The ViewInvestors go loco for cocos amid secular stagnation

You have to give the world’s big banks this: they’ve got gumption.

They have also got a new lively market in a financial product known as the “coco”. That is short for “contingent, convertible capital instrument” and some US$150 billion worth of these instruments have been issued since 2010.

Recall that in the aftermath of the global financial crisis, global banks were told they needed to put more money aside as a cushion against future crises, so they raised capital by selling equity stakes, or retaining profits instead of paying them out to shareholders.

But then someone said – hey, here’s another idea. How about we just borrow the money to fulfil these nettlesome requirements? And that’s what a coco is – it’s basically a loan, but if there is a crisis, the bank does not have to pay back the loan, instead it converts to equity.

In short, the coco is a complex financial product designed to meet regulations that arose after a financial crisis … that in no small part was caused by a proliferation of complex financial products.

The Peterson Institute for International Economics calls them “fool’s gold”, and says they are rife with moral hazard. “They encourage reckless lending by banks in the secure knowledge of a rescue if desperate times ensued,” Peterson fellow Avinash Persaud said in a recent policy brief.