It has been almost nine years since the Great Financial Crisis erupted and forever changed the financial world as we know it. Bear Stearns and Lehman Brothers were among the first and most prominent casualties of the crisis, but its circles are spreading in ever-widening circles, with bank failures up to this very day.

Just this week, another two banks were forced to throw in the towel, as the Italian government allowed its second-largest lender Intesa Sanpaolo to buy the assets of the regional, struggling lenders Banco Popolare di Vicenza and Veneto Banca. The government, in return, promised to back Intesa Sanpaolo's bid by up to €5.2 billion to avoid conflict with capital ratio requirements, with the buyer furthermore allowed to leave bad assets behind in the bankruptcies.

Veneto Banca senior bonds jumped on the rescue plan, while subordinated bonds were left worthless

The deal was made possible only after European Commission approval, which was needed to bypass a post-crisis EU regulation prohibiting governments from bailing out national banks with taxpayer funds. Those rules, ironically, were set in place by regulators in response to the very same crisis that caused the failures.

While the massive government involvement after the crisis undoubtedly has kept the financial system afloat, it has also been the subject of intense criticism from several sides. For many years, the mantra was that to maintain confidence in the financial system in the general public as well as among investors and avoid devastating bank runs, governments (or central banks) had to step in and rescue failing financial institutions.

But after the crisis, a growing chorus of market participants have argued that not only shareholders, but also bondholders (and maybe even depositors as well) must incur losses when a bank is unwound. According to the argument, this is necessary to maintain market discipline in the long term and deny "bad" banks access to cheap funding on the assumption that such banks would be implicitly government-guaranteed — a phenomenon commonly referred to as "moral hazard".

Furthermore, government involvement after the financial crisis suddenly put taxpayers on the hook for billions of potential (and in some cases realised) losses — something that has not gone down well with electorates.

Italian government bonds have performed well recently as the struggles of its banking sector is being addressed

 

This debate is being rekindled after the Italian bank rescue plan, which protects all senior bondholders as well as some subordinated bondholders from losses, as the loans are transferred along with all performing assets to the white-knight saviour, Intesa Sanpaolo. Senior bonds of the two lenders immediately jumped after the news by as much as 15 points, to reflect the reduced counterpart risk of the new owner. Subordinated bonds, those that were not transferred but left behind, on the other hand, were wiped out and are trading at pennies, if anything at all.

This now marks the third time this year that a European bank has been unwound without imposing losses on senior bondholders, following Banco Santander's recent takeover of Banco Popular Espanol and Italy's rescue of Banca Monte dei Paschi di Siena. As it turns out, the European Commission with its lofty ambitions of investor loss participation and protecting taxpayers, has not been able to prevent this, as politics and short-term interests seem to have influenced decision-making. In the end, taxpayers remain liable for bank bailouts, while investors, who have put their money at risk to earn a premium yield are held without losses.

Indeed, investors are now once again left to wonder whether any of the good intentions in post-crisis regulation will ever stand the test of time.


Michael Boye, CFA | Fixed Income at Saxo Bank