Plunderball – The new Euro banking game

We’ve all heard of deposit insurance, but does it mean what we all thought it meant – that up to a given sum we would not lose any money if our bank collapsed? And by the way – who pays the bill?

The simple idea we have all believed in was that up to a specified amount our money was guaranteed by a government deposit insurance scheme. Most countries have one. As long as your bank is in it you’re covered. Or at least you were till this week.

Before we get to the rapidly evolving changes lets just go over the details of what used to be the case.

It used to be that below the guarentee limit your money was safe. It was only any amount above the guarantee, that you could lose in a restructuring. When a bank went under the normal bankruptcy rules swung into action (I’m leaving aside the TBTF gorilla in the room. Let’s not poke him just yet).TBTF aside – the collapsed banks’ assets would collected in into a pile and all the bank’s creditors (those who bought its debt, lent it money, put their money into it) would be put on a list in order of seniority, with share holders at the bottom, unsecured and Junior bond holders next with Senior insured bond holders at the top. Depositors were always ranked up there with Senior bond holders. Those at top would get most if not all of their money back and not take a loss, those at the bottom would lose everything.

As a depositor you could still lose whatever money you had in the bank that was above the threshold but you might not. Your chances would be in line with the Senior bond holders. But as this bank debt debalce has mutated over the past 5 years so the old ranking of creditors has mutated with it. First the bail out funds like the EFSF and the ECB itself have made themeslves super senior. They have put themselves above Senior bond holders meaning in the event of a bank collape the ECB and EFSF, if they had been lending the bank money in return for collateral – would be first in line to get paid.

The private bond holders and the banks struck back at this idea a couple of years ago by ramping up the use of Covered Bonds. Covered bonds are way of trying to put private bond holders back above the ECB and EFSF. They are sold to investors on the claim that they are not just covered by a senior claim on the general assets of the bank – which would make them the same as traditional Senior bond holders – but that the Covered Bonds were also backed by a specially ‘ring-fenced’ set of assets of their own. So in a collapse the Covered Bond holders would have those ring-fenced assets withheld specially for them from the general pool of assets everyone else was queuing up for.

It remains to be seen if the ECB et al would recognize this arrangement as being senior even to them. It also is not clear to me in what I have read – if even the assets in the ‘ring-fence’ might not be pledged to more than one covered bond and possible even be hypothecated. None of this has, so far as I know, actually been tested in a case of competing claims at bankruptcy.

Be all that as it may – what is clear is that any amount of money you had above the guaranteed threshold would always have been at risk, BUT at the top of the pecking order alongside Senior Bond holders.

It is this long established order of seniority that has been torn up by what the EU tried to force upon Cyprus. As the financial publication Euromoney comments in an article on events in Cyprus,

…the complacent bailing in of the man-in-the street was the casual abandonment of the creditor hierarchy.

This is why the finanical markets were nearly as shocked as the man in the street. This established hierachy is the entire basis of all the arguments for saying Senior Bond holders could not be made to take losses in a bank collapse. They had to be protected. Now I always dissagreed with this and still do. I feel very strongly that depositors should morally come above everyone, and the senior bond holders should be in line like everyone else, not held as sacrosanct. Basically my view is we should protect the 99% ordinary depositors NOT the 1% bondholders.

But here we are now with that order of seniority having been torn up by the politicians. How now to argue for the Senior bond holders not to be touched? Suddenly there is no argument from principle. The principle was flushed when the Troika backed the Cypriot plan to seize money from ALL depositors. They can back-track and mumble about amendments to the plan all they like – the principle has been torn up.

Well it turns out other countries have been preparing to enforce this same – ‘force losses on all depositors’ – idea. New Zealand, as reported in an article by interest.co.nz has been working on what it calls its new Open Bank Resolution Policy (OBR). If put in place – and that is the NZ government’s intention,

The implementation of OBR would see all unsecured liabilities that rank equally among themselves, including deposits, having a portion frozen (My emphasis)

In response, as picked up over at Jesse’s cafe Americain, NZ Central bank has argued that really nothing has changed because,

…depositors have always needed to understand that deposits are not guaranteed… [OBR]…does not change the fact that depositors and other creditor funds are at risk…

This is at best highly disingenuous. Actually everything has changed. Under deposit guarantee depositors only lose ABOVE a threshold amount. Under OBR they ALL LOSE a given amount straight away.

… if a bank fails under OBR, all depositors will have their savings reduced overnight to help fund the bank’s bail out.

So it’s not just Cyprus. New Zealand has been working on the same idea. What about European countries?

ZeroHedge reported yesterday quoting from a report in El Pais, that Spain too has been working to implement the same idea.

Spain, it would appear, has changed constitutional rules to enable a so-called ‘moderate’ levy on deposits

UPDATE – and now, as picked up by The Slog, we have Joerg Kraemer, chief economist of the German Commerzbank sugesting Italy could/should seize 15% of Italian deposits.

And what about the UK ? Surely those fine bowler hatted gents of Threadneedle Street and the Right Honourable fellows over at Westminster – who stand for all that is good and dependable and NOT FOREIGN or FRENCH, wouldn’t ever think of such an outrage.

Back in December 2012 the FDIC and he BoE published a joint paper outlining their new approach for how to resolve any future collapse of one of the Too-Big-To-Fail banks, called “Resolving Globally Active, Systemically Important, Financial Institutions” . The paper is the blue print for how collapses, at what it calls G-SIFIs (Globally Systemically Important Financial Institutions) – get used to this term it will figure largely in your life in future whether you want it to or not- how they will be dealt with in future. I shall write more about this paper and the regime it outlines in future. It is not a pretty picture at all. But for now we need only look at section 34. which says,

34 The U.K. has also given consideration to the recapitalization process in a scenario in which a G-SIFI’s liabilities do not include much debt issuance at the holding company or parent bank level but instead comprise insured retail deposits held in the operating subsidiaries. Under such a scenario, deposit guarantee schemes may be required to contribute to the recapitalization of the firm, as they may do under the Banking Act in the use of other resolution tools. The proposed RRD also permits such an approach because it allows deposit guarantee scheme funds to be used to support the use of resolution tools, including bail-in, provided that the amount contributed does not exceed what the deposit guarantee scheme would have as a claimant in liquidation if it had made a payout to the insured depositors. (My emphasis)

As usual the official language is there to obscure rather than enlighten. But what it says is that the money that the Deposit scheme contains, instead of going to you, could now be used (read would be used) to bail out to the bank in order to prop it up. In other words the new system makes the Deposit Guarantee fund available for use as bail out money.

The rationale is that if using your deposit guarantee fund for propping up the bank ‘saves’ the bank from collapse then you wouldn’t need that deposit guarantee would you? This overlooks the one lesson we have all learned from the bank bail outs of the last 5 years, that the bail outs are never, ever, ever, a one off. The first one fails to save the bank as does the second and third and and and.

So if I have read the above correctly – the new system raids the Deposit Protection scheme, gives it to the bank instead of you and when that fails to save the bank…then what? The bank fails again and there is no money left in the Deposit Guarantee scheme.

And then? My guess is the government would say how they will replenish the fund – because they have your best interests at heart after all – BUT given ‘the exceptional circumstances’ and the ‘unforeseen severity of events’, no doubt forced upon them by rotten foreigners – the scheme cannot now be as generous as they would have liked it to be and the amount of the guaranntee has to be lower.

Will the UK and USA also go for the automatic seizure of money from accounts? My guess is they have been quietly planning on it but will now think twice about admitting to it. Preferring to keep it quiet until the next collapse when ‘circumstances call for desperate measures’ etc etc.

The reality is the banks are still bust – even the ones making huge profits – and when – not if – when the next bubble bursts and one bank starts to bring down another – they will all come for your money and we will all be collectively punished in order to make sure the wealthy and the powerful stay that way.

The bondholders in Cyprus could lose all of their investment and there still wouldn't be enough money to give the depositors 100%.

The government could give taxpayer money to the depositors, but Cyprus is broke.

Depositors lose, any way you look at it.

In the auto business they have a running gag - the taillight warranty.

The used car buyer asks "is there a warranty on this car?
The seller responds "Sure, a taillight warranty."
What the seller means is "As long as I can see your taillights, it's under warranty".

I am reminded of that when I hear about deposits that are guaranteed, until they decide they're not...

Very correct analysis.

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