Guest Post: Senior-Sub Question On Risk: Part Two Of Three

Submitted by JM

Senior-Sub Question On Risk: Part Two Of Three

If there was ever a setting where you would think risk is properly appreciated it would be in European banks.  Look at total return on senior-sub financial European financials since 2004.  On a total return basis, European senior bank debt has outperformed subordinate debt.  As a matter of fact, you’ve lost money if you own a portfolio that replicates the BarCap sub debt index going back to late 2004. 

Source:  BarCap

Question:  Why is sub such a persistent loser in times of crisis, precisely when people should be demanding compensating return for the risk?

Possible answers:

  • In light of the bailouts and liquidity provision, you can reasonably argue that the larger banks in Europe are quasi-sovereign entities.   As a result, there is no way to adequately discern the risk differential between senior and sub debt.
  • Is this an example of the foolishness of crowds? 



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