Derivatives Managed by Mega-Banks Threaten Your Bank Account. All Depositors, Secured and Unsecured, May Be at Risk
by Ellen Brown,
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.
[Smith fleshes out this derivatives argument
here.]
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 Roe 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 banking
from 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...
