On SWFs being paid to borrow | FT Alphaville

On SWFs being paid to borrow

The big story on Friday concerns the terms and structure of Qatar’s life-saving support for Barclays at the peak of the financial crisis in 2008. As Daniel Schäfer, Caroline Binham and Simeon Kerr report, the key issue is whether Barclays lent Qatar the money to buy shares in the bank.

As the FT reported late on Thursday:

While the terms of Barclays’ emergency fundraising have been under the scrutiny of the Financial Services Authority and the Serious Fraud Office since the summer – with a particular focus on fees paid for the deal – allegations over a loan to the Qataris is a new thread of the investigation. Two sources familiar with the situation have independently told the Financial Times of the investigation into the alleged loan.

If confirmed, such an arrangement could contravene market regulations if it was not properly disclosed at the time, legal and industry experts warned. “The concept of lending money to any investor to purchase your own shares raises a series of immediate questions about disclosure and other regulatory issues,” said Peter Hahn, a former banker at Citi now at Cass Business School.

Lending money to someone so that they can immediately invest it back in your own shares is turning out to be a bit of a theme during this extended crisis. As the FT also reports, Dexia, the Franco-Belgian lender, and Kaupthing have also come under scrutiny for purportedly doing exactly the same thing.

And if you come at this from a slightly broader angle it’s clear that these sorts of arrangements pop up all over the place. Two quick examples:

  • Car manufacturers lending money to customers to buy their own cars (in the knowledge that those cars will depreciate, so agreeing to buy them back from you immediately at a lower price).
  • The ECB lending money to have it invested straight back into the distressed bonds of its own sovereign shareholders (see also perpetualised national debt).

One point with this story that seems to be baffling people is the idea that Qatar (generally containing the richest people in the world) could possibly want or need to borrow money. Sovereign wealth funds are swimming in liquid securities and literally falling over themselves to invest their cash anywhere, any time, right?.

Well, these are also financially savvy institutions, smart enough to recognise a good opportunity to take on extremely cheap leverage when it comes their way. Why would you encumber or risk your own liquid assets, if you don’t have to? It’s the liquid assets that provide the SWF with its high credit rating and allow it to maintain a credit line when others can’t.

A key fact to keep in mind here is that Qatar was and continues to be a borrower of the highest possible quality. We suspect the SWF was, in effect, given the real negative interest rate environment, being paid to borrow.

A loan to Qatar was a prized asset for Barclays. This was a rock-solid, triple-A, never, ever, gonna default in a million years loan. Think of it in terms of Barclays leaning on the power of Qatar’s balance sheet. Banks, after all, are mostly valued on a book-value basis.

Add a super safe asset to your portfolio and you bolster your balance sheet and improve your equity valuation all in one go.

What you’ve got going on is the exploitation of a negative yield curve. And that, very simply, incentivises lending institutions to reward the very best credit names (who don’t need the money) to borrow from it.

Remember that the generalised problem during this crisis is not necessarily too much debt, but not enough performing debt (a.k.a safe assets).

Yet nowadays that sort of certainty involves … guess what… a negative rate.

And as we’ve discussed at length, negative rates either make banks redundant or turn them into pariah institutions — whose lending practices end up focusing not on investments that have conventionally added to supply, but ones that lead to false market support, contraction or in this case the propping up of their own businesses.

As Pimco’s Bill Gross commented on the phenomenon in his SuperNova epiphany on Thursday:

In effect, the initial magic of credit creation turns less magical, in some cases even destructive and begins to consume credit markets at the margin as well as portions of the real economy it has created. For readers demanding a more model-driven, historical example of the negative impact of zero based interest rates, they have only to witness the modern day example of Japan. With interest rates close to zero for the last decade or more, a sharply declining rate of investment in productive plants and equipment, shown in Chart 2, is the best evidence. A Japanese credit market supernova, exploding and then contracting onto itself. Money and credit may be losing heat and running out of time in other developed economies as well, including the U.S.

Related links:
The perpetualisation of debt - FT Alphaville
Barclays in Qatar loan probe - FT