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April 29, 2013
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“[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, as explained in my earlier article
here,
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. 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:
- Protect depositor funds from derivative raids by repealing the super-priority status of derivatives.
- Separate
depository banking from investment banking by repealing the Commodity
Futures Modernization Act of 2000 and reinstating the Glass-Steagall
Act.
- Protect both public and private revenues by establishing a
network of publicly-owned banks, on the model of the Bank of North
Dakota.
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.
Ellen Brown is an attorney, author, and president of the Public Banking Institute. Her latest book is
Web of Debt.
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