Canada Plans for its own Cyprus Scenario

Savers around the world have been watching the Cyprus scenario unfold as depositors money is quite suddenly up in the air. Canadian savers may want to know that the government there is making its own plans for a Cyprus style scenario.  Talk about a Canadian Economic Action Plan! 

Canadian Government Action Plan Logo

In the event that a “to big to fail” bank were to approach collapse in Canada, it would appear that the money deposited in the banks could be taken and then used to keep the bank viable.  The following words can be found on pages 144 and 145 of Jobs Growth and Long Term Prosperity – Economic Action Plan 2012 as tabled in the House of Commons  by the Hon. James Flaherty, Minister of Finance on 21 March 2013.  This is otherwise known as the budget.

Systemically important banks will continue to be subject to existing risk management requirements, including enhanced supervision and recovery and resolution plans.

The Government proposes to implement a bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada. Implementation time lines will allow for a smooth transition for affected institutions, investors and other market participants.

Before drawing conclusions, what do these words say?

First – “systemically important banks”. This means banks that are perceived as being too-big-to-fail (TBTF). The Office of the Superintendent of Financial Institutions (OFSI) identified six banks in Canada as being systemically important within the last week.  They are the Royal Bank of Canada, the Toronto-Dominion Bank,  the Bank of Nova Scotia, the Bank of Montreal, the Canadian Imperial Bank of Commerce and the National Bank of Canada.

This was a bit of a surprise to some observers, as it had been thought that only the RBC was TBTF.

Second – there is discussion of  a “bail-in regime.”  You should start getting nervous here.  A bail out is when an outsider gives the institution in trouble more money so it can keep going. A bail-in is when money from within the institution is used for the bail out and then those whose money was taken are given something in return.  Typically, those who have their money taken are offered shares in the institution in the hope that the institution will prosper again in the future and the shareholders can still have value. This was just done over the last few years in Spain. It did not work out too well.  See http://tinyurl.com/c9ds5b9.

Third – we see the words in the unlikely event that a systemically important bank depletes its capital.   In other words, if a bank suddenly goes broke.  This could be due to unforeseen loses such as a complex derivative contract that failed.  See a simple explanation of derivatives at http://tinyurl.com/blhtc3q
 

Fourth – there is the phrase the very rapid conversion of certain bank liabilities into regulatory capital.  The words “certain bank liabilities” is a fancy way of saying deposits. When you deposit a hundred dollars in a bank, this shows up on their spread sheet as a liability.  So what this phrase says is that bank deposits could be taken up and used by the bank and it could be converted into regulatory capital.  Regulatory capital is another way of saying banks must keep a certain amount of money on hand for meeting daily requirements such as withdrawals for deposits. The minimum amount that must be kept on hand is determined by the regulator. In this case the regulator is OFSI. 

So what does this all mean?

In short, it says that if a Canadian bank suddenly finds itself in financial trouble, money from depositors can be taken  in a “bail in” and used to keep the bank solvent.  Those who had their money taken would be given shares in the bank or some other form of compensation such as bonds.

Should you be worried?  

The document does not say so, but in such desperate circumstances, it might  be assumed that the deposits taken would be those that have more than $100,000.  Account below $100,000 dollars are guaranteed by the Canadian Deposit Insurance Corporation. So, small account holders should be OK.

Canada is not alone in doing this. The UK and the USA have a similar plan they discussed in December of 2012.   See  http://tiny.cc/z4jcuw

This is economics for the rest of us!  Enjoy the ride in the new economy.

Derivatives as Weapons of Mass Destruction: An Explanation for non-Economists

Weapons of mass destruction exist in the financial sector. They are called derivatives.  Here is a simple explanation of what they are written by ex-central bankers.  You should care, as they may destroy the financial system as we know it and all of us will be hurt. 

No one really knows how much damage could be done by an unwinding in the derivatives market, but the total exposure (potential losses) may be as high as 700 Trillion dollars (yes that is with a T).  JP Morgan alone may have as much as $90 trillion exposure.  Other financial institutions such as Goldman Sachs, Citigroup, RBS , UBS and RBC all have large exposures.

Photo: 

www.mbaskool.com

What the Heck is a Derivative? 

Tough question to explain, but here is a simple example.  

Farmers are planting wheat in the spring. They do not know what success they will have this year. Next to them is a flour mill which will grind their wheat.  Down the road is an investor, and he would like to make money off the wheat crop without doing work, but he is willing to take some financial risk.

 

The investor tells the flour mill the owner “It is only the spring, but I will give you money now in exchange for letting me control who uses your mill in the fall.”

The owner of the mill accepts the money, reasoning that he can make an average year’s profit for his mill off just this one investor, even if the crop fails completely. 

The crop is successful and the farmers arrive at the mill. The investor charges them to gain access to the mill and the mill grinds the wheat into flour.

The investor makes money by charging the farmers more than they would have paid the mill owner, but the investor now controls access to the mill for the season, so the farmers have no choice.

The investor made money not through his labour (the farmer) or by offering a service (the mill owner).   The investor derived his money (i.e. a derivative) by essentially betting that the price of wheat would stay high and the crop would be good.  If the crop had failed completely, the investor’s derivative would have failed and he would have lost all his money.

So, in economic terms, a derivative is a contract whose value is derived from the performance of underlying market factors, such as market securities, indices, interest rates or equity prices.  In this case, the underlying factor was the amount of wheat to be produced and its price which was not known in the spring of the year.

Can Derivatives be a Good Thing?

Yes.  Consider a medium sized trucking company that has just received a major contract for two years of shipping.  They are worried that they could lose money on the contract if the price of diesel fuel goes up suddenly. They approach an investor for a derivative.  The investor agrees to guarantee the price of fuel to the trucking company for the next two years. The price of the fuel will be higher than the current market price, but the trucking company believes they can still make a profit, even at the higher price, so this is good for them. The investor believes that the various rises and falls in diesel prices will allow him a profit. 

 

In this case, the trucking company has been able to outsource its risk (fuel price) to an investor in order to sign the contract with confidence.

Why did Derivatives Turned out to be Dangerous?

The key issue lies in the outsourcing of risk. An intelligent use of derivative can allow a business to outsource its risk. Unfortunately, the folks on Wall Street and in The City have found increasingly complex methods of using derivatives to outsource risk.  They believe that they can be almost risk free by covering all their investment risks with derivatives.

They have done this so much, there is now believed to be some 700 trillion dollars worth of derivative contracts out there – most of which are beyond the understanding of those who supposedly regulate finance markets. The risk involved is also beyond the understanding of the financial institutes involved.

The Killer

The financial institutes such as JP Morgan, UBS and CITI believe they have outsourced risk. But here is the killer. Everyone one of them is busy outsourcing risk by selling derivatives to other financial institutes. In other words, they are all outsourcing their risk to each other.  This is a closed loop with a finite amount of players. If everyone thinks they have outsourced their risk to everyone else, then they are collectively holding all the risk.  They are all vulnerable.

 

The end result is that the financial institutes that thought they were outsourcing risk may find they have to make payouts on the derivatives they bought and sold. The amount will exceed their resource levels and therefore they will go bust.  If there is another financial shock like the 2008 crisis, then the entire derivatives bubble may pop and the process will unwind on itself.

And then there are synthetic derivatives and synthetic derivatives combined with options trading, but might might be a story for another day.

Once again, we may  see the financial institutes lining up for more bailouts if this market unwinds.

This is economics for the rest of us. Financial derivatives should be seen as a weapon of mass destruction. 

 

The Predatory Eye on your Savings: Savers and Takers

Recent events in Cyprus, Spain and in the EU have shown that the previously taboo practice of taking your savings money has been broken.  Governments and banks, driven by the need for cash are exploring all possibilities. Like sharks, they must constantly move ahead to continue their intake of prey.
 


He is hungry and he is looking for your savings!
www.tntmagazine.com

Consider the statement of Mr Jeroen Dijsselbloem (pronounced Diesel Boom?), the former Dutch Finance Minister who is now President of the Eurogroup Council.  He stated that what happened in Cyprus is a template for what can happen next. He adds:

 

“If there is a risk in a bank,” he said, “our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalize yourself?’ If the bank can’t do it, then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalizing the bank, and if necessary the uninsured deposit holders.”  

In other words, shareholders and bond holders can expect a major haircut.

Then consider what the Bank of England and the American Federal Deposit Insurance Corporation (FDIC) have been jointly considering how savings deposits which are said to be guaranteed for the average saver or depositor will instead be used to bail out failing banks.  Hard to believe. (See more on this at http://tiny.cc/z4jcuw )  In other words, savers who thought their deposits were guaranteed for up to the first 100,000 may want to rethink that position.

In Spain, the Finance Minister has said that the Spanish government will put a levy (read tax) on banks based on the total amount of savings they hold.  Bank account holders in Spain can expect to pay this indirect tax through higher fees and lower service levels.  (See more at: http://tinyurl.com/cedrumy)

To reduce this to its most basic, the logic and math of the economists says: 

Banks and governments need more money to sustain their debt and overleveraged risks.

They cannot raise more through taxing a declining economy.

They are running out of accounting tricks to kick the can down the road.

Printing money is not working.

Savers have money.

The banks and the governments will change the rules so they can get the money.

Seen collectively, the economists who work for the banks and the government know where your money is and they need it. They are casting a predatory eye on your savings.

Unfortunately, the politicians will not stop this. Their own positions are closely aligned to the banks so they will assist the process. (See http://tinyurl.com/cdrnm7f)

This is economics for the rest of us.  Savers beware.

Savers and Takers: Where Your Savings Money Will Go Expained in Plain Language by Two Ex-Central Bankers

***Feel free to ask questions or leave comments below.  We will reply.***

Being a saver will be punished by the takers. 

The Savers:  Those with a savings account, a personal retirement fund, a pension fund holder, equity in their homes or other cash assets.

The Takers: Governments with unseasonably high debt levels, supra-international institutions such as the EU, bankers, and financial institutions.

Clip art by Ron Leishman - http://vecto.rs/
 

Reduced to its most basic, the financial crisis that started in 2008 and what we now see in Cyprus occurred because of debt.  Governments in general have been on a spending spree since the mid-1980s. They are running out of tax money and have used up almost all the accounting tricks which allow them to kick the debt can down the road.  At the same time, the banks allowed themselves to  become “overleveraged.”  This is a polite way of saying they took a series of incredibly high risks with saver’s money and now those risks are blowing up.  They also have huge exposure or potential loses through derivatives as well.

Stripped of all the economic, financial and governmental jargon, here is the issue and why you should be afraid if you are a saver.

1. Governments are holding massive debt and unfunded liabilities  and they need more money.

2. Banks are often over leveraged and they need/want more money to prop up their risks.

3. Savers have cash and other assets.

4. Governments and banks will change the rules so they can take this money.

5. Savers will lose their money and debtors will gain from this. 

How are they taking your money?  Sometimes it is quite clear how they take your money, other times it is difficult to appreciate what they are doing to you.  However, here are the main ways it is happening:

1. Tax or levy:  The government can simply impose a direct tax or levy on your individual savings account. This is what just happened in Cyprus.

2.  Indirect tax or levy:  The government can take an indirect tax by taking money from the banks based on their total holdings of savers money. Then the banks have to make this back from the savers. This is what Spain is doing.  See http://tinyurl.com/cedrumy

3.  Taking depositor’s insurance money:  The government can plan to take deposit insurance money in a time of crisis. Instead of this money going to the depositors as it was planned, it will instead go to bailing out the bank itself. See http://tiny.cc/z4jcuw for what the UK and USA have been thinking in this area.

 

4.  Long term low interest rates. By keeping interest rates artificially low, the central banks are helping debtors incur more debt through lower costs.  However, this means those with savings accounts are getting paid virtually nothing for their savings. Those with investments for retirement are getting little as well, meaning their retirement years will be poorer than they thought.

5.  Lines of credit based on home equity.  If you have equity (value) in your home, banks are often pushing you to take on more debt by getting a line of credit against your house. So they arrange a home equity line of credit and drive you into debt. You lose some of your equity and you pay them interest for the privilege of doing that!

6. Inflation. Governments and economists claim that inflation rates are around two percent per year. In your own world it may seem that prices are increasing faster than two percent per year and you are right.  Government figures often do not include expense such as fuel and housing! By allowing real world inflation to run around five percent and then by paying you nothing on your savings, your own purchasing power and real value is decreasing while the cost of the debt for government and banks goes down. Inflation is a silent but effect thief!

The confiscation of money in private bank accounts was generally thought of as being an illegal and unacceptable practice. Now, as governments become desperate, is becoming a matter of national policy, overturning years of protection for savers.

Do the government and the bankers actually have the power to do this? For more on this see:  http://tinyurl.com/cdrnm7f   or http://tinyurl.com/9wng9vf

In the 2012 American election, both candidates and pundits tried to frame the election as being between the “makers” who work and the “takers” who live off government benefits.  

 

The current financial crisis may turn this into a struggle between the “savers” and the “takers.”

This is economics for the rest of us.  Savers beware!

Spain Plans Small Raid on Saver's Deposits

***Please feel free to leave comments or ask questions at the bottom of the article. We will reply or will write a special article to answer your questions.***


With the negative publicity and real risks being generated by the raid on savings in Cyprus, you would almost think that policy leaders would see the danger in even talking about more raids on savers.



Minister Cristobal Montoro (right)
seen in this photo with an American industrialist
 - Photo from PBS.org

Not in Spain.  Believe it or not, the Spanish government is planning a depositors levy that will take some 0.1% to 0.2% from the banks based on their total level of deposits.  The difference appears to be that it will be the banks that have to pay the levy, rather than the money being taken from individual accounts.  The new measures will take effect in a matter of weeks. 

According to Treasury Minister Cristóbal Montoro, this levy will raise some 1.5 to 3 billion Euros.  This will help “impose order in the Spanish banking system” says the Minister without explaining how this will help.

We will only take this much - at least the first time! 
Photo by CBC.ca

Like any good politician, Mr Montoro says this is not his idea, but rather he is doing this to remain compliant with the wishes of the European Commission.  Again, no explanation of how this will keep the EC happy.

QUESTION:  Where will the banks get the 3 billion Euros to pay this new tax which will be based on deposits? 

ANSWER:  Depositors?  Stand by for more fees and lower service levels in Spanish banks as the banks find a way to pay this new tax. 

One thing is clear.  If you are a saver and you have money, the highly indebted governments and banks will find a way of getting it.

This is economics for the rest of us.  Savers beware everywhere!

 

 

(For more on what the Brits and the Americans are planning for their depositors, see http://tiny.cc/z4jcuw ) 

(For more on what is happening to Cyprus savers, see http://tinyurl.com/b2hqds6)

Social Unrest and Recovery in Europe: The Exarchia District of Athens and the New Face of Urban Europe?

***Please feel free to leave comments or ask questions at the bottom of the article. We will reply or will write a special article to answer your questions.***

When people are in their own community, they can be quite peaceful. But when they are disenfranchised by the central government and placed in the context of 

their national existence, they can suddenly turn rather violent.  There

is a lesson in this for all the governments in Europe. 

The face and nature of the new urban  Europe may be forming now in the Exarchia District of Athens. 

How do we know what social unrest will look like in Europe as the downwardly mobile economy continues to disappoint?  How will masses of  the unemployed rebuild after years of turmoil?  What will the youth of Europe do when faced with unemployment running to 50% or more?  

Syntagma Square, Athens showing a
minor police vs crowd confrontation 
on the 2012 national day. All photos by the author.

Surprisingly, the Exarchia District may hold some clues as to what the future of Europe holds. Being among the first areas to be hit by the economic downturn in Europe, it has the most experience in how you live through an economic collapse.  



Last year, I spent a few days in Athens, with most of the time spent in the Exarchia District.  This area is known to be the “home” of the rioters who occasionally attack Syntagma Square (Constitution Square) and other iconic symbols of the Greek central government.

 

I have a strong interest in economic matters and considerable experience in social unrest movements.  I had read the usual warnings from foreign embassies to stay away from the dangerous areas of Athens such as the Exarchia District. I was also informed that the Exarchia District is so bad that even the police will not go there, except in riot squads. Worst of all – OMG! – you are warned about violent anarchists.

 

Mural in the Exarchia District

Lacking as I do the proper amount of reverence for authority, the adventure path headed into the district. However, I did consider myself properly warned and ready to bolt should I run into hostile locals.  Much to my surprise, the next two days in the district were spent without so much as a hostile glance from the locals – even though it was clear I was a foreigner.

What can we learn from this experience?  Why might this be important for analysing the new future of Greece and Europe? 

1.  Despite the warnings from embassies about the danger, there was not a single incident of violence nor was I threatened in any way.  And this was on the day before the Greek national day and military parade in Syntagma Square.

 

2.  The streets were relatively clean and free of litter.  Every available wall space, however, was plastered with protest protesters and murals of every imaginable subject.

3.  I did not see a single credit or debit card reader on a counter for a Visa, American Express  or Master Card.  All transactions were in cash.

4.  Unlike the area around Omonia Square, it was noticed that there is a vibrant trade occurring in food, electronic goods, services, clothing etc.  Very few store fronts were closed, unlike much of the rest of Athens.  In Omonia Square, I was approached by local hawkers to buy anything from an I-phone to cocaine. The square and the streets around Omonia Square were filled with destitute people begging for food or money.  Much to my shock, I saw few people like that in the district. 

5. There was not a single sign or shop relating to a major international franchise such as Starbucks, Costa, or McDonald's, unlike the rest of Athens.

 

6.  Service at the sidewalk cafes on Exarchia Square was friendly and efficient despite language barriers.  The food (and beer) was good and under half the cost of the downtown areas.

 

Public parking lot reclaimed by anarchist
group in the Exarchia District now
used as a meeting area, playground and flower garden.

7.  Not a single police officer was seen for  the entire time. It is not clear to me what happens when something does go wrong. 

Observations

A new and vibrant sub-culture is being formed in the Exarchia District from the wreckage of the Greek economy.  Little solid information exists about what is really happening there beyond anecdotal views such as my own.  Clearly, an economy exists, but my best guess is that little of what happens there is captured in the official Greek statistics (which are known to be poor anyway).  The cash only economy appears to functioning well based on the number of shops open and the high rate of foot traffic in the restaurants, bars and other businesses.

Urban density in Athens.

Despite its fearsome reputation as the home turf of violent anarchists, there was no visible stress or hostility to foreigners such as myself.  This is really difficult to reconcile to the riots in Syntagma Square which can be quite violent.   

Conclusions 

In much of urban Europe, it is probable that self forming community structures will emerge which are only loosely politically linked to the central authority.  This linkage will be primarily though infrastructure such as water and electricity rather than social services and law enforcement. Even the infrastructure links will likely be less centralized than in the past as technology will allows for more efficient localized power production.   Less money will be spent on smart phones and more invested in local enterprises.  

The population in the urban areas will be less accepting and trusting of central authority and will seek to avoid it.  At the same time, the new urban population youth will have lower expectations of the central government and will place less demands on it.  Local councils will have more self-awarded powers and will defer less to large city mayors.

The urban community will be able to maintain a standard of living with fewer resources as it will seek to build value in the local community.  Products will be bought from local suppliers rather than international ones (i.e. no frozen French fries imported but local potatoes instead).  Businesses will be locally owned with no franchises – especially international ones.  International franchises such as Starbucks mean that a larger share of every purchase leaves the community.  Menus will feature more local, fresh and inexpensive products obtained from shorter supply chains which will mean safer and healthier food.  (For a humorous look at this issue see:  “Waiter, there is a horse in my soup” at http://tinyurl.com/a5dz86b ) 

A cash economy means more value stays in the local community. Every time a credit card or debit card is used, value leaves the local community and goes to large, centralized and international banks. Less money will be kept in banks.

Youth in the traditional 16-29 category will continue to be hard hit. They will have to create their own opportunities in the local area or head to a more rural existence.   This will be the toughest part of adapting to the new economy, especially given that the youth now are better educated in academic skills, but less competent in the technical skills of running a small business or managing a food producing property. 

 

And perhaps most importanlty, the behaviour of people may become increasinly contextual. When they are in their own community, they can be quite peaceful.  But when they are disenfranchised by the central government and placed in the context of their national existence, they may suddenly turn rather violent.  Somewhere in here is a lesson for most of the governments of Europe (and maybe everywhere).

Outlook

This is the future of what economics may look like for the rest of us.  Time to start paying closer attention.

Austerity Risk and the Financialization of the Economy – Student Arrests in Montreal

Austerity risk in Montreal may spread as hard times begin

 

Montreal police arrested 200 people on Friday, 22 March 2013 as part of a student protest designed to “celebrate” the anniversary of a major student protest last year. 



A small gathering of Anarcho-Primivitissts at an April 2012 protst.
 Most of the violence came from small groups such as this, not the
 main student groups. All photos in this article by the author.

The popular perception of the current events in Montreal is that students are protesting against an increase in tuition fees.  While fee hikes are one issue, a deeper series of problems is playing out in the background. Included in this are concerns about upcoming austerity measures and the nature of education itself.  Unnoticed by many Canadians, this protest movement was in fact driven by a combination of austerity measures and the financialization of the economy.   



The former Quebec Education Minister (Liberal) Line Beauchamp had stated that the fee increases were part of an overall reform program. This program was inspired by the European “Bolongne Process” for higher education.  Student leaders and many professors believe that the new “quality assurance” measures were in fact an underhanded method of reducing university education from (using Aristotle’s terms) a “liberal education” which produces problem solvers who can integrate knowledge over boundaries to a “servile education.” In this servile form of education, the student is reduced to performing a certain series of tasks which are determined by industry, banks or government.   Three major student groups as well as some professors unions in Quebec had been protesting this policy last year.  

Or as George Carlin put it:  They want people who are just smart enough to run the machines and do the paperwork but just dumb enough to passively accept all these increasingly crappier jobs with the lower pay, the longer hours, reduced benefits, the end of overtime and the vanishing pension that disappears the minute you go to collect it.

U de Montreal bookshop as seen in April of 2012. Note the
references to indigenous movements, OCCUPY and Los Indignados

Notice the reference to banks in the bottom right
hand corner.

Student literature has identified bankers (among others) as being targets for the ongoing protests.  Student leaders fear they are being asked to pay more for an education which is increasingly tailored to serve the interests of “business people, bankers and other private managers” rather than the broader needs of society or the students themselves. 

It might be a good idea for politicians and the press to pay closer attention to what is happening in Quebec.  A student movement has (arguably) been able to force a government from power in an election while continuing to challenge the views of the new government. 

This may be economics for the rest of us in the future.  Heads up!