It Can Happen Here: The Bank Confiscation Scheme for US and UK Depositors

Guest post by Ellen Brown, http://www.WebofDebt.com.

Confiscating the customer deposits in Cyprus banks, it seems, was not a one-off, desperate idea of a few Eurozone “troika” officials scrambling to salvage their balance sheets. A joint paper by the US Federal Deposit Insurance Corporation and the Bank of England dated December 10, 2012, shows that these plans have been long in the making; that they originated with the G20 Financial Stability Board in Basel, Switzerland (discussed earlier here); and that the result will be to deliver clear title to the banks of depositor funds.  

New Zealand has a similar directive, discussed in my last article here, indicating that this isn’t just an emergency measure for troubled Eurozone countries. New Zealand’s Voxy reported on March 19th:

The National Government [is] pushing a Cyprus-style solution to bank failure in New Zealand which will see small depositors lose some of their savings to fund big bank bailouts . . . .

Open Bank Resolution (OBR) is Finance Minister Bill English’s favoured option dealing with a major bank failure. If a bank fails under OBR, all depositors will have their savings reduced overnight to fund the bank’s bail out.

Can They Do That?

Although few depositors realize it, legally the bank owns the depositor’s funds as soon as they are put in the bank. Our money becomes the bank’s, and we become unsecured creditors holding IOUs or promises to pay. (See here and here.) But until now the bank has been obligated to pay the money back on demand in the form of cash. Under the FDIC-BOE plan, our IOUs will be converted into “bank equity.”  The bank will get the money and we will get stock in the bank. With any luck we may be able to sell the stock to someone else, but when and at what price? Most people keep a deposit account so they can have ready cash to pay the bills.

The 15-page FDIC-BOE document is called “Resolving Globally Active, Systemically Important, Financial Institutions.”  It begins by explaining that the 2008 banking crisis has made it clear that some other way besides taxpayer bailouts is needed to maintain “financial stability.” Evidently anticipating that the next financial collapse will be on a grander scale than either the taxpayers or Congress is willing to underwrite, the authors state:

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 [meaning the depositors] into equity [or stock]. In the U.S., the new equity would become capital in one or more newly formed operating entities. In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailed-in creditors would become the owners of the resolved firm. In either country, the new equity holders would take on the corresponding risk of being shareholders in a financial institution.

No exception is indicated for “insured deposits” in the U.S., meaning those under $250,000, the deposits we thought were protected by FDIC insurance. This can hardly be an oversight, since it is the FDIC that is issuing the directive. The FDIC is an insurance company funded by premiums paid by private banks.  The directive is called a “resolution process,” defined elsewhere as a plan that “would be triggered in the event of the failure of an insurer . . . .” The only  mention of “insured deposits” is in connection with existing UK legislation, which the FDIC-BOE directive goes on to say is inadequate, implying that it needs to be modified or overridden. 

An Imminent Risk

If our IOUs are converted to bank stock, they will no longer be subject to insurance protection but will be “at risk” and vulnerable to being wiped out, just as the Lehman Brothers shareholders were in 2008.  That this dire scenario could actually materialize was underscored by Yves Smith in a March 19th post titled When You Weren’t Looking, Democrat Bank Stooges Launch Bills to Permit Bailouts, Deregulate Derivatives.  She writes:

In the US, depositors have actually been put in a worse position than Cyprus deposit-holders, at least if they are at the big banks that play in the derivatives casino. The regulators have turned a blind eye as banks use their depositaries to fund derivatives exposures. And as bad as that is, the depositors, unlike their Cypriot confreres, aren’t even senior creditors. Remember Lehman? When the investment bank failed, unsecured creditors (and remember, depositors are unsecured creditors) got eight cents on the dollar. One big reason was that derivatives counterparties require collateral for any exposures, meaning they are secured creditors. The 2005 bankruptcy reforms made derivatives counterparties senior to unsecured lenders.

One might wonder why the posting of collateral by a derivative counterparty, at some percentage of full exposure, makes the creditor “secured,” while the depositor who puts up 100 cents on the dollar is “unsecured.” But moving on – Smith writes:

Lehman had only two itty bitty banking subsidiaries, and to my knowledge, was not gathering retail deposits. But as readers may recall, Bank of America moved most of its derivatives from its Merrill Lynch operation [to] its depositary in late 2011.

Its “depositary” is the arm of the bank that takes deposits; and at B of A, that means lots and lots of deposits. The deposits are now subject to being wiped out by a major derivatives loss. How bad could that be? Smith quotes Bloomberg:

. . . Bank of America’s holding company . . . held almost $75 trillion of derivatives at the end of June . . . .

That compares with JPMorgan’s deposit-taking entity, JPMorgan Chase Bank NA, which contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives, the OCC data show.

$75 trillion and $79 trillion in derivatives! These two mega-banks alone hold more in notional derivatives each than the entire global GDP (at $70 trillion). The “notional value” of derivatives is not the same as cash at risk, but according to a cross-post on Smith’s site:

By at least one estimate, in 2010 there was a total of $12 trillion in cash tied up (at risk) in derivatives . . . .

$12 trillion is close to the US GDP.  Smith goes on:

. . . Remember the effect of the 2005 bankruptcy law revisions: derivatives counterparties are first in line, they get to grab assets first and leave everyone else to scramble for crumbs. . . . Lehman failed over a weekend after JP Morgan grabbed collateral.

But it’s even worse than that. During the savings & loan crisis, the FDIC did not have enough in deposit insurance receipts to pay for the Resolution Trust Corporation wind-down vehicle. It had to get more funding from Congress. This move paves the way for another TARP-style shakedown of taxpayers, this time to save depositors.

Perhaps, but Congress has already been burned and is liable to balk a second time. Section 716 of the Dodd-Frank Act specifically prohibits public support for speculative derivatives activities. And in the Eurozone, while the European Stability Mechanism committed Eurozone countries to bail out failed banks, they are apparently having second thoughts there as well. On March 25th, Dutch Finance Minister Jeroen Dijsselbloem, who played a leading role in imposing the deposit confiscation plan on Cyprus, told reporters that it would be the template for any future bank bailouts, and that “the aim is for the ESM never to have to be used.”

That explains the need for the FDIC-BOE resolution. If the anticipated enabling legislation is passed, the FDIC will no longer need to protect depositor funds; it can just confiscate them.

Worse Than a Tax

An FDIC confiscation of deposits to recapitalize the banks is far different from a simple tax on taxpayers to pay government expenses. The government’s debt is at least arguably the people’s debt, since the government is there to provide services for the people. But when the banks get into trouble with their derivative schemes, they are not serving depositors, who are not getting a cut of the profits. Taking depositor funds is simply theft.

What should be done is to raise FDIC insurance premiums and make the banks pay to keep their depositors whole, but premiums are already high; and the FDIC, like other government regulatory agencies, is subject to regulatory capture.  Deposit insurance has failed, and so has the private banking system that has depended on it for the trust that makes banking work.

The Cyprus haircut on depositors was called a “wealth tax” and was written off by commentators as “deserved,” because much of the money in Cypriot accounts belongs to foreign oligarchs, tax dodgers and money launderers. But if that template is applied in the US, it will be a tax on the poor and middle class. Wealthy Americans don’t keep most of their money in bank accounts.  They keep it in the stock market, in real estate, in over-the-counter derivatives, in gold and silver, and so forth.

Are you safe, then, if your money is in gold and silver? Apparently not – if it’s stored in a safety deposit box in the bank.  Homeland Security has reportedly told banks that it has authority to seize the contents of safety deposit boxes without a warrant when it’s a matter of “national security,” which a major bank crisis no doubt will be.

The Swedish Alternative: Nationalize the Banks

Another alternative was considered but rejected by President Obama in 2009: nationalize mega-banks that fail. In a February 2009 article titled “Are Uninsured Bank Depositors in Danger?“, Felix Salmon discussed a newsletter by Asia-based investment strategist Christopher Wood, in which Wood wrote:

It is . . . amazing that Obama does not understand the political appeal of the nationalization option. . . . [D]espite this latest setback nationalization of the banks is coming sooner or later because the realities of the situation will demand it. The result will be shareholders wiped out and bondholders forced to take debt-for-equity swaps, if not hopefully depositors.

On whether depositors could indeed be forced to become equity holders, Salmon commented:

It’s worth remembering that depositors are unsecured creditors of any bank; usually, indeed, they’re by far the largest class of unsecured creditors.

President Obama acknowledged that bank nationalization had worked in Sweden, and that the course pursued by the US Fed had not worked in Japan, which wound up instead in a “lost decade.”  But Obama opted for the Japanese approach because, according to Ed Harrison, “Americans will not tolerate nationalization.”

But that was four years ago. When Americans realize that the alternative is to have their ready cash transformed into “bank stock” of questionable marketability, moving failed mega-banks into the public sector may start to have more appeal.

Comment by Washington’s Blog:  The big banks have already been “nationalized” in the sense that they are state-sponsored institutions .  In fact, the big banks went totally bust in 2008, and are now completely subsidized by the government.

Americans may not like the idea of nationalization, but they are even more  disgusted by crony capitalism … which is what we have now.

Moreover, as we pointed out in 2009:

Many argue that it would be wrong for the government to break up the banks, because we would have to take over the banks in order to break them up.

That may be true. But government regulators in the U.S., Sweden and other countries which have broken up insolvent banks say that the government only has to take over banks for around 6 months before breaking them up.

In contrast, the Bush and Obama administrations’ actions mean that the government is becoming the majority shareholder in the financial giants more or less permanently. That is – truly – socialism.

Breaking them up and selling off the parts to the highest bidder efficiently and in an orderly fashion would get us back to a semblance of free market capitalism much quicker.

Category: Bailouts, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

11 Responses to “Bank Confiscation Scheme for US and UK Depositors”

  1. Fredex says:

    I see Hunger Games.

  2. Clem Stone says:

    You’re gonna need a bigger mattress.

  3. ancientone says:

    My God. What a horrible thing to read on Easter morning.

  4. Thomaspin says:

    Keep one month’s living expenses with your bankster, the rest at Fidelity.

  5. TryingtobeRational says:

    Long time RSS feed reader, first time poster. Barry, I’ve always considered you a trusted and insightful source regarding financial matters. Thank you for your great efforts!

    I have, however, been recently disappointed by your guest blogger “Washington’s Blog”. He brings some very important info to light and keeps us all on our toes but several times he has posted things that, on further digging, turn out to be inaccurate or just downright rumor. It seems his confirmation bias is showing. (Don’t get me wrong, I think much of what the world banksters and governments are doing is criminal!) I know it would take a lot of effort for you or your readers to vet everything he posts but finding inaccuracies does lead me to devalue his posts. I find myself increasingly inclined to dismiss them – or feeling like I have to deeply research everything so I can sort the echo-chamber chaff from the kernels of truth. Sorry to say that this also impacts your blog’s reputation.

    Specific to this blog post, dig further into this: “Homeland Security has reportedly told banks that it has authority to seize the contents of safety deposit boxes without a warrant when it’s a matter of “national security,” which a major bank crisis no doubt will be.” Turns out to be a rumor, unsubstantiated, with no source documents backing it up that I could find. Not that I wouldn’t think it possible, but I wish he could keep things rational by linking to sources not to rumors.

  6. victor says:

    The banks (and the US Treasury) are already confiscating depositors’ money via negative interest rates. Where are you Bill Seidman of the Resolution Trust when we need you? Nassim Taleb reminds us that the banking sector has never turned a consistent profit over the years. As much as I despise socialism (I mean true socialism like in the second S of the defunct USSR) I’d go for nationalization, management expulsion, clawback and all and recapitalization of the parts with strict Volker type rules in place.

  7. victor says:

    Are money market accounts safer?

  8. FrViper says:

    Barry, as irrelevant, I love your picture looking to the skies, from wence our help shall come. It sure isn’t the Fed!

  9. Herman_Newticks says:

    Have to dispute this one in its entirety. The FDIC/BoE paper specifically refers to unsecured creditors of HOLDING COMPANIES, not banks. Depositors are not unsecured creditors of holding companies. Bank deposits are insured and banks are subject to an entirely separate resolution scheme with an independent funding source.

    “The FDIC is an insurance company funded by premiums paid by private banks.” Yes, but no. Legally, it is a mixed ownership government corporation. But there is no mixed ownership, b/c the federal governemnt bought and decommissioned all the existing stock, and removed the statutory authority to issue it. It is a government agency, wholly “owned” by the federal government, and backed by the full faith and credit of the U.S. gov’t.

    As for the reference to the the resolution powers being triggered by the failure of an insurer, the linked paper is not talking about the failure of the FDIC, but the failure of a SIFI insurer, Like the failure of AIG in 2008. This post is a mish-mash of half-baked ideas that reflect understanding neither of the joint proposal nor of the existing regulatory structure.

  10. oldbluejeans says:

    Well I might have been inclined to think that gold would get a bid after the Cyprus “thing”, or even after this. But it doesn’t. It seems that there are no safe places to store wealth, not in the traditional sense anyway. Maybe real estate or farm land. Wait – - no farm land is in bubble territory already. Gentlemen, choose your bubble!

  11. Martinghoul says:

    Agreed w/Herman_Newticks 100%. I can’t believe that TBP is republishing such a poorly researched and argued piece of rubbish. Even a superficial read of the FDIC-BoE paper shows that the outrageous claims made by Ellen Brown are just fabrications. Moreover, if you read the RBNZ piece on OBR, that also specifically addresses the issue of insured deposits, in contrary to the link posted. I mean I know everything published on the internet is obviously 100% true, or so the author of this rubbish seems to think. In seriousness, Ellen Brown is either seeking publicity by using the most panic-inducing headlines she could come up with, or, alternatively, she’s just not capable of understanding the material she is commenting on. Hence, as far as I am concerned, she has either no integrity or no credibility or neither of the two.