden said yesterday when he asked Congress for broader powers to claw back pay from executives of failed banks.

In corporate collapses, the bag-holding goes like this: secured creditors at the front of the line, unsecured creditors in the middle, and shareholders at the back. But CoCo bonds are designed to be “bailed in” in the event of a catastrophe, shunted all the way to the back and bearing the first losses. So while Credit Suisse’s stockholders can expect to get 0.76 Swiss francs per share, investors holding its CoCo bonds will get nothing.

There are some $250 billion of CoCo bonds out there, mostly at non-U.S. banks like HSBC and Barclays, and they came out of regulatory efforts to make banks safer after 2008. The biggest loss until this weekend was €1.35 billion, when Spain’s Banco Popular ran into trouble in 2017.

The top Republicans in Congress overseeing the financial system asked the Fed and FDIC yesterday to preserve documents related to the oversight and collapse of SVB, and to keep a list of officials involved, a preview of the coming fight over who’s to blame for this mess.

Much of the criticism has focused on the Fed’s move in 2018 to exempt all but the biggest banks from certain regulations. SVB, with about $215 billion in assets, fell below that threshold.

But the bank’s problems stemmed from the longer-term Treasuries and other bonds it held becoming less valuable as interest rates rose, a risk that certain regulations, even if they applied to SVB, wouldn’t have captured. (For one thing, annual stress tests like those that the biggest banks undergo, assume that in a doomsday scenario, the Fed would lower interest rates.)

Instead, that kind of oversight is more the purview of its day-to-day supervisors at the San Francisco Fed and California’s banking regulator (SVB is state-chartered). The New York Times reported that the Fed’s West Coast office had been flagging problems at the lender for two years to no avail before it collapsed, reflecting inadequate supervision.

It’s the beat cops closest to the banks, their examiners, who are supposed to be the first regulatory line of defense. That’s a better focus for a watchdog autopsy that could result in more effective oversight.

As far as fire sales go, Credit Suisse shareholders made out better than Bear Stearns’ but not quite as well as Wachovia’s, over a one-year horizon.

The collapse of Silvergate Bank and the decision of Signature Bank’s buyer not to take its digital-asset deposits leaves crypto investors without a major banking partner. Yet bitcoin is trading at its highest level since June and another anti-fiat asset, gold, is at a 12-month high as turmoil spreads through the traditional financial system.

If you’re liking Semafor Business, please share with family, friends, bosses, and juniors. And we want to hear from you — what we got right and wrong, and what we should cover next. You can reply to this email.

To make sure this newsletter makes it to you, be sure to add liz.hoffman@semafor.com and bsaacks@semafor.com to your contacts. In Gmail, drag this newsletter over to your ‘Primary’ tab.

See you Thursday.

Want more Semafor? Explore all our newsletters at semafor.com/newsletters

— Liz and Bradley