bank run 1931 by wikipedia
"[W]ith Cyprus . . . the game itself changed. By raiding the depositors' accounts, a major central bank has gone where they would not previously have dared. The Rubicon has been crossed."
--Eric Sprott, Shree Kargutkar, "Caveat Depositor"
The
crossing of the Rubicon into the confiscation of depositor funds was
not a one-off emergency measure limited to Cyprus. Similar "bail-in"
policies are now appearing in multiple countries. (See my earlier
articles here.)
What triggered the new rules may have been a series of game-changing
events including the refusal of Iceland to bail out its banks and their
depositors; Bank of America's commingling of its ominously risky
derivatives arm with its depository arm over the objections of the FDIC;
and the fact that most EU banks are now insolvent. A crisis in a major
nation such as Spain or Italy could lead to a chain of defaults beyond anyone's control, and beyond the ability of federal deposit insurance schemes to reimburse depositors.
The
new rules for keeping the too-big-to-fail banks alive: use creditor
funds, including uninsured deposits, to recapitalize failing banks.
But isn't that theft?
Perhaps,
but it's legal theft. By law, when you put your money into a deposit
account, your money becomes the property of the bank. You become an
unsecured creditor with a claim against the bank. Before the Federal
Deposit Insurance Corporation (FDIC) was instituted in 1934, U.S.
depositors routinely lost their money when banks went bankrupt. Your
deposits are protected only up to the $250,000 insurance limit, and only
to the extent that the FDIC has the money to cover deposit claims or
can come up with it.
The question then is, how secure is the FDIC?
Can the FDIC Go Bankrupt?
In 2009, when the FDIC fund went $8.2 billion in the hole, Chairwoman Sheila Bair assured depositors that their money was protected by a hefty credit line with the Treasury. But the FDIC is funded with premiums from its member banks,
which had to replenish the fund. The special assessment required to do
it was crippling for the smaller banks, and that was just to recover
$8.2 billion. What happens when Bank of America or JPMorganChase, which
have commingled their massive derivatives casinos with their depositary
arms, is propelled into bankruptcy by a major derivatives fiasco?
These two banks both have deposits exceeding $1 trillion, and they both
have derivatives books with notional values exceeding the GDP of the
world.
Bank of America Corporation moved its
trillions in derivatives (mostly credit default swaps) from its Merrill
Lynch unit to its banking subsidiary in 2011. It did not get regulatory
approval but just acted at the request of frightened counterparties, following a downgrade by Moody's. The FDIC opposed the move, reportedly protesting that the FDIC would be subjected to the risk of becoming insolvent if BofA were to file for bankruptcy. But the Federal Reserve favored the move, in order to give relief to the bank holding company. (Proof positive, says former regulator Bill Black, that the Fed is working for the banks and not for us. "Any competent regulator would have said: "No, Hell NO!'")
The
reason this risky move would subject the FDIC to insolvency is that
under the Bankruptcy Reform Act of 2005, derivatives counter-parties are
given preference over all other creditors and customers of the bankrupt
financial institution, including FDIC insured depositors. my (See my
earlier article here.)
Normally, the FDIC would have the powers as trustee in receivership
to protect the failed bank's collateral for payments made to depositors.
But the FDIC's powers are overridden by the special status of derivatives . (Remember MF Global? The reason its customers lost their segregated customer funds to the derivatives claimants was that derivatives have super-priority in bankruptcy.)
The
FDIC has only about $25 billion in its deposit insurance fund, which is
mandated by law to keep a balance equivalent to only 1.15 percent of
insured deposits. And the Dodd-Frank Act (Section 716)
now bans taxpayer bailouts of most speculative derivatives activities.
Drawing on the FDIC's credit line with the Treasury to cover a BofA or
JPMorgan derivatives bust would be the equivalent of a taxpayer bailout,
at least if the money were not paid back; and imposing that burden on
the FDIC's member banks is something they can ill afford.
BofA is not the only bank threatening to wipe out the federal deposit insurance funds that most countries have. According to Willem Buiter,
chief economist at Citigroup, most EU banks are zombies. And that
explains the impetus for the new "bail in" policies, which put the
burden instead on the unsecured creditors, including the depositors.
Below is some additional corroborating research on these new,
game-changing bail-in schemes.
Depositors Beware
An interesting series of commentaries starts with one on the website of Sprott Asset Management Inc. titled "Caveat Depositor,"
in which Eric Sprott and Shree Kargutkar note that the US, UK, EU, and
Canada have all built the new "bail in" template to avoid imposing risk
on their governments and taxpayers. They write:
[M]ost depositors naively assume that their deposits are 100% safe in their banks and trust them to safeguard their savings. Under the new "template" all lenders (including depositors) to the bank can be forced to "bail in" their respective banks.
Dave of Denver then followed up on the Sprott commentary in an April 3 entry on his blog The Golden Truth, in which he pointed out that the new template has long been agreed to by the G20 countries:
Because the use of taxpayer-funded bailouts would likely no longer be tolerated by the public, a new bank rescue plan was needed. As it turns out, this new "bail-in" model is based on an agreement that was the result of a bank bail-out model that was drafted by a sub-committee of the BIS (Bank for International Settlement) and endorsed at a G20 summit in 2011. For those of you who don't know, the BIS is the global "Central Bank" of Central Banks. As such it is the world's most powerful financial institution.
The links are in Dave's April 1 article, which states:
The new approach has been agreed at the highest levels . . . It has been a topic under consideration since the publication by the Financial Stability Board (a BIS committee) of a paper, Key Attributes of Effective Resolution Regimes for Financial Institutions in October 2011, which was endorsed at the Cannes G20 summit the following month. This was followed by a consultative document in November 2012, Recovery and Resolution Planning: Making the Key Attributes Requirements Operational.
Dave goes on:
[W]hat is commonly referred to as a "bail-in" in Cyprus is actually a global bank rescue model that was derived and ratified nearly two years ago. . . . [B]ank deposits in excess of Government insured amount in any bank in any country will be treated like unsecured debt if the bank goes belly-up and is restructured in some form.
Jesse at Jesse's Café Americain then picked up the thread
and pointed out that it is not just direct deposits that are at risk.
The too-big-to-fail banks have commingled accounts in a web of debt that
spreads globally. Stock brokerages keep their money market funds in
overnight sweeps in TBTF banks, and many credit unions do their banking
at large TBTF correspondent banks:
You say you have money in a pension fund and an IRA at XYZ bank? Oops, it is really on deposit in you-know-who's bank. You say you have money in a brokerage account? Oops, it is really being held overnight in their TBTF bank. Remember MF Global? Who can say how far the entanglements go? The current financial system and market structure is crazy with hidden risk, insider dealings, control frauds, and subtle dangers.
Also at Risk: Pension Funds and Public Revenues
William Buiter, writing in the UK Financial Times
in March 2009, defended the bail-in approach as better than the
alternative. But he acknowledged that the "unsecured creditors" who
would take the hit were chiefly "pensioners drawing their pensions from
pension funds heavily invested in unsecured bank debt and owners of
insurance policies with insurance companies holding unsecured bank
debt," and that these unsecured creditors "would suffer a large decline
in financial wealth and disposable income that would cause them to cut
back sharply on consumption."
The deposits of
U.S. pension funds are well over the insured limit of $250,000. They
will get raided just as the pension funds did in Cyprus, and so will the
insurance companies. Who else?
Most state
and local governments also keep far more on deposit than $250,000, and
they keep these revenues largely in TBTF banks. Community banks are
not large enough to service the complicated banking needs of
governments, and they are unwilling or unable to come up with the
collateral that is required to secure public funds over the $250,000
FDIC limit.
The question is, how secure are the
public funds in the TBTF banks? Like the depositors who think FDIC
insurance protects them, public officials assume their funds are
protected by the collateral posted by their depository banks. But the
collateral is liable to be long gone in a major derivatives bust, since
derivatives claimants have super-priority in bankruptcy over every other
claim, secured or unsecured, including those of state and local
governments.
The Cyprus Wakeup Call
Robert Teitelbaum wrote in a May 2011 article titled "The Case Against Favored Treatment of Derivatives":
. . . Dodd-Frank did not touch favored status [of derivatives] and despite all the sound and fury, . . . there are very few signs from either party that anyone with any clout is suddenly about to revisit that decision and simplify bankruptcy treatment. Why? Because for all its relative straightforwardness compared to more difficult fixes, derivatives remains a mysterious black box to most Americans . . . . [A]s the sense of urgency to reform passes . . . we return to a situation of technical interest to only a few, most of whom have their own particular self-interest in mind.
But that
was in 2011, before the Cyprus alarm bells went off. It is time to pry
open the black box, get educated, and get organized. Here are three
things that need to be done for starters:
For more information on the public bank option, see here. Learn more at the Public Banking Institute conference June 2-4 in San Rafael, California, featuring Matt Taibbi, Birgitta Jonsdottir, Gar Alperovitz and others.
No comments:
Post a Comment