SOURCE: ASCOT ADVISORY
One of the recent top stories in 2016 so endemic and explicative of what is going on in banking involves the Austrian financial institution Hypo Alpe Adria, which incidentally was taken over by Austrian Government authorities in 2009 and placed into receivership under an entity named Heta Asset Resolution. Flash forward to about March of 2015, whereby it was revealed that the equivalent of US$8.5 Billion Dollars has disappeared from the balance sheet and as a result that entity has now been taken over by Austria’s Financial Market Authority. So here is the first question: what were these people doing for almost 7 years? I know there was some football championships (soccer for the Americans) on television that might have diverted attention for awhile, but 7 years?
Ironically enough, the local Austrian municipality of Carinthia, where the bank is (was) headquartered, guaranteed 10 billion Euros worth of Heta debt, which they cannot now honor in full bringing this crisis to a new pinnacle. The Austrian national government also agreed to back one Billion Euros worth of bonds issued in 2012 to supposedly help re-capitalize the bank which the Austrian Federal Government claims they will honor. Interestingly enough, the 1931 default of Creditanstalt in Austria was considered one of the defining moments ushering in the so-called Great Depression of that era and some point to very similar circumstances with Hypo Alpe Adria. Does history repeat itself or is it just a coincidence?
Enter the Bail-In (not to be confused with Bruce Lee’s enter the dragon, although one might see a correlation with the bank depositors being the recipients of financial karate chops). In the infinite wisdom of many political leaders, the bail-in paradigm is now upon us with the Austrian Government also saying JA, JA to implementing the bail-in option for Hypo Alpe Adria (or should we say Heta Asset Resolution?). And of course all European Union nations were required to pass bail-in legislation for their respective countries in 2016, so do not think this applies only to Austria alone (in fact, the bail-in paradigm is also in place in Canada and the US, so do think this is native to Europe only either). And regarding this matter, a news story from late 2015 reported that The European Commission was taking legal action against the Netherlands and Luxembourg for failing to implement banking bail-in initiatives. Supposedly Poland, the Netherlands, Luxembourg, Sweden, Romania and the Czech Republic were warned already for not complying with the so-called bank recovery and resolution directive (in simple layman terns, bail-in legislation). So, this nonsense is actually being forced upon all EU countries via the courts, and is not merely a suggestion. In other words, pretty much for all of the so-called developed countries, they want this to be the law.
But, considering the Austrian Government has already poured 5 Billion Euros into the bank via a tax-payer bailout, they have decided that now it is time to do the bail-in thing (if the Ying does not work, try the Yang). The problem is though, unlike the partial loses the depositors in Cyprus experienced (home of the original and first bail-in), speculation is that account holders of Hypo Alpe – Heta Asset will lose it all and not just a heavy trim (the financial term is haircut, but unlike leaving the barber shop feeling neat and clean, the financial terminology refers to loss of your money and your proverbial and metaphorical pants, which is one kind of grooming most people wish to avoid). Technically the first phase of this involves 100 percent loss for the subordinated debt holders, and a 50 percent loss for other classes of debt. And one of the weapons in the bail-in arsenal is the conversion of debt to equity. But, simply wiping out debt holders and converting that to equity (stock) does not infuse NEW operating capital into the bank. So, where oh where can they get their hands on capital if no government bail-out funds are forthcoming? The answer my dear Watson are the savings account holders and other depositors. So, if you are someone with a savings account with this institution you may soon be eating a very foul tasting wiener schnitzel, so to speak.
And not to go off on a seemingly unrelated tangent, we have previously called negative interest rates voodoo economics. Honestly, that is not complete (although it is in terms of the crackpot economists that actually support this idea, the term voodoo is accurate). Rather, negative interest rates are in fact a stealth banking bail-in albeit one that is done monthly and on going. How so? Because each and every month under this negative interest nonsense, the bank is taking money out or charging the depositor interest instead of paying them interest. And who gets that money? The government? The nuns at the monastery of St. Albans? No my dear friends, the bank itself where such deposits are held. The economic arguments in favor of this witch doctor medicine proclaim it is necessary to stimulate the economy by forcing citizens to spend their money (as opposed to save and invest it). However, as we predicted and as we have already seen in Japan, the only thing this has done is motivate people to pull money out of the banks, and naturally sales of home safes have gone through the roof (so if you want an investment idea, buy the stocks of home safe manufacturers as they should be doing a brisk business in Europe and the US in the future).
So, by now you are probably thinking that this guy (me) has a big mouth and always criticizes without offering any solid and logical solutions, and you are probably right. Therefore, here is how we would handle a failing or failed banking institution. First off you liquidate ALL customer savings accounts and time deposit accounts for 100 percent. In other words, whatever the account balance is as of the date the entity is taken over, every single depositor gets a check for the full balance they had in their account at that moment. The result is, these individual depositors loose nothing and have the opportunity to save that money in another solvent financial institution, spend it or whatever they want to do. In conjunction with that exercise, the bank is placed into receivership while hopefully government appointed accountants and administrators can sell off real estate and other assets and otherwise said wind down the mess, trying to at least break even and recoup the tax payer money that was paid out to savings account holders. But, in the least you discharge or make whole the people that had nothing to do with the losses, meaning the depositors, right away and immediately. However and simultaneously you leave the stock and bond holders frozen for very last if there is miraculously any money left over after the complete liquidation, which is often doubtful in such cases. And please understand why we say this. No one likes to loose money, including yours truly. However, on a macro level it is important to understand why this order is fair and necessary.
First and foremost what kind of a person invests in stock, bonds issued by private corporations and typical bank savings accounts? In terms of the traditional bank savings account we are talking about people that are risk adverse, are trying to save money for whatever reason and probably do not have the extra discretionary funds for stocks or other kinds of investments that carry higher degrees of risk (and higher opportunity for reward of course as well). The bus driver that takes you to work, the train conductor, the cleaning lady in your office and even your crazy elderly aunt Kathy with a house full of cats. These are people that put their savings, however meager it might be, into a bank and accept low rates of return in exchange for the perceived safety. These are people that do not know what a derivative is, probably do not care, and would be appalled to realize what a supposed conservative and prudent financial institution is using their savings account money for. That is NOT what they signed up for when they opened their savings account. On a macro economic level, if you make sure these people all get their money back, their savings, you are getting money back into the hands of those consumers that actually do spend and consume. In the least, you protect the innocent and reward good banks by having the opportunity to gain new depositors. If you simply give that money to a private corporation in the form of a bail out, that money is NOT going directly back into the real economy and is only shoring up loses (throwing good money after bad).
Next up we have the stock and bond investors. Bond investors are of course more conservative that equity investors and are looking for higher returns than may be offered by traditional bank savings products but also are keenly interested in the promised return of their capital. However, they do know (or should know) that by investing into bonds issued by a private company, that such a company could go broke and not return the money that was lent. So bonds certainly do offer a higher element of risk and are NOT government guaranteed as are funds in a bank savings account via the various government banking insurance programs. And then of course we have the stock investors, the cowboys of the group that are willing to take the risk on equities because they are hopeful of the higher returns it might bring. But, in both cases, there is risk involved and such investors of these kinds of securities know it. In addition, one can assume such investors are putting their own discretionary savings at risk in such investments, and not money they cannot afford to loose. So, the profile of the stock or bond investor is quite different from the savings account holder.
Does this really make any sense and is it applicable in the real world? According to the Hypo Alpe Adria group 2013 annual report, it seems that they had about 8.2 Billion in depositor liabilities (what they owed savings account holders and time deposit deposit holders) if we are reading the report correctly. I would have to imagine the deposit base was higher prior to 2009 but none the less, let us use the 2013 numbers as a point for discussion. The Austrian Government had already bailed out the bank to the tune of 5.5 Billion Euros between 2009 and 2012, as in basically infused cash which was seemingly thrown down a rabbit hole. Mind you, this was tax payer money that being injected into a failed private banking institution. Would it not have been better to use that money to simply close all customer savings and other kinds of accounts, pay them off in full and try to recoup the rest via the winding down operation? Surely there is a government banking insurance fund in Austria, so you let that entity cover whatever they have promised to cover and use that 5.5 Billion Euros to cover the rest (and you try to recoup that with the liquidation process).
When governments bail out failed or failing financial institutions they are playing a dangerous game and one they should not be involved with. Firstly, they are favoring private business owners over individual citizens, and using public funds to do it. Secondly, they are creating what is known as moral hazard, encouraging such private businesses to continue to operate in a reckless manner believing if they get into trouble again that the government will be there once again with more tax payer funds. Bail outs are not the answer or solution AND bail-ins certainly are not either. Let delete the word bail altogether from the lexicon.
In terms of the banks attempting to whittle down their derivatives activity, it is true that The Bank For Internal Settlements (BIS) reports the notional amount of outstanding over-the-counter derivatives contracts dropped by around $84 Trillion to $553 Trillion in 2015. However, we are still talking about an outstanding total of derivatives contracts that far exceeds current world GDP. In addition, when looking at the net unallocated totals of liabilities versus claims on a regional basis, we see some disturbing numbers. The Bank For Internal Settlements (BIS) calculates that at the close of 2015 the EU has liabilities that are 800 percent of claims, which means they owe 800 percent of what they have on the books for money owed to them. In all of the developed world combined (including the US), the ratio is that liabilities are 400 percent of claims. Do you know what areas have the best prognosis at the moment (at least in terms of these same statistics)? The emerging or developing markets, which ALL have claims higher than liabilities. Asia is actually the best off with claims of 700 percent or 7 times that of liabilities.
In terms of the United States and health of the banking sector, it was recently reported that many of the larger money center banks in New York failed to produce a viable (financially) will. A will or last testament, as in what will happen to your assets when you DIE, or go bankrupt in this case. The New York Times reports on April 16, 2016 that: The Fed and the F.D.I.C., which jointly oversee the largest banks, agreed that the plans put forward by five of the big banks, JPMorgan, Bank of America, Wells Fargo, State Street and Bank Of New York Mellon, were not credible or would not facilitate an orderly resolution under the U.S. Bankruptcy Code. Bloomberg reports on April 13, 2016 that: U.S. regulators have asked their internal watchdogs to examine how assessments of banks’ plans for winding down during a potential bankruptcy ended up in a news article. The Federal Reserve and Federal Deposit Insurance Corp. requested that inspectors general investigate whether someone at their agencies leaked details on bank’s so-called living wills.
Here is our take away or question about all this. 1. Is there an actual concern by the US Federal Reserve and the US Government Banking Insurance Program for depositors (FDIC) that the largest money center banks might go bankrupt in 2016? 2. An information report is leaked to the press and almost instantly government law enforcement is called into action. So, a government banking report is leaked and all heck breaks loose yet a theft of data occurs at a private law firm and no one seems to be interested (at a government level) in knowing who the thief is? As Sargent Shultz from the Hogans Heroes sitcom used to say: Very Interesting!
Regardless, one does not create a will unless there is real concern about dying (unlike people, corporations are theoretically perpetual and immortal so to speak, no?). Likewise, one does not create a structure to allow for bank bail-ins unless one thinks this will be needed and put into action in the future. People that open bank savings accounts are NOT doing so with the understanding or intent on becoming unsecured creditors to a financial institution. Rather, they do so with the understanding they are giving their money to a safe and prudent fiduciary. Using tax payer or public funds to bail out or prop up a failing private company is wrong and economically unwise on a number of levels. It has been 8 years since the so-called financial crisis of 2008, and Billions of Dollars and Euros have been infused into those respective banking systems since that time. So, are all these banks finally solvent yet? Has the public tax payer bail out money actually solved the problem or has it merely postponed the day of reckoning? Apparently not.
Likewise for the idea of a bail-in, which is in effect forcibly taking money away from depositors to cover foolish decisions by the bank’s management. Even if the funds are taken out of the depositors savings account and they are given stock in return, that is NOT what such account owners signed up for. If you think I stretch the truth, you may wish to read the December 2012 report issued jointly by the Bank of England and the US FDIC titled: Resolving Globally Active Systemically Important Financial Institutions. This report is a plan designed to assign losses to shareholders and unsecured creditors as a resolution strategy for failing banks. The plan also calls for exchanging or converting a sufficient amount of the unsecured debt from the original creditors (depositors) of the failed company into equity.
It should be understood that financial services entities, such as banks and securities brokerages, are nothing more and nothing less than intermediaries matching savers and investors with those persons, companies or governments looking to borrow capital or secure equity investors. Just as real estate brokers and agents do not build homes and commercial buildings, but rather merely match up buyers and sellers (collecting a commission in the process), banks do not create innovative new industries to grow the economy. They simply lend the money to other people that have the talent and ability to do so. The point is, governments have placed too much importance on a small sector of the economy that is providing a brokerage function. Banking is an important part of the economy, but only a small part of it and not the entire economy itself. If the rest of the economy is gravely ill, the health of a few large banks will not matter much.
Summing it all up, the question remains: will 2016 evolve into being remembered as the bail in year? Hard to say for sure, but many governments around the world certainly seem to think so (why would the EU insist that such bail in legislation be in place no later than 2016?). In terms of individual investors trying to protect themselves we still think it is a good idea to have some funds saved or invested elsewhere, mainly in the emerging or developing markets which still are growing, and are less likely to get involved with this bail in nonsense (try to tell a rice farmer the government wants to allow the banks to take his money out of his savings account to cover bank loses, see how that plays out). One needs to think and behave like the proverbial squirrel stashing nuts in different tress and preferably in trees in different forests, for safety sake.
John Schroder is the author of this article and his firm, Ascot Advisory Services, has been assisting clients for 17 years in The Dominican Republic with residency applications, citizenship applications, banking and investment accounts, and other legal services (real estate contracts and title transfer, company formation services)