REVIEW OF BANK BAIL-IN’s
by: Larry Coudriet- Original Issue March 8, 2016; Revision 1 (May 2018- minor rewrite)
This blog reflects my overall thoughts on the risk being assumed by bank depositors in light of various indications that worldwide, banking institutions will engage in practices that will better insure that these banking institutions will be less likely to fail. Part of the present/pending legislation to mitigate the bank’s risk is to use the deposits held by the bank to prevent bank failure. The tone and the priority of the present legislative dialog is to protect the bank.
Using depositors funds to facilitate bank solvency is to treat deposits as part of the bank capital structure. As such, these deposits can be used to underwrite and fund bank’s risk due to the bank’s derivative exposure. This practice of confiscation of depositors funds for bank protection is now identified as “Bail-Ins”.
Former hedge fund manager Shah Gilani writes for Money Morning. In a November 30, 2015 article entitled “Why I’m Closing My Bank Accounts While I Still Can,” he writes:
Your deposited cash is an unsecured debt obligation of your bank. It owes you that money back.
If you bank with one of the country’s biggest banks, who collectively have trillions of dollars of derivatives they hold “off balance sheet” (meaning those debts aren’t recorded on banks’ GAAP balance sheets), those debt investments/bets have a superior legal standing to your deposits, and they get repaid before you get any of your cash.
Did I get that right? Their derivative exposure is a senior claim to my deposits! Maybe, just maybe, that is why they have such high derivative exposure- it places them in a win-no-lose situation.
Federal Reserve Bank of NY Economic Policy Review / December 2014
Following is a review of a publication suggested by Charles Rotblut, Chief Editor of AAII Journal. Link to NY Fed on Bail-Ins Dec 2014
My first reaction after some 45 minutes reading is that this document is difficult for the individual investor to comprehend. (Perhaps that was the intention). However, there were a few concepts that I found to be disturbing and even perhaps scary in their consequences.
First is the notion that we are discussing “Bail-Ins” at all. In years gone by, bank depositors relied on the trust and solvency of the large financial institutions to protect THEIR DEPOSITS! It concerns me when a discussion ensues that deposits can be viewed as part of the capital structure of the bank, and are discussed along with other “liabilities” of the bank. In days gone by, these notions would never be considered, let alone be discussed. The 2006-2008 fiasco was a wake-up call that there existed massive risk that was not properly managed by the Financial Institutions themselves or the regulatory agencies that were to oversee their operations. Basically, few people saw the last disaster coming. I suspect more “financial damage” is coming our way.
One might say this “discussion” by the Fed is a good thing as there is now transparency and discussion of the risk that always had existed when consumers placed their money in a bank as a “deposit”. True enough. On the other hand, I also see this discussion as a possible “trial balloon”, or even a “benchmark” discussion so the regulators have on record (notably the above article published by the NY Fed), as evidence that the public “was aware of “Bail-Ins”. (It’s right there in the title “Why Bail-In? And How!”). I find this title frightening on its own.
In this Fed publication I found more than 100 references to “Bail-In” and picked out a few quotes that are disturbing in themselves.
p.217 “Bail-in begins before it begins. The regulator must prepare for the bail-in well in advance.”
p.218 “There will probably not be much private liquidity in times of stress, even though the bail-in creates an extremely well capitalized megabank.”
p.222 “Bail-in transforms the meaning of capital. In bail-in, parental debt does exactly the same thing as equity: it protects financial liabilities from a degradation of value. If this is the function of capital, we may conclude that with bail-in, all non-financial liabilities are capital!”
I found this last quote particularly disturbing as my interpretation is that deposits (a non-financial liability, no?) are seen to function as bank capital. I abhor the idea that my deposits further capitalize the bank, and thereby would allow more risk-taking on the part of the bank. (I’m out of here!)
I also have concerns that bail-in legislation could be enacted at any time (if it is not already), and we would need to be constantly vigilant to actually know this has been enacted. At the time of such recognition, appropriate “reactions” to new legislation may be too late to be effective. Furthermore, I find this entire topic poorly covered in mainstream financial press. In fact it is virtually nonexistent!
As any good investor does, one weighs the risk/reward of each and every investment. The “investment” identified in this case is the bank deposit. While bank deposits were once paying a significant rate of interest, that is no longer true. I researched the interest rate offered by PNC in my “Performance Interest Checking Account”- it is a measly 0.01% APY. That earns the $10,000 in my checking account just $1.00 each year. (In the interest of full disclosure, I have already removed some funds to a “safer institution”)
So, as a logical investor, I thus determined that the return on the investment is negligible. Naturally then, the entirety of my focus is on the risk. I do see risk in this situation, and the main source of that risk is I cannot clearly identify the magnitude or the details of said risk. (Yes, certain people in Italy had deposits wiped out entirely as they didn’t understand or foresee that risk either). Furthermore, In the NY FED article, the words “Bankruptcy” and “Reorganization” show up repeatedly. Again, I see only serious risk with no attendant reward.
My limited experience with bankruptcy proceedings (in securities litigation) is that the bankruptcy judge has broad discretion as to the form and nature of the settlement/resolution. Again in this scenario, I, the depositor, am placed in a lose-no-win scenario should the judge choose to confiscate my deposits. Furthermore, my funds would then be unavailable should I require them for day to day needs. With the glacial speed of government, this resolution could take months, perhaps years?
“Swift Resolution”- Where’s My Money?
Worst yet (and I think this is the case), with Bail-In procedures already in full effect, and newly acquired capital assets of the bank (our deposits) already in place, a swift ‘resolution” will be implemented during the next “crisis”. I suppose then, that when you learn of the next financial crisis, you will hear from main stream media that the “banks survived well through this crisis”, only to discover the following day that your deposits have been taken. Legislators will praise themselves for “not having repeated the last crisis”; you will be busted.
Based on available information to evaluate the “Bail-In” risk, I continually find myself in the difficult situation of trying to find and evaluate information from the FED or branches of the US Government, neither of whom I trust for their competency or ethics. One merely needs to follow the money trail from the 2006-08 debacle to see who were the beneficiaries.
Ellen Brown J.D. who has seemingly no vested personal financial interest in this topic continues to warn depositors in several news articles about the risk of “Bail-Ins”. Her only possible “selfish” interests in addressing this issue seem to be minuscule- at worst she is an author selling books. My personal take on her is that she is a forthright individual who writes, lectures, and blogs to protect the small-guy depositor. I rather trust her, and share her altruistic motives.
You will find that Ellen Brown has many more articles on this topic. Just Google search her name and “Bail-In” for more reads.
Admittedly I could spend much, much more time to investigate, and stay attuned to the latest in Bail-In legislation, rules or regulations. Presently, with somewhat obfuscating evidence at hand, I believe the pursuit of the “real story” on Bail-Ins is at best elusive. It would seem easier to change banking institutions rather than continue this quest and continued concerns with my deposits being confiscated through a “bail-in”. As a skilled investor I have at times made decisions using only my best estimations of risk and reward- even when the valuations of relevant input parameters are at best murky. (In fact these have been my very best investments- being able to act in uncertain situations. Typically I employ many such investments to mitigate the risk).
At this point in this investigation, my conclusion is fairly clear. With an all-risk, no-gain situation, I find it prudent to not make this investment. Yes, it IS an investment, and I believe you will concur with this identification when you think it through. Unfortunately, I have already made this investment (like most of you) through usual “default banking practices” on my part. I now understand that I need to unwind these deposits ASAP.
Get your deposits out of Money-Center Banks. Institutions who do not carry derivative exposure on their books would seem to be a safe bet. If you wish to check further, make sure the chosen bank is well capitalized.
Do this now! When the legislation is put in effect (and I believe it is already), I suspect that there will be rules about moving your deposits. It is pretty clear to me that awareness of this non-quantifiable risk could create a “run” on Money Center Banks, thereby precipitating their collapse. So, do this now, while you can…
From my knowledge of bank and S&L structures, I think one should consider mutually owned S&L’s and Credits Unions. These institutions are unique in their structure. YOU “own the bank” in this structure; no “shareholders” are involved. As an owner you will find your interests align directly with the depositors. Clearly THESE owners (of the mutually-owned S&L’s and Credit Unions) won’t be screwing themselves as depositors!
Revision of November 8, 2017. I have recently reviewed numerous sources, and it appears that these Bail-Provisions are indeed in effect at this time for US banking institutions.