“EU Officially Adopts The Bail-In” With Graham Mehl

It has now been more than a year since that fateful weekend in the Mediterranean when everything changed. However, like most of the big changes we’ve seen lately, there is a subtlety afoot that somehow results in few noticing. This should surprise no one really. How the world can change in such dramatic ways without any type of mass awakening is a topic more for the psychologists who help pull the strings and the evil they represent than for anyone involved in the analysis of economics and events, but I say the above so that you know you’re not kidding anyone.

Even a year later, the subtlety continues and ignorance abounds. Most still don’t know the ramifications of the passage of the Dodd-Frank bill back in 2010. They take it at its word that it is a consumer protection act, but is nothing of the sort. They’ll reap what they sow. The evidence has been plentiful, the analysis outstanding. There have been countless opportunities for people to learn of the truth. Ours is not to concern ourselves with those who refuse to have their eyes opened, but for those who are seeking knowledge. After all, nobody can fault someone who doesn’t know, but wants to. There are plenty who do, especially in light of the EU’s passage of a new set of bail-in ‘rules’ this week. Much of this was already known and previously agreed to, but there are some more interesting spin-offs and it is definitely worth revisiting. The mere fact that they’re spending so much time prepping for another bank blowup essentially guarantees that one is coming at some point. These things tend to become self-fulfilling prophecies in and of themselves, and when there is so much potential looting and pillaging to be done, all the more so!

We want to state up front that this is an extensive subject and that it is impossible to provide a comprehensive look at all the facets of the emerging truth regarding the bail-in mechanism and the entire associated minutia in a single essay. Our commitment is to dedicate our remaining articles to this topic alone in the hopes of providing a singular source of information on the topic.

A Palliative Diversion – Exhibit I

Since there was a bit of an uprising in certain corners of the alternative media, evidently some folks in the EU decided that it was necessary to pass a few laws stating exactly how future resolution of failed banks would happen. What is interesting is the reporting of how all this took place versus what we already know to be true. The latest gem comes from the NY Times – the self-proclaimed gold standard of media honesty. Perhaps their gold is laden with tungsten as well. Or maybe it is just pyrite. You be the judge.

“The approvals — which had been expected after arduous negotiations among the union’s regulators, governments and legislators — come more than five years after problems in the American housing market, and the discovery of a big hole in Greece’s finances, set loose a wider banking crisis that led countries including Britain and Portugal to use public money to bail out their troubled lenders.

In one case, in Cyprus, the authorities were initially prepared to trim depositors’ savings to bail out banks before an outcry by Cypriots and European legislators forced a change of tactics.”

So if we’ve got this right, the bail-in in Cyprus never actually happened? Ok, this is good, so we go back a year to the same putrid fool’s gold standard and get the following:

“Desperate times call for desperate measures, and when you are an offshore banking center, whose banking assets represent 800 percent of your host country's G.D.P. and are about to collapse, you have to take the least bad deal you can get. This is what the Cypriot government did when it agreed to an international bailout, despite being forced to raise almost six billion euros – a third of its G.D.P. – through an unprecedented levy on bank depositors.”

Desperate times call for desperate measures - an “unprecedented levy on bank depositors”.  These folks obviously think you are stupid. Or else they think you’ve got a memory like a sieve or don’t know how to spend 5 seconds using an Internet search engine. Such is the brazen nature of the press today.

We digressed a bit, but we needed to lay a foundation of prior falsehoods before analyzing the rest of this story. Perhaps a bit more groundwork is in order. It is well known that much of Europe is Socialist in nature. However, there is a unilateral nature to that socialism. It is fine to take from someone else to give to us, but don’t you dare take from us to give to someone else. This is the by-product of a welfare state and the same mindset is becoming very popular in America. The seeds of class warfare are easily sown in such an environment.

So to encapsulate unilateral socialism, you’ve got the little guy in the EU saying it is ok to rob a big guy to pay for the welfare state, but don’t take my bank account. Then you’ve got the big guy saying hey, my gains are private and they’re mine, but my losses are public, meaning they’re yours. And ne’er the twain shall meet. So what we have here is an impossible task – to please everyone. Ultimately, in a capitalistic society, the risk takers should be the ones who pay, but unfortunately, because we have criminals running the governments of the West, we’ve got a system where the risk-takers are able to leverage everyone else along with themselves. They take hostages, but no prisoners. Instead, they make everyone a risk-taker, and most participants don’t even realize it.

So when it goes wrong, the original risk takers can’t bear all the losses because the losses are far in excess of their ability to repay. Hence the bailout/bail-in mess. Let’s connect some dots here. We had the situation in Cyprus. Deposits were looted regardless of the tripe the NYT wants to print. They admitted it themselves. Then we come up with what is called the SRM, or Singular Resolution Mechanism, for the EU. I am referencing a working paper, again from the IMF from April 24, 2012, linked here.

The above-referenced paper defines a bail-in as the following:

“Bail-in is a statutory power to restructure the liabilities of a distressed SIFI by converting and/or writing down unsecured debt on a “going concern basis.”

(Author’s Note: A ‘SIFI” is a ‘Systemically Important Financial Institution’. Aka G-SIFI where ‘G’ means ‘Global’)

“In bail-in, the concerned SIFI remains open and its existence as an ongoing legal entity is maintained. The idea is to eliminate insolvency risk by restoring a distressed financial institution to viability through the restructuring of its liabilities and without having to inject public funds (except for the provision of liquidity support as a backstop). This would require restoring capital to a level over and above regulatory requirements to ensure the institution’s survival, including under stressed assumptions. It could be achieved either by converting existing debt to equity as part of the debt restructuring or by injecting capital brought in by new shareholders, or by a combination of the two. The aim is to have a private- sector solution as an alternative to government-funded rescues of SIFIs.”

So let’s get this straight and then see what exactly it is this new idiotic measure is supposed to be protecting the EU commoners from and why we called it palliative.  Say you have a bank with a billion in assets. This includes all assets, but NOT deposits since deposits are a liability where the bank is concerned. Pay attention here. So the idea of the SRM is to basically maintain a façade of sorts, to keep the status quo going while the powers that be try to shuck and jive their way into a ‘solution’. And they will need to because many times the liabilities are many multiples that of assets thanks to the miracle of unrestrained leverage.

This is done by possibly converting debt to equity, bringing new capital to the table, or both, according to the IMF. So who exactly is going to race to invest in a failed bank? Answer – you. We reference an earlier essay from this year that mentions the term ‘lending by captive domestic audiences’. This concept was outlined in yet another IMF whitepaper. Granted, the term was used in the specter of ameliorating government debt blowouts, but could easily be applied to banks as well and we believe it will. Could your pension fund, IRA, or 401 be snagged either in part or in its entirety to make a bank whole? Certainly. There are already three live examples of segregated customer funds being stolen to make brokerage operations whole, so what’s the big jump to doing it for a bank or even a sovereign?

The second reason why the answer is ‘you’ is because when the bank’s debt is converted to equity, your deposits are liabilities of the bank and fall into the same category on the balance sheet as debt. So instead of being a depositor in a failed institution, you might end up being a shareholder, which is far worse. At least creditors get the first swipe at things in a bankruptcy. There is rarely anything left for equity holders. Take a look at the share prices of any of the failed banks of 2008 and tell us how you’re going to get made whole. You’re not. It gets better, especially in America and we’ve signed onto this same charade. Once your deposits get converted to equity and you become a shareholder, any hope of FDIC protection that might have existed goes right out the window because that insurance specifically excludes equity holders. Of course the media and powers that be will assure you that all is well; that the SRM will guarantee that there will be no bankruptcy proceedings. This is more nonsense. One quick look at the liabilities of medium sized institutions points out the fact that there aren’t nearly enough deposits – or public money for that matter – to put even these Humpty Dumpty’s back together again.

And, for the record, the EU signed onto the SRM last June. So we’ll say this one more time – for the cheap seats. Just because it is that important that it is worth saying again. When you dump your paycheck in a bank, you’re no longer an uninterested party. You’ve become a risk-taker. An investor. Whether you know it or believe it doesn’t matter. Your bank goes poof because of a London whale or some other Corzine-ish trading gaffe and suddenly you’re in big trouble. And you know the big guys aren’t going to go down for this; you are.

A Palliative Diversion – Exhibit II

Now we’ll get into what the Europeans have supposedly done to ‘protect’ the little guy from the evils of the insolvency of a G-SIFI. Before you’re even done, you’ll probably wonder what all the fanfare is about; this is essentially what they agreed to last year. And you’d be right. Sometimes the lack of news is news itself. According to the NYT, this is the essence of what has been passed:

“The measures approved on Tuesday, which some critics said did not go far enough to protect taxpayers, include a law confirming a guarantee on deposits up to 100,000 euros, or $138,000.

Another law, a bank recovery and resolution directive, gives the 28 states in the union a common rule book for handling failing banks. That law would also oblige creditors to take extensive losses before state funds are used.

The other main law voted on Tuesday, a regulation for a single-resolution mechanism, establishes a board to ensure that the owners and creditors of major lenders in the euro zone pay first in cases of failure. That regulation would also establish a common fund of €55 billion, to be built up over eight years, financed by all euro zone banks to help cover the costs of closings.”

Just a couple of questions here:

First, who are the creditors? For the answer to that one, which by the way is never answered in any of the media releases about these new laws, we just go back to the original SRM agreement – co-written by the FDIC and Bank of England. Depositors are clearly indicated as creditors since, from an accounting perspective, that is precisely what they are. Deposits are on-demand liabilities of the bank because it must pay them on demand.

Second, has anyone bothered to consider the magnitude of a G-SIFI failure? We know that the not-so-USFed pledged up to and possibly over $20 trillion to deal with the mess back in 2008 and that was only the first shock. As alluded to above, US bank deposits total around $950 billion, give or take. Is there anyone out there with a brain that thinks there is enough capital to even cover these clowns when a big one goes down? Just take a look at the derivatives books of the largest banks. If even one goes down, it takes out every depositor on Earth several times over. Not to mention that it won’t be just one; it’ll likely be a bunch of them. This is like the cold war days when the US/USSR had enough nukes to destroy the world a hundred times over or whatever it was and openly bragged about it. That is basically what is going on here, just in a different setting.

Thirdly, does anyone think 55 billion Euros is going to be enough to cover anything? This is like taking on a forest fire with a garden sprinkler. But see, it won’t be the banks who ultimately stock this fund; it’ll be the consumer. The Proletariat. It is just another way to get a pound of flesh from the little guy. Sure the banks have to put the money up, but they are merely conduits and will simply pass along the costs of stocking the fund to their customers either in the form of fees or in the lack of interest payments.

Along these lines, the not-so-USFed’s ‘stress tests’ of the banks are somewhat telling. Even these watered down tests are showing plenty of cracks and there is no rush to fix the problems and no penalties for either delay or outright non-compliance. Keep in mind that not a single criminal charge has been filed as a result of the 2006-2008 mess or any subsequent events. Not one head has rolled. None will. The stress tests, in our opinion, are just a face-saving tactic for when the inevitable happens. Again, remember who works for whom. The fox is truly guarding the hen house in this regard. How many people would give any credibility to an audit that was done by an outfit that is wholly owned by the firm they are auditing? That’s precisely what we’ve got here.

The hacks that wrote these ‘laws’ know all of the above and they also know it would make more sense to let the Proletariat keep their pittance and at least keep the economies going, but they don’t want that. They want to bring the whole mess down so they can create their utopia. We see it here in Europe and we see it in America as well. To sum it up, the ‘news’ of the passage of new laws in Europe this week really isn’t all that significant with regards to what was done. It is what wasn’t done that is all the more important.

A Palliative Diversion – Much Ado About Nothing

The whole ‘going concern’ idea mentioned in the above-referenced IMF staff discussion note (another type of whitepaper) is merely doublespeak for maintaining the status quo. It extends the denial and undoubtedly the lying. Instead of admitting that institution X is defunct, broke, and irretrievably shattered, we’ll put up a farce instead, pretending that all is fine, all the while trying to prevent a fire sale. See below directly from the document (page 5):

“i. reduce the likelihood of government bail-out by ensuring that shareholders and creditors bear losses, thereby limiting moral hazard risk and improving market discipline;

ii. minimize systemic risks by quickly restoring confidence, thereby reducing the need for fire sales or disorderly liquidations of financial contracts, and preserving the going-concern value of the distressed institutions; and

iii. achieve effective cross-border resolutions.”

If you watched during the fall of 2008, you saw how opportunistic the banksters are. They are vultures. They will feed off the carcass of their competitor before the competitor is even dead. This is their nature. If anyone thinks that a bunch of guidelines based on ‘going-concern value’, and the prevention of ‘disorderly liquidations’ mentioned above is going change that, then they need to get the Naïve Nellie of the year award. And at the end of the day, the root of the problem STILL has yet to be addressed.

Why are we letting G-SIFIs even become systemically important in the first place? Why are they continuously allowed to leverage the rest of us to the brink on a daily basis? That we admit their role and its danger and try to contain the potential devastation rather than putting them back in their proper role is proof positive who is really in charge here. It is proof of a system run amok. It is proof of a heads we win, tails you lose mentality on the part of these folks. More importantly, it is proof that we need to take responsibility for ourselves and understand that we are our own best protection. The ‘authorities’ are there to help; they’re just not there to help you.

Graham Mehl is a pseudonym. He currently works for a hedge fund and is responsible for economic forecasting and modeling. He has a graduate degree with honors from The Wharton School of the University of Pennsylvania among his educational achievements. Prior to his current position, he served as an economic research associate for a G7 central bank.

Andy Sutton is the Chief Market Strategist for Sutton & Associates, LLC – a Registered Investment Adviser in Pennsylvania. His focuses are econometric modeling and risk management. The firm specializes in wealth preservation and growth and recognizes the validity of non-paper assets in achieving a balanced approach. The firm is also currently working with a growing clientele towards avoiding the risks routinely visited in this column.