We’ve all heard of deposit insurance, but does it mean what we all thought it meant – that up to a given sum we would not lose any money if our bank collapsed? And by the way – who pays the bill?

The simple idea we have all believed in was that up to a specified amount our money was guaranteed by a government  deposit insurance scheme. Most countries have one. As long as your bank is in it you’re covered. Or at least you were till this week.

Before we get to the rapidly evolving changes lets just go over the details of what used to be the case.

It used to be that below the guarentee limit your money was safe. It was only any amount above the guarantee, that you could lose in a restructuring. When a bank went under the normal bankruptcy rules swung into action (I’m leaving aside the TBTF gorilla in the room. Let’s not poke him just yet).TBTF aside – the collapsed banks’ assets would collected in into a pile and all the bank’s creditors (those who bought its debt, lent it money, put their money into it) would be put on a list in order of seniority, with share holders at the bottom, unsecured and Junior bond holders next with Senior insured bond holders at the top. Depositors were always ranked up there with Senior bond holders. Those at top would get most if not all of their money back and not take a loss, those at the bottom would lose everything.

As a depositor  you could still lose whatever money you had in the bank that was above the threshold but you might not. Your chances would be in line with the Senior bond holders. But as this bank debt debacle has mutated over the past 5 years so the old ranking of creditors has mutated with it. First the bail out funds like the EFSF and the ECB itself have made themeslves super senior. They have put themselves above Senior bond holders meaning in the event of a bank collape the ECB and EFSF, if they had been lending the bank money in return for collateral – would be first in line to get paid.

The private bond holders and the banks struck back at this idea a couple of years ago by ramping up the use of Covered Bonds. Covered bonds are  way of trying to put private bond holders back above the ECB and EFSF. They are sold to investors on the claim that they are not just covered by a senior claim on the general assets of the bank – which would make them the same as traditional Senior bond holders – but that the Covered Bonds were also backed by a specially ‘ring-fenced’ set of assets of their own. So in a collapse the Covered Bond holders would have those ring-fenced assets withheld specially for them from the general pool of assets everyone else was queuing up for.

It remains to be seen if the ECB et al would recognize this arrangement as being senior even to them. It also is not  clear to me in what I have read – if even the assets in the ‘ring-fence’ might not be pledged to more than one covered bond and possible even be hypothecated. None of this has, so far as I know, actually been tested in a case of competing claims at bankruptcy.

Be all that as it may – what is clear is that any amount of money you had above the guaranteed threshold would always have been at risk, BUT at the top of the pecking order alongside Senior Bond holders.

It is this long established order of seniority that has been torn up by what the EU tried to force upon Cyprus.  As the financial publication Euromoney comments in an article on events in Cyprus,

…the complacent bailing in of the man-in-the street was the casual abandonment of the creditor hierarchy.

This is why the finanical markets were nearly as shocked as the man in the street. This established hierachy is the entire basis of all the arguments for saying Senior Bond holders could not be made to take losses in a bank collapse. They had to be protected. Now I always dissagreed with this and still do. I feel very strongly that depositors should morally come above everyone, and the senior bond holders should be in line like everyone else, not held as sacrosanct. Basically my view is we should protect the 99% ordinary depositors NOT the 1% bondholders.

But here we are now with that order of seniority having been torn up by the politicians. How now to argue for the Senior bond holders not to be touched? Suddenly there is no argument from principle. The principle was flushed when the Troika backed the Cypriot plan to seize money from ALL depositors.  They can back-track and mumble about amendments to the plan all they like – the principle has been torn up.

So what now? What happens in this new disorder?

Well it turns out other countries have been preparing to enforce this same – ‘force losses on all depositors’ – idea. New Zealand, as reported in an article by interest.co.nz  has been working on what it calls its new Open Bank Resolution Policy (OBR). If put in place – and that is the NZ government’s intention,

The implementation of OBR would see all unsecured liabilities that rank equally among themselves, including deposits, having a portion frozen (My emphasis)

In response, as picked up over at Jesse’s cafe Americain,  NZ Central bank has argued that really nothing has changed because,

…depositors have always needed to understand that deposits are not guaranteed… [OBR]…does not change the fact that depositors and other creditor funds are at risk…

This is at best highly disingenuous. Actually everything has changed. Under deposit guarantee depositors only lose ABOVE a threshold amount. Under OBR they ALL LOSE a given amount straight away.

As the co-leader of NZ Green party Russel Norman pointed out,

… if a bank fails under OBR, all depositors will have their savings reduced overnight to help fund the bank’s bail out.

So it’s not just Cyprus. New Zealand has been working on the same idea. What about European countries?

ZeroHedge reported yesterday quoting from a report in El Pais, that Spain too has been working to implement the same idea.

 Spain, it would appear, has changed constitutional rules to enable a so-called ‘moderate’ levy on deposits

UPDATE – and now, as picked up by The Slog, we have Joerg Kraemer, chief economist of the German Commerzbank sugesting Italy could/should seize 15% of Italian deposits.

And what about the UK ? Surely those fine bowler hatted gents of Threadneedle Street and the Right Honourable fellows over at Westminster – who stand for all that is good and dependable and NOT FOREIGN or FRENCH, wouldn’t ever think of such an outrage.

Well sadly…

Back in December 2012 the FDIC and he BoE published a joint paper outlining their new approach for how to resolve any future collapse of one of the Too-Big-To-Fail banks, called  “Resolving Globally Active, Systemically Important, Financial Institutions” . The paper is the blue print for how collapses, at what it calls G-SIFIs  (Globally Systemically Important Financial Institutions) – get used to this term it will figure largely in your life in future whether you want it to or not- how they will be dealt with in future. I shall write more about this paper and the regime it outlines in future. It is not a pretty picture at all. But for now we need only look at section 34. which says,

34 The U.K. has also given consideration to the recapitalization process in a scenario in which a G-SIFI’s liabilities do not include much debt issuance at the holding company or parent bank level but instead comprise insured retail deposits held in the operating subsidiaries. Under such a scenario, deposit guarantee schemes may be required to contribute to the recapitalization of the firm, as they may do under the Banking Act in the use of other resolution tools. The proposed RRD also permits such an approach because it allows deposit guarantee scheme funds to be used to support the use of resolution tools, including bail-in, provided that the amount contributed does not exceed what the deposit guarantee scheme would have as a claimant in liquidation if it had made a payout to the insured depositors. (My emphasis)

As usual the official language is there to obscure rather than enlighten. But what it says is that the money that the Deposit scheme contains, instead of going to you, could now be used (read would be used) to bail out to the bank in order to prop it up. In other words the new system makes the Deposit Guarantee fund available for use as bail out money.

The rationale is that if using your deposit guarantee fund for propping up the bank ‘saves’ the bank from collapse then you wouldn’t need that deposit guarantee would you? This overlooks the one lesson we have all learned from the bank bail outs of the last 5 years, that the bail outs are never, ever, ever, a one off. The first one fails to save the bank as does the second and third and and and.

So if I have read the above correctly – the new system raids the Deposit Protection scheme, gives it to the bank instead of you  and when that fails to save the bank…then what? The bank fails again and there is no money left in the Deposit Guarantee scheme.

And then? My guess is the government would say how they will replenish the fund – because they have your best interests at heart after all – BUT given ‘the exceptional circumstances’ and the ‘unforeseen severity of events’, no doubt forced upon them by rotten foreigners – the scheme cannot now be as generous as they would have liked it to be and the amount of the guaranntee has to be lower.

So, so sorry.

And that is what I think is being planned in the UK and USA.

Will the UK and USA also go for the automatic seizure of money from accounts? My guess is they have been quietly planning on it but will now think twice about admitting to it. Preferring to keep it quiet until the next collapse when ‘circumstances call for desperate measures’ etc etc.

The reality is the banks are still bust – even the ones making huge profits – and when – not if – when the next bubble bursts and one bank starts to bring down another – they will all come for your money and we will all be collectively punished in order to make sure the wealthy and the powerful stay that way.

I have thought more about what I wrote in The Humiliation of Greece and have come to the conclusion that I was, in part, wrong. So I would like to offer a sincere an unreserved apology to all those who read it

I would also like to offer an explanation of where I went wrong and finally an amendment to the argument.

An Explanation

The bulk of the article and its main argument, I think,  still stand. I think the argument about the Bond swap is fine. But where I went wrong was in regards of the proposed new law. In a nut shell my mistake was that I assumed  the proposed law giving up all rights to assets and immunity from prosecution, was a law which would be applied generally. I assumed the proposed law would apply to any default on any debts to any sovereign creditors. I think this is not the case.

I would like to say that one reader ballymichael did try to point this out to me but I was very slow to realize what he was saying. I picked a bad time to be obtuse and I would like to say both thank you and sorry to him in particular.

If I now understand ballymichael’s point it is that this law would apply to loans made by the Troika but not to other loans made by other nations or lenders.  Thus were Greece to default on bonds it had sold to China let’s say, then Greece would be able to default as would any other nation.

The knock on effect of this is that the final part of my article – which I did say was speculative – is wrong. Even if the private debts were counted as Sovereign as I suggested they could be, this would not trigger the proposed law. Thus this is not a way of recapitalizing private Greek banks and saving them from their debts. That will still have to be done by the means employed so far.

Embarrassed as I am that my specualtion was wrong I am also glad. The betrayal is not as foul as I had specualted it might be.

However, it is still pretty bad.

An Amendment

The new law would pertain only to those loans made by the Troika. The Troika being the European Union, through its various agencies including bail-out funds such as the EFSF and the ESM, and then the ECB and the IMF.  The problem for Greece is that the Troika is not really just one creditor among many. It is now Greece’s most powerful and main creditor. What this means is that because the central bulk of its debts cannot now be defaulted without the new law laying Greece open to being gutted like a fish, this essentially prevents Greece for defaulting on any of its debt no matter who the creditor was. Greece could default on debts owed to lets say the BoE or China but such a default would not clear enough of the nation’s debts ot make it worth while.

The more loans Greece ‘accepts’ from any Troika bail-outs the more this will be the case.  The ability to strip Greece in the event of any default confered by the proposed law makes lending to greece via the bail out funds such as the EFSF and ESM the ‘safest’ way to lend by far. If Germany wants to lend to Greece it can now chose to do so via the bail out funds rather that as nation to nation.  Other lending will still happen because it is clear the new law pins Greece down and makes any default almost unworkable.

Thus although my original argument was, as I have said, wrong, in many ways the new law still has many of the same wider effects as I had originally thought, just by a more round about way.

As for the speculation about Greece’s private banks and their private debts – as I said my speculation was wrong. Those banks and their debts will continue to be protected by the method used so far – Troika funded bail outs.

I hope you will accept my apologies.  It is a shitty way to end the year. But at least it was no one’s fault but mine.

I do realize that the currency of any blog is how trustworthy people feel it is. I hope this blunder has not shaken your confidence irrevocably.

There is always a danger – which I am very aware of – of getting out of one’s depth when trying to write about issues which depend upon technical aspects of finance and law. The worry of getting out of my depth is never far from my mind.  But the alternative is to go back to accepting the platitudes and bland assurances of those ‘smartest men in the room’, who have always claimed to know better and who would like nothing better than  for us to stop trying to understand and to stop asking questions.

I cannot bring myself to do that even when I find I have embarrassed myself so publically.

I hope 2013 brings you and yours rude good health and joy.