The summits and crisis meetings continue. But most observers have surely given up expecting anything substantial to come out of any discussion between eurozone leaders. Maybe, if we get to the end of the end of the endgame, something will have to happen. Fiscal transfer union? Breakup of the euro? Choose your poison. Whatever it is, it will take a long time to play out.
So there’s a choice in the capital markets. One can either sit it out until the next "solution" comes along, or act. The very point of capital markets, from a social perspective, should be making financial intermediation more robust.
Without large, ostensibly liquid public markets, borrowers need to rely on banks. Mortgage borrowers, SMEs, corporates — they all need bank funding, creating a brittle chain that is reliant on the solvency of the banks, and in turn the solvency of the sovereign. In the old days, that was fine; now, not so much.
Surely the joy of a public bond market is that end-accounts can meet end-borrowers with only an underwriter in the way? The chain of intermediation can be shorter, but it is able to take many more paths. So it should be more robust.
Unfortunately, that doesn’t seem to work in practice. Introducing more paths of financial intermediation means more market participants that are held in the sway of fear and greed. Liquid instruments mean price discovery works faster than for other assets, making it much scarier. Dealers don’t want to get hit; asset managers are marking to market, and nobody is buying.
But this is unsustainable. Certain assets — senior ABS of granular assets, covered bonds, blue chip corporates — will continue to throw off cash, and should weather whatever storms are brewing in the eurozone. Buyers will get par back with all the coupon payments, the fixed income investor’s ideal situation.
It’s hard to be the first issuer to return to a crisis-hit market, but someone needs to start building a wall between the messy vortex of weak banks and weak sovereigns and the productive real economy.
More bond protection could help, along with strengthening the wall — what if corporates started adding a put option for a eurozone breakup? Of course they’d have to hedge this, which would push up CDS spreads for peripheral Europe. But that would be the price of separating good from bad.
The new normal won’t be pretty, but it’s no good sitting around and watching the headlines roll in. Good credits are out there and money needs to be invested. Start building the wall.