by David Engstrom
Aside from our trust in God, yet still proclaimed on all of our currency, it may be our most sacred trust. That being the trust we have in our bank to hold our money and keep it safe. It is unthinkable to most, that you can put money in the bank and lose it. In fact, we were taught as kids, that you should save some of your money and for so doing you could earn interest on the accumulated balance.
On November 16, 2014, that all changed. On this date, the G20 formalized new standard procedures for handling bank failures to include bail-ins. No longer would taxpayers be called upon to bail out troubled financial institutions. Rather, the shareholders, bondholders, pensioners and creditors would be called on to bail-in their trusted financial institution, and in some cases, their country.
The standardized procedures for dealing with future bank failures that have materialized since the last banking crisis was in response to a cry for no more taxpayer bail outs. It was as if a battle had been won. Those considered “too big to fail” had finally been cut down to size. The victory reverberated through Wall Street. Even would-be Presidential candidates leaned on the victory to proclaim their belief that taxpayers should no longer bear the burden of having to bail out failed institutions.
Little did they know.
The term “bail-in” has been coined, even accepted, but is far from understood. You see, when it comes to bail-ins, everyone knows the definition of a shareholder, a bondholder, or pensioner. But, if you think you know how “creditors” is defined in this agreement to hold the aforementioned accountable when a bank fails, you may be shocked. “Creditors” includes “depositors.”
Remember Cyprus? Cyprus was said to be a one-off event. When the Cypriot bank failed, a bank holiday was declared – the bank closed its doors – and mayhem prevailed. Not only did the shareholders and bond holders of the bank find themselves listed in the loss column, but so did its depositors. A significant part of their deposits were taken to help “bail-in” the bank.
Let the Bail-Ins Begin
The Greek Saga
The financial collapse of Greece has tested the bail-in process. Current rescue plans by the European Central Bank, the IMF and the European Union have commonly been referred to as bail outs. Make no mistake though, bail outs were accompanied by massive bail-ins. Publicly, the bail-ins have been referred to as “austerity”. And hardest hit? Pension funds and those currently receiving pension payments!
According to The Economist, “entitlements have been cut at least 10 times” Since the Greek saga began in 2009. Greece’s social security system has also been reformed to increase social security taxes on those still working. Each time Greece needs another bail out to meet current debt obligations, creditors negotiate for even more “austerity”.
Some now fear a Grexit, which would constitute a default on current debt. The ramifications here are far-reaching. Early stories regarding the fall of Greece suggested a default could affect banks around the world, including U.S Banks. Later stories suggest the situation has been mitigated. According to a May 1, 2017 story in The Times, however, a desperate twist in the story has developed.
In a story titled, “Greece Stages Bank Raids in Hunt for Unpaid Tax,” we read,
“Authorities in Greece will raid bank safety deposit boxes to confiscate cash, bonds and even works of art as they move to collect billions of euros in unpaid tax.”
Now the bail-in becomes more real and apparent. On February 16, 2017, ZeroHedge reported the “Greek Bank Run re-accelerates.” Come July 2017, another 7 billion Euro debt payment is due. Faith is running out and so are depositors.
As you can see, even after billions of Euros in bail outs and billions more in bail-ins, the situation in Greece still roils. Next!
The Monte dei Paschi di Siena bank, Italy’s third largest bank and the world’s oldest bank began to fail in late 2016. The failure was triggered by a run on bank deposits. Within days, Italy’s cabinet, in an effort to restore confidence and stem the flow of cash out of the bank, approved a 20 billion Euro bail out. This deal was not immediately finalized.
As the crisis unfolded, the word bail-in was rarely used even though EU rules require junior bondholders to take losses before government can intervene with a bail out. Then on June 1, 2017, the bail-in word broke out. In a story release by the Financial Times, “Brussels and Rome Seal Rescue Deal for Monte dei Paschi,” an investor bail-in and deep restructuring was agreed to.
It appears, just as in the case of Greece and Greek Banks another taxpayer bail out will be accompanied by another bank customer bail-in for Italian bank, Monte dei Paschi di Siena.
THIS JUST IN!!
As I write, ZeroHedge just reported that two more Italian Banks just failed. Veneto Banca and Banca Populare di Vicenza. After a months long effort to save the banks via new sources of public funding, these efforts were abandoned. According to ZeroHedge, “stockholders will be crushed.” “Junior bondholders will likely get slammed hard.” At the same time efforts are being made to protect senior bondholders and depositors.
The bank closed on a Friday and re-opened business as usual on Monday. This in an effort to stave off a bank run. The story is developing and it is yet to be seen if a bank run can be avoided and if depositors can indeed be protected against bail-in actions.
On June 7, 2017, Banco Popular, a large Spanish lender was bought for the token sum of 1 Euro by Santander, Spain’s largest bank. The sale was induced by a run on the bank which was draining Popular’s deposit balances at a rate of $2.2 billion dollars a day. Popular’s Stock value plunged 50% in just 4 days before regulators declared it worthless.
Once again shareholders would be wiped out along with junior bondholders. So far, the takeover by Santander has spared depositors of participation in the bail-in. It appears Europe is holding bank deposits sacred in current bail out bail-in actions. One sniff of another Cyprus-style bail-in by depositors could begin a wave of bank runs across Europe and perhaps across the pond as well. Indeed it was the final days of a bank run that sealed Banco Populars’ fate.
Domino of European Bank Failures Falls Across the Pond
As reported by the Financial Post on April 26, 2017, a $600 million bank run (Canadian) on Canadian Home Trust, a subsidiary of Home Capital Group, was triggered by reports that Home Trust needed $2 billion of emergency funding. The funding was provided. It is reported that fears of a continuing bank run have been assuaged by news of the funding and a vote of confidence from Warren Buffett, who is said to have purchased $247.7 million worth of Home Capital stock.
At first blush, one may wonder why Warren Buffett is investing in a financial institution that just underwent a bank run that ultimately drained the institution of as much as 90% of its deposit reserves.
If we harken back to September 24, 2008, just days after Lehman Brothers filed bankruptcy, we see Warren Buffest made an historic bet on Goldman Sachs, injecting $5 billion of cash at a time when banks were failing left and right. Buffett bought warrants that by March of 2011, yielded him a $3.7 billion return on a $5 billion dollar investment. As we came to learn, Buffett’s move was back dropped by a massive taxpayer bail out of “too big to fail” U.S. Banks.
Is there a backdrop to his latest bet on Home Capital Group? Being federally regulated, Home Trust depositors are insured by the Canadian Deposit Insurance Corporation (CDIC). According to Rob Engen, as reported in Boomer and Echo, it also falls under the purview of Canada’s bail-in regime introduced in 2016.
Is it starting to make sense? Engen reports that the bail-in regime is designed to protect taxpayers and depositors in the worst of cases. However, in a Canada Free Press report, we see specifically the purpose of the bail-in legislation . . .
“In the crash of 2008 governments “bailed out” banks with billions of dollars. The next time around banks will be permitted to seize your deposits and exchange them for shares, shares in a failed bank.”
If warren Buffett’s 247.7 million votes of confidence indeed brought depositors back into the fold, or kept others from leaving, could those depositors have unwittingly become just the security Warren Buffett needed to seal this deal? Time will tell – It always does.
Bank Runs and Bail-ins Coming to America
As the saying goes: when your neighbor loses his job we are in recession; when you lose your job we are in depression. Such is the perception when our global neighbors endure bank runs, bail-ins, austerity and raided pension funds. It’s too far away to affect us. We are America. It’s not happening here. Now the warning alarms are sounding and signs are appearing that America is not immune from another bank and credit crisis.
In his 2014 Letter to Shareholders, JPMorgan CEO Jamie Dimon, warned, “there will be another crisis.” In his 2016 Letter to Shareholders Dimon warns again, “There will be market panic again and it won’t just affect the banks . . .”
A recent JPMorgan report put the spotlight on a crisis that appears to be developing now right before our eyes: a deposit crisis. According to a May 8, 2017 Bloomberg article, JPMorgan says the period of time between 2009 and 2014 saw bank reserves swell with $2.5 trillion of excess deposits as a direct result of the Fed’s quantitative easing (QE) policies.
QE is a fancy way of saying “printing money to buy U.S. Treasuries and Mortgage Backed Securities.” The Fed bought government issued Treasuries to help fund the national budget and service the national debt. The Fed also purchased Mortgage Backed Securities from banks to relieve them of toxic assets and strengthen their bank balance sheets.
This created an abundance of deposit reserves enabling U.S. banks to pass “stress tests.” Tests administered by the Fed to ensure that in the event of another financial crisis, banks have enough reserves to avoid the need for more bail outs or bail-ins as the law now allows.
In October, 2014 the Fed brought quantitative easing to an end – or so it was said. However, QE never really ended as the Fed then pledged to re-invest proceeds from earnings on various bonds back into more bonds. Having ballooned to something near $4.5 trillion, Fed Reserve Chairwoman Janet Yellen just announced the Fed would begin to unwind its own balance sheet. No more re-investing.
This is what has spooked JPMorgan and prompted the warning to smaller banks. Just as the Fed’s easing policies pumped up reserves, an end to those policies will begin to drain deposit reserves. It’s like continually having to blow up that beach floaty toy, the one with a hole in it, in order to stay afloat. But, once you stop huffing and puffing the floaty toy sinks, taking you with it. Hence, JP Morgan’s warning of an impending deposit crisis once the Fed stops re-investing earnings from assets held on its balance sheet.
Bank Failures Cross the U.S. Border
“2017’s Elevated Bank Failure Figure Is Not A Cause For Concern”
This was the headline of a May 26, 2017 Forbes.com article. Famous last words, eh? By this date, the number of U.S. failed banks reported, equaled the total for the entirety of 2016: five. The number may seem insignificant now, but if JPMorgan is right, these five fallen dominos may only be the beginning. In this article, failures were attributed to rising interest rates and a rising number of loan defaults.
Guaranty Bank was said to be struggling to maintain profitability. The bank catered to low and mid-level income customers. Bank assets were reported at $1 billion, an amount approximately equal to the total of deposits. In a rising rate environment, the outlook for maintaining a high level of deposits grows dimmer as depositors are forced to dip into their deposit reserves to service debt. Higher rates also inhibit loan growth, hence, bank profitability. In anticipation of this, regulators shut the bank down and transferred performing assets to First Citizens Bank and Trust.
In the process some 107 branches were closed, most of them located in retail locations such as grocery and general merchandise stores. Closing of these branches set off a run on the bank by customers who said it was no longer geographically convenient to deal with one of the 12 remaining brick and mortar locations. Frankly, however, it takes no stretch of imagination to see that many simply feared for the safety of their deposits in a failed institution regardless of who the new owners were.
It appears JP Morgan’s warning should be met with heed. Investment expert, Steven D. Hovde, chief executive of Chicago-based Hovde Group, said, as reported in the Milwaukee Journal Sentinel, “the U.S. Office of the Comptroller of the Currency ‘pulled the rug out’ from Guaranty Bank when it suddenly closed it down Friday night.” Hovde thought the shutdown of the bank was unnecessary.
It was reported the bank was shut down despite regulators knowing the bank was in the midst of a $100 million deal to recapitalize. Obviously, it was deemed “not enough” in light of impending rate increases which will make it even more difficult for the bank’s assets to perform – regardless of who owns the assets. If more and more of bank-customer deposits are drawn on to service debt, voila, bank deposits fall.
Bank Failure #6
Within days of the failure of Guaranty Bank, another U.S. bank bit the dust – Fayette County Bank in St. Elmo, Illinois. The bank was small with only $34 million in assets. Little was said about why regulators pulled the plug, but they did. And, while the size of the bank suggests this to be an insignificant failure, the implications here could be very dark.
The entire state of Illinois is – right now – in a deep crisis. For all intents and purposes, Illinois is BANKRUPT. Fortunately – or maybe unfortunately – while a state may be in de facto bankruptcy, states, as of now, cannot formally file for bankruptcy relief.
Currently, Illinois is said to be $15 billion in arrears on current liabilities, not to mention the estimated $203 billion of unfunded liabilities. You may wonder what options a state has to deal with debt if it cannot file for bankruptcy relief. The answer is simple. YOU DEFAULT! This creates a situation darker than a total eclipse. $15 billion of unpaid current liabilities suggests certain individuals and businesses have not been paid. That means, these individuals and businesses have been drawing down on bank deposits to either run their business or put food on the table.
We all know what that means. Yup! A statewide run on the banks has likely begun and Fayette County Bank may be just the first of many bank failures in the State of Illinois.
Are U.S. Banks About to Stress Out?
In June, results of U.S. bank stress tests were released. According to a June 22, 2017 CNBC report, “U.S. banks made it through the latest round of stress testing relatively unscathed.” These tests are part of the Dodd-Frank regulatory requirements. Among the bank assets under scrutiny are their levels of deposit reserves. All seems well in Mudville – or is it?
At a time of stagnant wage growth, an historically low labor force participation rate, and low GDP growth, how is it that banks are flush with cash? Let’s ask our billionaire buddies. According to another CNBC report, the world’s billionaires are hoarding cash. On average, the world’s 2,473 billionaires are hoarding 22.2 percent of their total net worth. An estimated $1.7 trillion worth.
A May 16, 2017 Bloomberg report titled, Rich Retirees Are Hoarding Cash Out Of Fear, suggests growing apprehension over the markets and the economy. Yet another June 1, 2017 CNBC report would seem to confirm a trend into cash. The Spectrem Millionaire Investor Confidence Index fell 17 points lower in May than it was in just the month prior. Nearly 40% of millionaires planned to avoid investing in the near term.
All of this adds up to one thing. There is currently an abundance of cash, sitting in banks, afraid to leave the confines of safety. Billionaires are hoarding cash, millionaires are hoarding cash and the Fed, still engaged in quantitative easing, is keeping deposit levels artificially high. Why is this a precarious situation? If JPMorgan is warning of an impending deposit crisis, do you think millionaires and billionaires are going to keep holding cash? Even a small move out of cash by millionaires and billionaires could have a huge impact on the ability of banks to survive future stress tests.
We have already seen how a bank that caters to low and mid-income level clients has failed in anticipation of dwindling deposit reserves. We have also seen a small working person’s bank fail because of an apparent lack of liquidity. If the danger of a deposit crisis is real enough to cause JPMorgan to issue a warning, perhaps we should heed that warning. In this new era of the bail-in, one should be ever vigilant of another major bank crisis – indeed another debt crisis.
And if you don’t want to take my word for it, look what Jamie Dimon had to say about another potential Lehman event.
“It is instructive to look at what would happen if Lehman were to fail in today’s regulatory regime. Lehman would have far stronger liquidity and ‘bail inable’ debt.. . If Lehman failed anyway, regulators would now have the legal authority to put the firm in receivership (they did not have that ability back in 2007–2008). The moment that happened, unsecured debt of approximately $120 billion would be immediately converted to equity.
Converting unsecured debt to equity means bail-in. The banks pension fund would be raided and pensioners see the cash value of those assets converted to shares in the bank. Bondholders’ assets and depositors’ cash could also be converted, at least in part, to shares of stock in the failed institution.
The vigilant will see signs of another approaching financial crisis. In the absence of a possible bail out, I suspect most won’t stick around long enough to fund a bail-in. Let the bank runs begin! And, if that happens, where would the money go? The markets? Millionaires and billionaires appear to be avoiding the markets. That’s one reason they are hoarding cash. Real Estate? Data suggests real estate is back in bubble territory. Bonds? Perhaps, but money is currently fleeing bonds.
Contrary to what you may hear in the mainstream, more and more investors are turning to gold and silver. Foreign investors, foreign governments and foreign central banks are rushing into metals. And perhaps ironically, our own JPMorgan has reportedly amassed huge physical gold reserves as well as what may be the largest private hoard of physical silver. Now we know why.
Today, less than 1% of investable assets are held in gold and silver. If we are entering a new era of bank runs and bail-ins, watch out! The run into physical precious metals could be quick and powerful. It’s happened before – and in my humble opinion – it will happen again – ONLY BIGGER!
Bloomberg – May 16, 2017
ZeroHedge – February 8, 2009
The Economist – Feb 18, 2016
The Times – May 1, 2017
Seeking Alpha – December 24, 2016
ZeroHedge – February 16, 2017
Financial Times – June 1, 2017
Seeking Alpha – December 18, 2016
The Economist – June 10, 2017
The Guardian – June 7, 2017
ZeroHedge – June 24, 2017
The Conversation – April 26, 2017
The Guardian – June 25, 2017
CNN Money – September 24, 2008
Bloomberg.com – May 8, 2017
Business Insider – March 19, 2011
Boomer and Echo – Rob Engen – May 8, 2017
Canada Free Press – June 22, 2016
Forbes.com – May 26, 2017
Milwaukee Journal Sentinel – May 9, 2017
American Banker – May 26, 2017
JP Morgan Letter to Shareholders – 2016
CNBC – June 22, 2017
CNBC – August 10, 2016
CNBC – June 1, 2017
CBS MoneyWatch – January 12, 2017