Beware of bail-ins

In a speech yesterday, in Stockholm Sweden, Vice Chairman of the Federal Reserve and former governor of the Bank of Israel and former chief economist at the World Bank, Stanley Fisher noted:

“As part of this approach, the United States is preparing a proposal to require systemically important banks to issue bail-inable long-term debt that will enable insolvent banks to recapitalize themselves in resolution without calling on government funding–this cushion is known as a “gone concern” buffer.”

Mr. Fisher gave no details as to whom in the United States was preparing the bail-in proposal and what “bailinable long term debt” is.

It Happened in Cyprus, But Can It Happen Here?

In spring of 2013 the failing European Bank of Cyprus performed a bail-in that required depositors to help save the bank by foregoing a large portion of the money they had deposited in the bank. In return for their forebearance, depositors were given equity shares in the failing bank.

Customers who deposit money in banks are lending that money to the bank. Depositors are in effect, unsecured creditors. If the bank fails, depositors get in line with other unsecured creditors to see how many cents on the dollar, if any, they can retrieve.

In the United States to offset this result, the Federal Deposit Insurance Corporation (FDIC) since 1933 insures bank deposits up to $250,000*. THe FDIC, however, is woefully underfunded to handle payouts in the event of a large bank failure. The new proposal is designed to allow failing banks to get back on their feet “without calling on government funding.”

Under the proposed bail-in scenario, the faiure of a “sytematically important bank” (a.k.a. “too big to fail”) will receive no government funding to stay afloat. In order to keep their casino doors open, a too big to fail bank will just call on their loyal depositors to help out by taking whatever percentage of the depositors’ money they need to stabilize the bank.

After $4 trillion of quantitative easing by the Federal Reserve over the past five years, and record profits at the largest U.S. banks, it would seem that the U.S. banks should be sound and talk of bailing them in, unnecessary. Apparently, not as Mr. Fischer’s comments make clear.

With banks already paying close to zero interest on deposits and the real possibility that a depositor could actually lose money by keeping it in a too big to fail bank, what incentive do depositors have in keeping their cash in such banks?

*At the time of the Cypriot bail-in, EU depositor insurance was in place.

Source