Oh what a tangled web we weave, when first we practice to deceive. – Sir Walter Scott
George Rebane
Remember those banks and other financial institutions that were ‘too big to fail’? Well, the IMF has confirmed that the world of global finance still has such enterprises so that if one goes down, it has the tendency to pull others down, resulting in worldwide chaos. In the past – recall 2008 – governments put billions of taxpayer monies into such banks to keep them solvent as they started to be stiffed on the loans and other risky commitments that they had made.
Regardless of all the happy dancing in the Rose Garden about increased employment and improving economy, what’s really happening is that the global economy, including America’s, is in a mess. As a result, governments all over are worried sick about the size of future bailouts which promise to be huge compared to the amounts paid out a few years back. Their reaction to this really tells the true tale of what is going on in the world’s fisc, and it ain’t pretty. Catastrophe looms.
In response, the mavens at IMF have come up with a couple of ‘improvements’ to make things better in the future. But don’t hold your breath about anything becoming better for you. First, institutions too big to fail will no longer be labeled so obviously. Instead, they will be called Systemically Important Financial Institutions, or SIFIs for short. All that means is that each SIFI finds itself in a row of dominoes made up of other SIFIs and lesser banks, so that no SIFI is going to go down alone.
Now before telling you about the second improvement, you have to understand how SIFIs (think banks) run their balance sheets. Their assets are comprised of all the loans and other risky financial arrangements they have made with other SIFIs and governments which promise them some profit. And their liabilities are really the funds that they have taken in from depositors, checking account holders, retirement accounts, and others who have placed their money into what they thought is a safe place. Why are such deposits called liabilities? Because the SIFI has contractually promised to pay back such monies with accrued interest to the account holders (i.e. you and me).
Assets minus liabilities are still called shareholder equity. But SIFIs must also keep a reserve of cash as part of their assets, which means that they can’t lend all of it out. The cash reserve is supposed to service the usual traffic of depositor withdrawals and other expenses incurred during normal operations – the greater a SIFIs liabilities, the greater the cash reserve it must have on hand. When assets fall below liabilities, the SIFI (or any bank) is considered to be insolvent and must close its doors.
The problem now comes in tough times when outfits and people who have borrowed from the SIFI can no longer service their loans. When this happens the SIFI’s assets fall as loans are downgraded (as to their recoverable amounts) or just written off, and the cash reserve then starts being consumed in normal operations. This reserve drops even faster as people begin withdrawing more funds to pay their bills during recessions. And there better be cash on hand to pay the withdrawals, or there will be an instant run on the bank when the word gets out. When the SIFI can’t service its debts held by creditors, then sooner or later its assets drop below liabilities and insolvency is pounding on the door – then the first domino drops.
Governments in the past have rushed in with large bailouts to save certain SIFIs (AIG, Freddie, Fannie, …) and let others (Lehman) die. But the cost has been very high, and future costs will be many times higher. So the IMF has come up with its piece de resistance that has all governments smiling – out with the bailout and in with the ‘bail in’.
All those smart government and international money types kept looking at the problem, and finally concluded that it’s those damn SIFI liabilities that really foul up the whole international financial order. The required arithemetic of keeping more assets than liabilities could be handled two ways. We’ve already tried increasing diminishing assets with bail outs, and that cost the politicians a bundle when they were seen giving money to banks. So why not try reducing liabilities instead, and the bail in was born.
The bail in is when the SIFI tells its depositors that they are not getting (all) their money back. To do that requires some new and clever legislation, otherwise it would be called thievery and bankers not giving depositors their money would be hauled off to jail. But with a few properly bamboozled bills going through the legislatures, we could soon have laws that make the very same thievery all legal and proper. Then the SIFIs would just send letters to their depositors telling them the size of the haircut they have just been given, and the poor schlubs have no recourse. It’s called ‘equal justice under law’. (The bail in has already been successfully pioneered in places like Greece and Cyprus, and Dodd-Frank invites SIFI bail ins in the US.)
So that’s what’s going on right now in international financial circles. People are figuring out how they can quietly pass such legislation, and have it in place when the next inevitable crash happens, either with a single SIFI going unstable or another government engineered recession like the one we had and are still not recovered from yet.
Bail ins turn the long held view of asset riskiness upside down. What used to be considered risky – stocks, precious metals (commodities), real estate – will now be viewed differently than the formerly solid non-speculative investments like CDs, savings accounts, bonds, etc. The point to remember is that your (savings account) asset is actually the bank’s liability. And with bail in legislation in place, you want to rethink keeping assets that someone considers to be their liabilities. Making possible the rescue of SIFI’s with bail ins will change the whole equation. At some point people will begin to realize that when you own stocks, commodities, or real estate, these assets are NOT the liabilities of any other enterprise which would like to minimize them by whatever means, fair or foul.
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