L50) The world’s mega banks now have official permission to pledge depositor accounts as collateral to make leveraged derivative bets



Wow!!  If there was ever a com­pelling rea­son to back away from banks and “too big to fail” ones par­tic­u­larly, and look for refuge in Whole Life Insur­ance, here’s plenty of reason…best regards to all, Michael E.

Thanks Michael.

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It’s Offi­cial: The World­wide Bail-ins Are Coming

By Mark Nest­mann • Decem­ber 23, 2014

In case you missed the announce­ment, Cyprus-style bail-ins are com­ing to a bank near you.

On Novem­ber 16, lead­ers of the G20 Group of Nations – the 20 largest economies – made an impor­tant deci­sion. The world’s mega banks now have offi­cial per­mis­sion to pledge depos­i­tor accounts as col­lat­eral to make lever­aged deriv­a­tive bets. And if they lose a bet, the counter-party to the con­tract has first dibs on your money.

The gov­ern­ments of these 20 coun­tries are now sup­posed to put these arrange­ments into law. Most, includ­ing the US, have already done so.

You could be for­given for not pay­ing much atten­tion to the G20 meet­ing, because it was mostly “more of the same” – the lat­est plan to have cen­tral banks inject tril­lions more dol­lars into the global economy.

But the G20 also endorsed a pro­posal with a mind-numbingly tedious title: Ade­quacy of Loss-Absorbing Capac­ity of Global Sys­tem­i­cally Impor­tant Banks in Res­o­lu­tion. Not exactly a page-turner. Your aver­age Amer­i­can is more likely to watch Chicago Fire than to delve into the minu­tiae of the global finan­cial system.

But this pro­posal pro­foundly changes the rules for bank­ing glob­ally, and not in a good way. Deposits in banks that are “too big to fail” will be “promptly recap­i­tal­ized” with their “unse­cured debt.” This avoids those nasty taxpayer-funded bailouts that proved so polit­i­cally unpop­u­lar dur­ing the 2008 – 2009 finan­cial crisis.

And the largest chunk of unse­cured debt is your bank deposits. Insol­vent banks will recap­i­tal­ize them­selves by con­vert­ing your deposits – check­ing accounts, but also money mar­ket accounts and CDs – into stock.

Thus, when you deposit money in a bank, you’re tak­ing the same risk as some­one buy­ing a stock. Or, for that mat­ter, bet­ting on a horse named “Falling Star” at the local race­track. Because, in effect, that’s what banks are doing with your money.

The G20 has also offi­cially declared that deriv­a­tives –the toxic con­tracts War­ren Buf­fett calls “finan­cial weapons of mass destruc­tion”  – are secured debts. Since your bank deposits are now only unse­cured debt that the bank has pledged to a secured cred­i­tor, guess who gets your money if the bet goes the wrong way for the bank? Answer: It’s not you.

Heads, the bank wins. Tails, you lose.

For­tu­nately, “insured deposits” won’t be sub­ject to this treat­ment. In the US, 100% of deposits in insured banks are pro­tected up to $250,000 per depos­i­tor, cour­tesy of fed­eral deposit insur­ance. But it’s hardly reas­sur­ing that this fund has a reserve ratio under 1%. For every $100 on deposit, the FDIC has less than one dol­lar to back it with.

This is still a lot of money – $54 bil­lion at the end of Sep­tem­ber. But it’s dwarfed by $6 tril­lion in insured deposits, not to men­tion deriv­a­tives con­tracts with a total value of nearly $300 tril­lion. Indeed, the fail­ure of just a sin­gle major Wall Street bank could exhaust the fund.

Fed­eral law autho­rizes bor­row­ing from the US Trea­sury to make up the short­fall, but when a bank­ing cri­sis hits, it’s not likely to occur in a vac­uum, as I described in this essay. Lots of other peo­ple will be demand­ing a hand­out, many of them with stronger polit­i­cal con­nec­tions than you or I could ever hope to muster.

How bad could it get? Well, under the sce­nario the G20 just blessed, unin­sured bank depos­i­tors would be even worse off than account-holders in the government-owned banks in Cyprus that became insol­vent in 2013. Their claims were con­sid­ered supe­rior to those of deriv­a­tive counter-parties. Some unin­sured depos­i­tors got almost half of their money back (although at one government-owned bank, they got nothing).

A more apt exam­ple would be Lehman Broth­ers. When it declared bank­ruptcy in 2008, unse­cured cred­i­tors got about 21 cents on the dollar.

You might be won­der­ing why the G20 made this deci­sion. The obvi­ous incen­tive is to avoid polit­i­cally unpop­u­lar bailouts of mega-banks that are “too big to fail.”

But there’s a less obvi­ous rea­son as well. The G20 hopes that you’ll invest in gov­ern­ment bonds backed by the “full faith and credit” of its mem­ber gov­ern­ments. That will have the effect of keep­ing down inter­est rates on the alarm­ingly high debt car­ried by almost every G20 member.

How can you pro­tect yourself?

The most impor­tant pre­cau­tion is to min­i­mize your expo­sure to the bank­ing sys­tem. Keep bank deposits well below the deposit insur­ance max­i­mums. Accu­mu­late phys­i­cal cur­rency, pre­cious met­als, and other “real assets.”

Diver­si­fy­ing your invest­ments inter­na­tion­ally also makes sense, but because bail-ins have now gone global, it’s no longer as sim­ple as just open­ing an account out­side the US or what­ever other coun­try you live in. Use only strong, well-capitalized banks to hold the funds you keep in the bank­ing sys­tem. Look for banks with as high a level of “Tier 1” liq­uid­ity as pos­si­ble – 25% at the min­i­mum. (By com­par­i­son, the min­i­mum required in the US is only 6% to be clas­si­fied as “Well-Capitalized.”) If you have at least $500,000 or so to spare, open an account with an off­shore pri­vate bank that has no com­mer­cial lend­ing or deriv­a­tives exposure.

I don’t know when the next global finan­cial cri­sis will hit. But when it does, I do know who will pay for it. And it won’t be the bankers or the finan­cial geniuses who designed the “finan­cial weapons of mass destruc­tion” that led to their downfall.

Get your assets out of the “too big to fail” banks – now. It’s only a mat­ter of time before the *HTF.

Mark Nest­mann