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Americans warned bank ‘bail-ins’ coming

Experts say institutions will grab deposits without warning

28 Sep 2013
by Clark Kent

With the United States facing a $17 trillion debt and an acidic debate in Washington over raising that debt limit on top of a potential government shutdown, Congress could mimic recent European action to let banks initiate a “bail-in” to blunt future failures, experts say.

Previously the federal government has taken taxes from consumers, or borrowed the money, to hand out to troubled banks. This could be a little different, and could allow banks to reach directly into consumers’ bank accounts for their cash.

Authority to allow bank “bail-ins” would be in lieu of approving any future taxpayer bailouts of banks that would be in dire need of recapitalization in order to survive.

Some financial experts contend that banks already have the legal authority to confiscate depositors’ money without warning, and at their discretion.

Financial analyst Jim Sinclair warned that the U.S. banks most likely to be “bailed-in” by their depositors are those institutions that received government bail-out funds in 2008-2009.

Such a “bail-in” means all savings of individuals over the insured amount would be confiscated to offset such a failure.

“Bail-ins are coming to North America without any doubt, and will be remembered as the ‘Great Leveling,’ of the ‘great Flushing’ (of Lehman Brothers),” Sinclair said. “Not only can it happen here, but it will happen here.

“It stands on legal grounds by legal precedent both in the U.S., Canada and the U.K.”

Sinclair is chairman and chief executive officer of Tanzania Royalty Exploration Corp. and is the son of Bertram Seligman, whose family started Goldman Sachs, Solomon Brothers, Lehman Brothers, Bache Group and other major investment banking firms.

Some of the major banks which received federal bailout money included Bank of America, Citigroup and JPMorgan Chase.

“When major banks fail, they are going to bail them out by grabbing the money that is in your bank accounts,” according to financial expert Michael Snyder. “This is going to absolutely shatter faith in the banking system and it is actually going to make it far more likely that we will see major bank failures all over the Western world.”

Given the dire financial straits the U.S. finds itself in, these financial experts say that Congress could look at the example of the European Parliament, which recently started to consider action that would allow banks to confiscate depositors’ holdings above 100,000 euros. Generally, funds up to that level are insured.

Finance ministers of the 27-member European Union in June had approved forcing bondholders, shareholders and large depositors with more than 100,000 euros in their accounts to make the financial sacrifice before turning to the government for help with taxpayer funds.

Depositors with less than 100,000 euros would be protected. Considering protection of small depositors a top priority, the E.U. ministers took pride in saying that their action would shield them.

“The E.U. has made a big step towards putting in place the most comprehensive framework for dealing with bank crises in the world,” said Michel Barnier, E.U. commissioner for internal market and services.

The plan as approved outlines a hierarchy of rescuing struggling banks. The first will be bondholders, followed by shareholders and then large depositors.

Among large depositors, there is a hierarchy of whose money would be selected first, with small and medium-sized businesses being protected like small depositors.

“This agreement will effectively move us from ad hoc ‘bail-outs’ to structured and clearly defined ‘bail-ins,’” said Michael Noonan, Ireland’s finance minister.

The European Parliament is expected to finalize the plan by the end of the year.

The purpose of this “bail-in,” patterned after the Cyprus model, is to offset the need for continued taxpayer bailouts that have come under increasing criticism of the more economically well-off countries such as Germany.

Last March, Cyprus had agreed to tap large depositors at its two leading banks for some 10 billion euros in an effort to obtain another 10 billion European Union bailout.

While this action prevented the collapse of Cyprus’ two top banks, the Bank of Cyprus and Popular Bank of Cyprus, it greatly upset depositors with savings more than 100,000 euros.

WND recently revealed that the practice of “bail-ins” by Cyprus a year ago was beginning to spread to other nations as large depositors began to see their balances plunge literally overnight.

A “bail-in,” as opposed to a bailout that countries especially in Europe have been seeking from the International Monetary Fund and the European Union, is a recognition that such outside monetary injections won’t be forthcoming.

Sinclair said that the recent confiscation of customer deposits in Cyprus was not a “one-off, desperate idea of a few Eurozone ‘troika’ officials scrambling to salvage their balance sheets.”

“A joint paper by the U.S. federal Deposit Insurance Corporation (FDIC) and the Bank of England (BOE) dated December 10, 2012 shows, that these plans have been long in the making, that they originated with the G20 Financial Stability Board in Basel, Switzerland, and that the result will be to deliver clear title to the banks of depositor funds,” Sinclair said.

He pointed that while few depositors are aware, banks legally own the depositors’ funds as soon as they are put in the bank.

“Our money becomes the bank’s, and we become unsecured creditors holding IOUs or promises to pay,” Sinclair said.

“But until now, the bank has been obligated to pay the money back on demand in the form of cash,” he said. “Under the FDIC-BOE plan, our IOUs will be converted into ‘bank equity.’ The bank will get the money and we will get stock in the bank.”

“With any luck,” Sinclair said, “we may be able to sell the stock to someone else, but when and at what price? Most people keep a deposit account so they can have ready cash to pay the bills.”

Such plans already are being used, or under consideration, in New Zealand, Poland, Canada and several other countries.

Source

European bank runs and failure of Credit-Anstalt in 1931

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21 May, 2012, 14:52
Posted by Zarathustra

The events in Europe right now is essentially a slow-motion bank run (or “bank jog”) on various European banks in the periphery.   Greece, for instance, have been losing deposits in their banks, while Spanish bank Bankia was rumoured to have massive among of deposits being withdrawn.  And of course, in the days of modern banking with internet and other stuff, you don’t even need to see a massive queue outside a bank to know that there’s a bank run.

Disturbingly, what’s happening today in Europe reminds me of something happening more than 80 years ago, when bank failures triggered bank runs virtually in the whole of Europe, later bank holidays in hope to stop bank runs, capital control, and countries going off gold standard.  Sure enough, by thinking about the event in 1931 by no means suggest that I think what happened then will surely happen in 2012.  It is always, however, good to look at the history and see what we can learn from it.

We all knew that the Great Depression started in 1929.  Perhaps lesser known is that one of the more dangerous legs of the slump during the the Great Depression did not start until 1931 when an Austrian Bank Credit Anstalt went bust.

At the time, it was the biggest bank of Austria.  Its failure triggered a European banking crisis, with bank runs started first with Austrian banks, then with German banks.

In Liaquat Ahamed’s wonderful book Lords of Finance: The Bankers Who Broke the World, he wrote that while Austria was a small country with the GDP about one tenth of Germany’s, remarkably the failing on its biggest bank sent a massive shockwave to the whole of Europe, an ultimately to the world economy.  While the big central bankers were trying to come up with rescue packages, without the experience of modern central banking, they came in too late, with too little money.

During the time of the Great Depression, it was the French which had the biggest gold reserve after the United States.  At the time of Credit Anstalt’s failure, the French was apparently faring relatively well among European countries.  And not surprisingly, politics was in play in their attempt to save themselves.  France, although financially stronger among European great powers, they were not keen at all to save the Germans and Austrians (perhaps still quite keen to punish them for starting World War One).  When the United States unilaterally forgo war debts from Europe for a year, which included German’s reparation, France was furious.  Liaquat Ahamed quoted that the British Prime Minister at the time Ramsay MacDonald saying that “France has been playing its usual small minded and selfish fame over Hoover proposal…”, while the Bank of England Governor’s Montagu Norman said, according to Ahamed, that “Berlin was being ‘bled to death’ while the French and the Americans were busy arguing” (p. 413).  And sure enough, when the German’s central bank Reichsbank asked Banque de France and the French government for help, that didn’t work. The French government offered some loan with conditions, which the Germans thought of that as “political blackmail”.

As the crisis worsened, Danatbank, at the time the second biggest bank in Germany, went bust some two months later after Credit Anstalt failed.  On 13 July, it failed to open for business, triggering yet another wave of massive bank runs on every other German banks.  With the banking crisis at its worst, a two-day bank holiday was imposed in German to prevent further drain in deposits.  Later, banks in virtually the whole of Europe are closed.

Meanwhile, in London, the government is considering measures to reduce budget deficits even as the banking crisis hit Britain, partly because of UK’s banks exposure to Germany and other countries in the continental Europe, and the Bank of England was losing gold reserve, forcing the Bank to raise interest rate when it should not.  The military’s salary would be cut in hope to plug the budget gap, but the some sailors in the Royal Navy became (predictably) very angry and essentially went on strike, an event which is now known as the Invergordon Mutiny.  Not a particularly huge event, but enough to send a shockwave to the City of London with stock market crashed and a sterling crisis.  In about a week after the Mutiny, Britain was forced out of the gold standard.

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You Have Just Witnessed The Death Of Developed Market CDS

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Macro Man

Like many derivatives products dreamed up by Wall Street’s financial innovators, the Developed Market (DM) Sovereign Credit Default Swap (CDS) market was borne out of the desire to transfer risk off the books of banks to investors suited to managing those risks. Following the successful establishment and effectiveness of risk transfer in the corporate CDS market, the onset of the Asian Financial Crisis spurred growth in trading in Credit Default Swaps on Emerging Market countries’ debt. However, legal documentation issues relating to the 1998 Russian bond default hinted at the structural problems embedded in the contracts, subsequently confirmed when the economically coercive 2001 Argentinean so-called “Mega-Swap” did not trigger CDS. Indeed, even though Argentina eventually repudiated its debt unilaterally, many protection buyers’ swaps had already expired by then, and trading volumes in EM CDS fell substantially, only really recovering post the 2003 overhaul of ISDA’s rulebook.

It is then, perhaps, surprising that despite proven complications related to the terms under which EM Sovereign CDS would pay out that market participants extended the concept to cover Developed Market Sovereigns in 2006. Arguably, along with its siblings ABS CDS, made famous by Hedge Fund manager John Paulson’s multi-billion dollar bet against the US Subprime market, trading in DM CDS took off as a way to hedge the risk of countries who had been forced to assume the liabilities of their banking systems coming under pressure themselves. But as with earlier EM-specific non-triggers, the Icelandic government’s decision to put its banks into administration in November 2008 rather than default on its own debt, resulted in its CDS falling from as wide as 1400bps to current levels closer to 320bps. The LSE’s Professor Willem Buiter, a former Bank of England MPC member, in early-2009 asked the question “Is the London Reykjavik on Thames?”, leading to CDS on the UK to spike to as high as 166bps, but this sparked many to point out that the UK’s debt was denominated in Sterling, which the Bank of England could print an unlimited amount of. A month later, in March 2009 the Bank of England’s decision to purchase £75bn in its Asset Purchase Programme seemed to support this view, despite a second widening of UK CDS in the run up to the 2010 General Election as investors worried about the UK government’s commitment to its medium term solvency.

Nevertheless, the incoming PASOK-led Greek government revealed in November 2009 that the country had under-reported its deficits, triggering the onset of the Eurozone crisis, and Greek CDS began to widen, culminating in the April 2010 EU/IMF bailout of Greece, and a month later, in the face of contagion to other European government bond markets, the establishment of the European Financial Stability Facility (EFSF). An explosion in trading of DM CDS on Eurozone peripheral countries’ debt ensued as hedge funds sought to speculate upon the likelihood of an eventual Greek default and banks sought to hedge their exposures to those countries built up over the preceding decade.

Inevitably, faced with the political cost of bailing out foreign countries, European politicians lashed out at the CDS market, blaming it for breeding panic and allowing speculators to “bet” against bond markets and the Euro. As seen in the 2008 Global Financial Crisis, banks under pressure, along with politicians, blamed short sellers and speculators for spreading rumours and exacerbating the situation, while speculators argued that the market was merely “the messenger”, pointing to fundamental problems with balance sheets. As financial market pressures became ever more severe, European policymakers resorted to short selling bans and attempted to implement a ban on CDS trading. The debate continues to rage over whether the CDS market caused or exacerbated the Eurozone crisis, or whether the crisis was inevitable.

But what eventually killed the Developed Market Credit Default Swap market in the end, was the agreement with the Institute of International Finance (IIF), representing banks owning Greek bonds, to accept a 50% haircut on their holdings. The possibility that despite such a large haircut on Greece’s debt, that CDS contracts would not trigger, led many investors and bank hedging desks to question the value of their CDS contracts. The repercussions soon spread, as those institutions that believed they had hedged their bond holdings, or bet upon a Greek default, rushed to sell their contracts before the price collapsed. Volumes soon collapsed as it became evident that developed market governments had the ability to force their banks into taking haircuts without rewarding what they view as speculators.

Developed Market CDS soon faded into history alongside Perpetual Floating Rate Notes, Libor-cubed Notes, Asset Backed Collateralised Debt Obligations, War Loans, Endowment Mortgages and other financial products that were found wanting.

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