Liam Dann: Welcome to the 'doom loop'

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Bond markets are spooked, credit risk is on the rise and banks stocks are being sold. As if oil prices and a new tech wreck weren't worrying enough, we now have some serious financial sector panic to contend with.

Deutsche Bank shares plunged yesterday morning on news that it might miss payments on its slightly comically named CoCo bonds.

Actually, if there is anything clown-like about these bonds it is the sad irony that they are a derivative product designed after the global financial crisis to absorb risk and avoid the kind of mega meltdown that shocked the world in 2008.

Contingent convertible capital instrument (CoCo) is also a less funny name. The contingent bit is the built-in safety switch that allows a bank to stop interest payments on the product when its capital ratios reach dangerous levels.

If things get really bad the losses fall to investors with the bonds converted to equity. The flaw in the system seems to be that the first hint of failure to pay prompts a dramatic equity sell-off for the bank.

So the very thing that was supposed to avoid risk actually creates it. This is something the less cheery economic commentators out there have dubbed "a doom loop".

The CoCo bonds issue may yet resolve itself. There is talk of a Deutsche buy-back and they are a product that is sold only out of Europe. But the addition of banking credit and banking risk to the current gloomy global malaise is entirely unwelcome.

Ultimately it is a symptom of central banks reaching the limits of their power with no way to cut already non-existent rates in response to new economic threats.

The European and Japanese central banks have already cut rates below zero. The US just raised rates from near zero but there is already talk that they may have to reverse that this year.

According to Bloomberg there are now US$7 trillion of global bonds that offer investors negative returns. In other words the owners of that money are so risk averse that they are prepared to pay a fee to the borrower to keep it safe for them.

That's not the way investing is meant to work -- a least not in a world where wealth is being created.