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The story broke from nowhere and caught many off
guard. To others it was the manifestation of previously unspoken fears. It
was, and is, by far the biggest story of 2013, the decade, and quite possibly
the millennium. It was the crossing of another Rubicon. For years and
decades, the financial piranhas had wandered around the edges, nibbling a
little here and a little there. Inflation, bailouts, and other monetary
mischief had already eroded the value of most currencies. But never before
had they actually made the boldest of moves – to steal what were always
considered to be the most liquid and secure of funds – bank deposits.
In a weekend, the liquid became the illiquid and the secure became the
repossessed. Hey, let’s not split hairs here, the money was stolen. The
media dutifully came up with another new buzzword – the
‘bail-in’. Talk about putting a positive spin on outright theft.
We’ve already covered Cyprus in great detail.
That story goes on and is largely ignored by the mainstream press corps;
however, Cyprus was just a small prize. There are much bigger fish to fry
– like you. This week’s column will cover the groundwork that has
already been laid to turn America into the next Cyprus. I am not positing
here that we will necessarily be the next in line chronologically, but it
will happen eventually – and likely sooner than later. There are other
pools of wealth in other parts of the world that may serve as additional beta
tests prior and I claim no inside knowledge of the blueprint, but can only
attest to the fact that it does in fact exist and more importantly, to make
you aware of it now.
Spain, Canada, and New Zealand have already adopted
specific measures using the ‘bail-in’ approach to guarantee the
solvency of the ‘too big to fail and too big to jail’ banksters using depositor money. For simplicity’s
sake, a bail-in is pretty much the opposite of a bailout. In a bailout, which
we all know far too well, everyone shoulders the losses of
the offensive, insolvent institution. Think of TARP.
However, that ‘socialization’ of losses tends to annoy folks;
especially those who had no prior pecuniary interest in the aforementioned
offensive institution. And yes, I do mean offensive.
However, in a bail-in, instead of getting the funds
from the general public, the strategy is to swipe (not write-down, not give a
haircut, etc.) depositor assets. This is done by a bit of wordsmithing.
Under previous customary definitions, depositor assets were also known as the
bank’s liabilities. Obviously an insolvent bank has more liabilities
than assets (in simple terms) and as such changing the status of account
holders from ‘depositors’ to ‘unsecured creditors’
means the bank can ‘repatriate’ your money to pay off its bad
debts. Truth told, this is nothing new; there is already the precedent of a
series of frighteningly similar situations that are already part of
America’s decaying reputation as an advocate for private property
rights.
The Precursor
– Sentinel Management Group
If all this is starting to sound a bit familiar,
that is because in principle a variation of this has already happened in the
case of the Sentinel Group. Late on Friday August 17, 2007 (always over a
weekend, don’t EVER forget that), the company filed for Chapter 11
bankruptcy protection.
Blockage of the sale of firm assets to the hedge
fund Citadel Investment Group caused lawsuits to be filed against Sentinel by
two brokerages: Farr Financial and Velocity Futures. On August 20, 2007, the
SEC filed a complaint in US District Court in Chicago alleging that Sentinel
had used falsified statements to obtain a $321 million line of credit and had
comingled $460 million of segregated client assets with assets in its
proprietary ‘dealer’ or ‘house’ account. On June 1,
2012, the former CEO and head trader were indicted on federal fraud charges
for defrauding more than 70 customers of over $500 million.
Here’s where it gets dicey. BNY Mellon is the
firm that provided the $321 line of credit and it filed suit and the courts have ruled (in
error and on the side of criminal behavior) that customer funds may
be used by Sentinel to pay off BNY Mellon’s credit line. There have
been two similar subsequent cases in the brokerage world – MFGlobal and Peregrine Financial Group. The Sentinel
ruling is going to make it awfully difficult, if not impossible, for the
clients of those firms to recoup lost funds. This is precisely the type of
moral hazard that we need to be avoiding, not encouraging. To allow a few too
big to fail – too big to jail firms to leverage the entire system is
not only insanely foolish, but criminal as well.
Granted, Sentinel was a brokerage house that went
belly up because it made bad bets, but allowing the firm to steal customer
money to make good on its line of credit was little more than a precursor for
a savings and loan entity to do the same thing. Or in the case of Cyprus,
several savings and loan entities. However, given the incestuous relationship
between commercial banks and brokerages thanks to the 1999 repeal of Glass-Steagall, there is ostensibly no difference between the
situations at Sentinel, MFGlobal, and PFG and what
happened in Cyprus. Can the brokerage arm of a big bank put the entire
operation at risk? Absolutely. Are you protected if you happen to have
deposits in such a bank? Absolutely not.
Of course in any case, the big insiders will be
tipped off well in advance and have the opportunity to move their money
elsewhere long before the hammer falls, leaving the Proletariat scrambling
for ATMs after the banks close on a Friday afternoon.
Act Two –
Canada, Spain, New Zealand, or America?
Let’s look at the blueprints and what
we’ve got regarding Canada, Spain, New Zealand, and even from our ever
quiet, perpetually underfunded friends at the FDIC. There has been a bevy of
whitepapers released over the past few months that outline how various
jurisdictions are going to deal with future crises. Note that the emphasis is
on cleanup rather than prevention. Nobody is interested in preventing another
disaster and that is precisely why we’re going to have one. I am going
to link these whitepapers from our site so that you can look for yourself and
draw your own conclusions. I challenge everyone reading this paper to do
exactly that.
Exhibit One: “Resolving Globally Active, Systemically
Important, Financial Institutions” – FDIC / Bank of England
They call them G-SIFIs; short speak for Globally
Active, Systemically Important Financial Institutions. These are your
Citigroup, JP Morgan, Lloyds of London, BNP Paribas, and Societe
Generale folks. They’re intertwined in a web
of deceit, corruption, and astronomical leverage and when one goes, they all
go. That is why the paper refers to them as being ‘Systemically
Important’. Like we need these characters for something. These
aren’t even banks really; they’re casinos on steroids.
Let’s take a look at some of the bankerspeak
from the Bank of England and FDIC shall we?
“These strategies have been designed to enable
large and complex cross-border firms to be resolved without threatening
financial stability and without putting public funds at risk.”
– Note the emphasis on ‘public funds’ ie:
bailouts and the concomitant promise that bailouts will no longer be used.
“A process to ensure the equitable treatment
of the creditors, depositors, counterparties and shareholders of group
entities, regardless of the jurisdiction in which they are located, which
would require careful assessment of the provision of intra-group
financing;” – Note
‘equitable treatment’ clause.
Here’s the London Whale and the essence of the entire paper:
In the U.S., the strategy has been developed in the
context of the powers provided by the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010. Such a strategy would apply a single receivership
at the top-tier holding company, assign losses to shareholders and unsecured
creditors of the holding company, and transfer sound operating subsidiaries
to a new solvent entity or entities. – Still no specific mention of where depositors fit in.
And a bit more on who ultimately takes the hit, but in vague terms:
Title
II (of the Dodd-Frank Act) requires that the losses of any financial company
placed into receivership will not be borne by taxpayers, but by common and
preferred stockholders, debt holders, and other unsecured creditors, and that
management responsible for the condition of the financial company will be
replaced.
Note
that depositors are not mentioned anywhere in this exchange. It only says
that taxpayers won’t take the hit. So there will be no more bailouts.
Allegedly. The portion of interest to depositors is the bit about
‘other unsecured creditors’. If only equity and debt holders are
going to be held responsible for ‘making the firm whole’ in
receivership, then what happens when a hundred dollar stock can’t get a
bid at five bucks because the firm is insolvent? Look at Lehman. Confiscating
every share and selling it wouldn’t have even come close to righting
the ship. Double that for bonds. Besides, who would even want it? Even
assuming there were buyers at par, thanks to leverage, the amount needed to
effectively resolve the insolvent firm could easily be many times the
proceeds of any sale. The ONLY liquid assets within reach for an insolvent
bank are the deposits. Yet deposits and depositors aren’t even
mentioned in the FDIC/BOE report. Follow along:
“An
efficient path for returning the sound operations of the G-SIFI to the
private sector would be provided by exchanging or converting a sufficient
amount of the unsecured debt from the original creditors of the failed
company into equity. In the U.S., the new equity would become capital in one
or more newly formed operating entities.”
And
this is where the noose closes around the necks of depositors. Pay close
attention. Unsecured debt is money that is OWED by the now insolvent bank to
creditors. That debt is unsecured, meaning that the creditors can’t
repossess buildings, etc. to make good on the unpaid debt. So they’re
going to take a bunch of people that are owed something and turn them into
owners of the company by converting debt to equity. So what you have is the
common and preferred stockholders wiped out and a bunch of creditors now
owning the company. But where does the capital come from that is mentioned in
the above paragraph? All we’ve done to this point is shuffled some deck
chairs on the SS BrokenBank. We’ve wiped out
the original capital/owner’s equity and replaced it with
‘unsecured debt’ holders. This
resolution mechanism ONLY works if you assume that the deposits fall into the
same category as ‘unsecured debt’ and as such are written-down
along with unsecured debt (a la Cyprus). Otherwise you’d be in a
situation where public money would be needed to re-liquefy the new firm and
both Dodd-Frank and the FDIC/BOE report specifically state that public money
will not be put at risk. Instead, depositor money will be at risk. Yet the
FDIC/BOE report does not explicitly say that, and in fact does quite a bit of
outstanding grammatical grandstanding to avoid even alluding to it.
It
must also be noted that the FDIC/BOE report was dated 10-December-2012; well
in advance of the Cypriot bank holiday. The blueprints for America and Europe
were laid well ahead of the beta test.
Exhibit II –
“Report and Recommendations of the Cross-Border Bank Resolution
Group” – Bank for International Settlements – 2010
This report pre-dated the combined FDIC/BOE report by nearly 2 years
and was one of the first whitepapers released by a major banking
‘authority’ after the demise of Lehman Brothers and several other
firms in 2008. Again, the ambiguity of the language must be noted and the
not-so –subtle grouping of depositors with ‘other
creditors’. See below:
“The operation of national regulatory,
corporate and insolvency regimes in home/host jurisdictions including the
scope of potential ring fencing measures, the treatment of intra-group
claims, safe harbour provisions for financial
contracts, the treatment of depositors and other creditors under the relevant
resolution frameworks, and market, regulatory and legal constraints that may
require early disclosure of an impending crisis;”
Note again as in the FDIC/BOE report the lumping together of
depositors and ‘other creditors’. Formerly, depositors were NOT
considered creditors and had separate and distinct rights under the law. For
US bank account holders, the biggest ‘right’ is FDIC protection
afforded depositors. That protection is not afforded to creditors.
Below is another example of where depositors are amalgamated with
creditors. What obligations do depositors have to a bank anyway? And even
further, what obligations do they have when a bank goes bust other than to
safeguard their assets? Follow along as the BIS report begins to shift the
definition of and mindset concerning depositors:
A commitment of national jurisdictions to undertake
the necessary legal reforms, which may require a harmonization of national
rules governing cross-border crisis management and resolutions, including
rules on core issues such as a common definition for bank insolvency, avoidance
powers, minimum rights and obligations of creditors including depositors,
treatment of intra-group claims, ranking of claims, rights to set-off and
netting, and the treatment of certain financial contracts, submission and
admission of claims, and distributions to creditors;
Also, and perhaps ironically, the BIS paper and the FDIC/BOE paper
differed dramatically with regards to the possibility of public bailouts for
compromised firms such as Lehman. Banks shoot their own wounded. When one
gets in trouble, credit lines are withdrawn, loans refused, and the failing
institution is isolated. That is what caused the need for tremendous publicly
funded bailouts in 2008. Obviously such actions are politically unfavorable,
especially when you have a Treasury Secy who
blatantly lies about how the money will be used.
Making a note of the change in tenor from 2010 to 2012 is critical.
The emphasis shifted from taxpayer-funded bailouts to the model of swiping
depositor money to sustain broken firms. Of course nobody was really sure how
that would work out. Hence the perfect test in Cyprus. Physically isolated,
the Cypriots never had a chance. And, right on schedule, the biggies were forewarned and
made their quiet exit before D-Day. This part always comes out later and is released very quietly.
In Conclusion –
Some Pointers
In America, the segment of folks who are
actually awake are pretty upset about all this and have noticed the change in
tone from the bailout to bail-in model. Understandably, they’re not too
happy about it and seek insight. There are a couple of signposts and points
to remember about these types of events:
1) Beware of Friday afternoons after market close. This is when the
big actions occur. Bankruptcy filings are made and these crises are whipped
up to a frenzy state. This is done for a reason. It gives the powers that be
the entire weekend to plot behind closed doors while nobody can do a thing.
In Cyprus they closed the banks and when the ATMs were empty, that was it.
The crisis was on. Lehman happened over a weekend. That is no guarantee, but
that has been the modus operandi in
the past.
2) We’re one headline from an identical crisis here. The same
applies to the EU and the rest of the world. This is the nature of the game
that is played. It is literally impossible for any person to fully comprehend
the amount of leverage that is being employed in terms of the OTC derivative
market alone. The exposure is tremendous and systemic. The BIS and the rest
can write all the whitepapers and talk about orderly this and that all they
want. The truth is when (not if) that mountain starts shaking, all bets are
off. And again, the focus of the banking ‘authorities’ has been
on cleanup rather than prevention. Understanding this is key
to grasping the concept that these folks realize they can’t control
these markets or events. It’s a financial Frankenstein and nobody
really knows what it is going to do.
3) Follow the blueprints – and the money. The BIS paper, and
more importantly, the FDIC/BOE paper, lay the blueprints on how these crises
will be dealt with moving forward. I find it hilarious that the papers cite a
public distaste for bailouts. I guess they figure that swiping bank accounts
is going to be more palatable. Of course it won’t be packaged that way.
We’ll be told that the ‘haircut’ will only be for the
‘rich’. However, by the time it is over, everyone will be cleaned
out to some extent. Just look at the end result in Cyprus. They knew all
along the Proletariat was going to take a beating. Class warfare is the
oldest weapon in the book when it comes to getting people to subscribe to
draconian social measures. Yep, nail the other guy, just leave me alone. It
works every time.
There are many analysts who believe these events are imminent. I tend
to disagree. Don’t forget that this is, in many ways, a psychological
warfare operation. There is always the potential of a black swan event,
however, I would think that there would be some time separation between
Cyprus and the next event(s) to allow the public to go back to sleep. That
said, those who adequately prepare now should be
prepared to maintain those preparations – perhaps indefinitely. This is
not a one or two month, then back to the party type situation. Our world has
changed many times in the last decade. This is just another step in that
progression away from liberty.
The FDIC/BOE report may be found by clicking here.
The BIS report may be found by clicking here.
Andrew W.
Sutton, MBA
Chief Market Strategist
Sutton & Associates, LLC
http://www.sutton-associates.net
andy@suttonfinance.net
Sutton &
Associates, LLC is a Registered Investment Adviser in the Commonwealth
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