Would You Loan Money to a Bank?

Today’s Daily Reckoning raises our tattered warning flag, smoke signal and distress flare: Governments and banks are up to their usual sneaky tricks. You’d better pay attention to this because one day it’s going to come back and bite. And it’s your money, Ralph, as the ad used to say.

While everyone is going through the monthly ritual of guessing what the high priests at the Reserve Bank of Australia are divining from the future, what you should be thinking about is what happens to your money in the next banking collapse.

Here’s the story. Back at the G20 meeting in Brisbane, the powers that be decided to rewrite the rules around how banks treat our money. Here’s how The Examiner described it last month:

‘The G20 will implement a new policy that makes bank deposits on par with paper investments, subjecting account holders to declines that one might experience from holding a stock or other security when the next financial banking crisis occurs.

[This creates] a new paradigm where banks no longer recognize your deposits as money, but as liabilities and securitized capital owned and controlled by the bank or institution.’

That  means if a bank, or more than one, should fail, it does appear that the law can confiscate your money to prop up the bank. The precedent for this was set in Cyprus, when depositors where given a ‘haircut’. It just went global.

The new rules put depositors behind other creditors in any insolvency case. Russell Napier, writing in ZeroHedge, called it the ‘day money died’. He suggest that, in some ways, it’s actually more secure to hold banknotes — once you go above the deposit guarantee of the State —instead of a banking deposit. That’s because the banknotes can’t be written down in value or ‘bailed-in’.

Where exactly depositors rank will be different in every country. I don’t think you need to panic about your money right now. But Ellen Brown, a US lawyer and author, also points out the key point on her Web of Debt blog.

The new rules prioritise the banks’ derivative obligations ahead of everyone else. Derivative trading is highly profitable for the banks. It’s a $280 trillion market for the US banks alone. The Australian banks have a $21 trillion exposure. And now, if the market blows up, the deposits in the bank will go with it. Effectively, the legislators are rubber stamping the banks’ casino bets ahead of safekeeping the money entrusted to them.

Not many people seem fazed by any of this. Or maybe the collapse in the oil price is overshadowing it. I’m sure it will be forgotten as the good times roll on and memories of 2008 continue to fade. Who worries about this stuff when you’re living the good life?

History teaches no clearer lesson than the fact that the financial system recovers from one banking crisis to lurch into another one sometime down the track. The whole time the regulators and the politicians assure everyone the system is safe.

You could do worse than subscribe to Cycles, Trends and Forecastsfor this reason alone. Consider it cheap insurance for your money. We’re under no illusions about the safety of the financial system. We track it closely. When the next severe downturn comes to Australia — and we believe we have a reasonable guide to when that will be — you don’t want to be blindsided.

I’ve told this story before, but former Westpac Chairman Sir James Foots declared in the opening statement of the 1988 annual report to be ‘a splendid performance’ by the bank. It was after a 69% profit increase for 1987‒88. What happened in the next four years? Westpac wrote off $6.3 billion in faulty loans and had to have a $1.2 billion rights issue to maintain its capital base. It almost went broke.

The best way to think of your money in the bank is an unsecured loan. And you’re an unsecured creditor. You’re not depositing your money; you’re lending it.

And it’s always been like this. What is money, anyway? A man called A. Mitchell Innes wrote a long essay on this in The Banking Law Journal in May 1913. And going back over the centuries, he came to the conclusion that money, and the very foundation of human exchange, is credit. ‘A depositor,’ he wrote, ‘sells to his banker his right on someone else […] The danger lies not in the banknote but in imprudent or dishonest banking.

Can the regulators stamp out ‘imprudence’ or dishonesty? Not when there’s so much money to be made. And around in circles we go.

Callum Newman+
For Markets and Money

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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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