The
problem is simple. Deposit taking institutions must not carry a
significant derivative portfolio whatsoever and that portfolio must
be publicly disclosed as to exposure. This allows depositors to
judge their real exposure which is the second problem. Banks today
have abandoned their risk adverse position and now present real
depositor risk.
During
the present clean up phase we have been going through, these rules
have been set aside. This must now end if we are to expect
independent depositors to be comfortable again.
The
good news is that mortgage lending is now expanding again and the
banks are rebuilding profitable books. While this happens, it is
appropriate to insist that those balance sheets get cleaned up and
perfected.
It
should be blindingly obvious to even the blind dumb and stupid, that
the too big to fail model of investment banking is not a growth model
and has in fact been a wealth destruction model. Growth by merger is
a growth model driven by improving credit that inevitably becomes
unsustainable in banking in particular, but also in other industries.
I
have been calling for regulated redistribution of banking authority
down to the States at least, simply because this is the present path
of least resistance. A better path may just be an interest penalty
based on loan size that goes to the FDIC. We cannot seem to get a
tax on it but if the expense rises as the loan size increases, then
we are at least properly offsetting this newly understood risk.
Recall
that Lehman’s, Bear Sterns and Merril Lynch failed. Now try to
rationalize too big to fail.
Bail-out is Out,
Bail-in is In
Time for Some
Publicly-Owned Banks
APRIL 30, 2013
by ELLEN BROWN
“[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 articleshere.) 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, ChairwomanSheila 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 and president of the Public Banking Institute. In Web
of Debt, her latest of eleven books, she shows how a private banking
oligarchy has usurped the power to create money from the people
themselves, and how we the people can get it back. Her websites are
http://WebofDebt.com,
http://EllenBrown.com, and http://PublicBankingInstitute.org.
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