A BIS Bomb That Could Shake the World

Aug.20.10 | About: Vanguard Total (BND)

A shocking, yes shocking, piece of news came to my attention by way of FT Alphaville: the BIS is considering a proposal that would require all bonds to be converted to equities before public bailouts.

Well, I actually made a similar, though not nearly as all-encompassing, proposal right here in early June. But the BIS proposal is not limited to one specific type of bonds (Reverse Convertible Bonds in my proposal). This would radically change the capital structure. The BIS is anything but radical. So the fact that they're publicly pondering it is already very significant.

Throughout the Great Bailout of 2008, time and again equities owners were wiped out while bond holders got bailed out (so much so that Bill Gross feels he's entitled to publicly bully the government and dictate legislative/fiscal/monetary policies). The fact that equities are wiped out before bonds in times of crisis is expected; that's exactly how the capital structure should work. But when the public bailout needs to choose an entry point, therefore implicitly but directly picking winners and losers, it becomes very unfair and triangularish.

If this picks up momentum, it may be the singular trigger that ends the bond bullrun, for good. The whole shbang of fixed income, credit rating, credit trading, corporate financing, financial planning, pension, etc etc would all need some serious rethinking.

I think my RCB idea is much better, although I'm ashamed of being made to look timid and conservative by the BIS. And I doubt it'll happen. But if something more timid (like the RCB idea) comes through in the end, it'd still be a big change.

Disclosure: None