Photo Credit: Jean Lee/ Shutterstock.com
April 9, 2013 |
Cyprus-style confiscation
of depositor funds has been called the “new normal.” Bail-in policies
are appearing in multiple countries directing failing TBTF banks to
convert the funds of “unsecured creditors” into capital; and those
creditors, it turns out, include ordinary depositors. Even “secured”
creditors, including state and local governments, may be at risk.
Derivatives have “super-priority” status in bankruptcy, and Dodd Frank
precludes further taxpayer bailouts. In a big derivatives bust, there
may be no collateral left for the creditors who are next in line.
Shock
waves went around the world when the IMF, the EU, and the ECB not only
approved but mandated the confiscation of depositor funds to “bail in”
two bankrupt banks in Cyprus. A “bail in” is a quantum leap beyond a
“bail out.”
When governments are no longer willing to use taxpayer money
to bail out banks that have gambled away their capital, the banks are
now being instructed to “recapitalize” themselves by confiscating the
funds of their creditors, turning debt into equity, or stock; and the
“creditors”
include the depositors who put their money in the bank thinking it was a secure place to store their savings.
The
Cyprus bail-in was not a one-off emergency measure but was consistent
with similar policies already in the works for the US, UK, EU, Canada,
New Zealand, and Australia, as detailed in my earlier articles
here and
here.
“Too big to fail” now trumps all. Rather than banks being put into
bankruptcy to salvage the deposits of their customers, the customers
will be put into bankruptcy to save the banks.
Why Derivatives Threaten Your Bank Account
The
big risk behind all this is the massive $230 trillion derivatives
boondoggle managed by US banks. Derivatives are sold as a kind of
insurance for managing profits and risk; but as Satyajit Das points out
in
Extreme Money, they actually increase risk to the system as a whole.
In
the US after the Glass-Steagall Act was implemented in 1933, a bank
could not gamble with depositor funds for its own account; but in 1999,
that barrier was removed. Recent congressional investigations have
revealed that in the biggest derivative banks,
JPMorgan and
Bank of America,
massive commingling has occurred between their depository arms and
their unregulated and highly vulnerable derivatives arms. Under both the
Dodd Frank Act and the 2005 Bankruptcy Act,
derivative claims have super-priority over all other claims,
secured and unsecured, insured and uninsured. In a major derivatives
fiasco, derivative claimants could well grab all the collateral, leaving
other claimants, public and private, holding the bag.
The tab for
the 2008 bailout was $700 billion in taxpayer funds, and that was just
to start. Another $700 billion disaster could easily wipe out all the
money in the FDIC insurance fund, which
has only about $25 billion in it. Both JPMorgan and Bank of America have over $1 trillion in deposits, and
total deposits covered by FDIC insurance are about $9 trillion. According to an
article on Bloomberg
in November 2011, Bank of America’s holding company then had almost $75
trillion in derivatives, and 71% were held in its depository arm; while
J.P. Morgan had $79 trillion in derivatives, and 99% were in its
depository arm. Those whole mega-sums are not actually at risk, but the
cash calculated to be at risk from derivatives from all sources is at least $12 trillion; and
JPM is the biggest player, with 30% of the market.
It
used to be that the government would backstop the FDIC if it ran out of
money. But section 716 of the Dodd Frank Act now precludes the payment
of further taxpayer funds to bail out a bank from a bad derivatives
gamble. As summarized in
a letter from Americans for Financial Reform quoted by Yves Smith:
Section
716 bans taxpayer bailouts of a broad range of derivatives dealing and
speculative derivatives activities. Section 716 does not in any way
limit the swaps activities which banks or other financial institutions
may engage in. It simply prohibits public support for such activities.
There
will be no more $700 billion taxpayer bailouts. So where will the banks
get the money in the next crisis? It seems the plan has just been
revealed in the new bail-in policies.
All Depositors, Secured and Unsecured, May Be at Risk
The
bail-in policy for the US and UK is set forth in a document put out
jointly by the Federal Deposit Insurance Corporation (FDIC) and the Bank
of England (BOE) in December 2012, titled
Resolving Globally Active, Systemically Important, Financial Institutions.
In
an April 4th article in Financial Sense,
John Butler points out that the directive does not explicitly refer to
“depositors.” It refers only to “unsecured creditors.” But the
effective meaning of the term, says Butler, is belied by the fact that
the FDIC has been put on the job. The FDIC has direct responsibility
only for depositors, not for the bondholders who are wholesale
non-depositor sources of bank credit. Butler comments:
Do you see
the sleight-of-hand at work here? Under the guise of protecting
taxpayers, depositors of failing institutions are to be arbitrarily,
de-facto subordinated to interbank claims, when in fact they are legally
senior to those claims!
. . . [C]onsider the brutal,
unjust irony of the entire proposal. Remember, its stated purpose is to
solve the problem revealed in 2008, namely the existence of insolvent
TBTF institutions that were “highly leveraged and complex, with numerous
and dispersed financial operations, extensive off-balance-sheet
activities, and opaque financial statements.” Yet what is being proposed
is a framework sacrificing depositors in order to maintain precisely
this complex, opaque, leverage-laden financial edifice!
If you
believe that what has happened recently in Cyprus is unlikely to happen
elsewhere, think again. Economic policy officials in the US, UK and
other countries are preparing for it. Remember, someone has to pay. Will
it be you? If you are a depositor, the answer is yes.
The
FDIC was set up to ensure the safety of deposits. Now it, it seems, its
function will be the confiscation of deposits to save Wall Street. In
the only mention of “depositors” in the FDIC-BOE directive as it
pertains to US policy, paragraph 47 says that “the authorities recognize
the need for effective communication to depositors, making it clear
that their deposits will be protected.” But protected with what? As with
MF Global, the pot will already have been gambled away. From whom will
the bank get it back? Not the derivatives claimants, who are first in
line to be paid; not the taxpayers, since Congress has sealed the vault;
not the FDIC insurance fund, which has a paltry $25 billion in it. As
long as the derivatives counterparties have super-priority status, the
claims of all other parties are in jeopardy.
That could mean not just the “unsecured creditors” but the “secured creditors,” including state and local governments.
Local governments keep a significant portion of their revenues in Wall
Street banks because smaller local banks lack the capacity to handle
their complex business. In the US, banks taking deposits of public funds
are required to pledge collateral against any funds exceeding the
deposit insurance limit of $250,000. But derivative claims are also
secured with collateral, and they have super-priority over all other
claimants, including other secured creditors. The vault may be empty by
the time local government officials get to the teller’s window. Main
Street will again have been plundered by Wall Street.
Super-priority Status for Derivatives Increases Rather Than Decreases Risk
Harvard Law Professor
Mark Row maintains that the super-priority status of derivatives needs to be repealed. He writes:
.
. . [D]erivatives counterparties, . . . unlike most other secured
creditors, can seize and immediately liquidate collateral, readily net
out gains and losses in their dealings with the bankrupt, terminate
their contracts with the bankrupt, and keep both preferential
eve-of-bankruptcy payments and fraudulent conveyances they obtained from
the debtor, all in ways that favor them over the bankrupt’s other
creditors.
. . . [W]hen we subsidize derivatives and similar
financial activity via bankruptcy benefits unavailable to other
creditors, we get more of the activity than we otherwise would. Repeal
would induce these burgeoning financial markets to better recognize
the risks of counterparty financial failure, which in turn should dampen
the possibility of another AIG-, Bear Stearns-, or Lehman
Brothers-style financial meltdown, thereby helping to maintain systemic
financial stability.
In
The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences,
David Skeel agrees.
He calls the Dodd-Frank policy approach “corporatism” – a partnership
between government and corporations. Congress has made no attempt in the
legislation to reduce the size of the big banks or to undermine the
implicit subsidy provided by the knowledge that they will be bailed out
in the event of trouble.
Undergirding this approach is what Skeel
calls “the Lehman myth,” which blames the 2008 banking collapse on the
decision to allow Lehman Brothers to fail. Skeel counters that the
Lehman bankruptcy was actually orderly, and the derivatives were unwound
relatively quickly. Rather than preventing the Lehman collapse, the
bankruptcy exemption for derivatives may have helped precipitate it.
When the bank appeared to be on shaky ground, the derivatives players
all rushed to put in their claims, in a run on the collateral before it
ran out. Skeel says the problem could be resolved by eliminating the
derivatives exemption from the stay of proceedings that a bankruptcy
court applies to other contracts to prevent this sort of run.
Putting the Brakes on the Wall Street End Game
Besides eliminating the super-priority of derivatives, here are some other ways to block the Wall Street asset grab:
(1) Restore the Glass-Steagall Act separating depository bankingfrom investment banking. Support
Marcy Kaptur’s H.R. 129.
(2) Break up the giant derivatives banks. Support
Bernie Sanders’ “too big to jail” legislation.
(3) Alternatively,
nationalize the TBTFs, as advised in the New York Times by Gar Alperovitz. If taxpayer bailouts to save the TBTFs are unacceptable, depositor bailouts are even more unacceptable.
(4) Make derivatives illegal,
as they were between 1936 and 1982 under the Commodities Exchange Act. They can be unwound by simply netting them out, declaring them null and void.
As noted by Paul Craig Roberts,
“the only major effect of closing out or netting all the swaps (mostly
over-the-counter contracts between counter-parties) would be to take
$230 trillion of leveraged risk out of the financial system.”
(5) Support
the Harkin-Whitehouse bill to impose a financial transactions tax on Wall Street trading. Among other uses, a tax on all trades might supplement the FDIC insurance fund to cover another derivatives disaster.
(5) Establish
postal savings banks
as government-guaranteed depositories for individual savings. Many
countries have public savings banks, which became particularly popular
after savings in private banks were wiped out in the banking crisis of
the late 1990s.
(6) Establish publicly-owned banks to be depositories of public monies,
following the lead of North Dakota,
the only state to completely escape the 2008 banking crisis. North
Dakota does not keep its revenues in Wall Street banks but deposits them
in the state-owned Bank of North Dakota by law. The bank has a mandate
to serve the public, and it does not gamble in derivatives.
A
motivated state legislature could set up a publicly-owned bank very
quickly. Having its own bank would allow the state to protect both its
own revenues and those of its citizens while generating the credit
needed to support local business and restore prosperity to Main Street.
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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