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Bond Outlook April 2nd

Can central banks give an implicit guarantee that they will allow no bank to fail without reintroducing the moral hazard which has done so much to cause the crisis?

Bond Outlook [by bridport & cie, April 2nd 2008]

It is hard not to get caught up in the optimism that the credit crisis may be over when world stock markets stage such a recovery. We are obliged, however, to remain as sceptical as ever given the lack of improvement in the fundamental causes, deficits, housing, and leverage. Moreover, it is strange that with UBS doubling its write-offs and DB “slipping in” additional write-offs of EUR 2.5 billion can be perceived as “signs of the end of the crisis” and justification of an equity rally led by financials. Does the explanation lie rather in the perception that central banks now have an implicit but nonetheless clear policy that they will let no bank fail. Financial companies of all types may come and go, but the banks, especially the prime brokers (investment banks), will not be allowed to fail as the risk of systemic meltdown is too great. Tuesday’s successful convertible preference share issue for Lehman is a both a cause and an effect of the renewed confidence in the banking sector.

Moral hazard writ large!

Right on cue after our affirmation last week that tighter regulation must follow greater public finance involvement in banks, Paulson announced his intention of a massive overhaul of the US financial regulations.

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