It was not that long ago (2007-2008) the CDO market, (collateralized debt obligations – an overly complex and structured financial product that is backed by a pool of loans and other assets and sold to institutional investors), brought down the USA and other first world economies.
The banks were considered ‘too big to fail’; but they did. The USA Government bailed-out most of the oldest and most prestigious banks in that country.
The term ‘too big to fail’ while not new in the American lexicon, it was not a popular term until President Obama agreed with the Chairman of the Federal Reserve at the time, Ben Bernanke when he defined the term as basically (I’m paraphrasing) : …a firm that is too big to fail is one that’s complex, interconnectedness with the countries financial system are so critical that it should collapse unexpectedly into liquidation, the rest of the financial system and the economy would face a severe economic collapse as a consequence.
Bernanke’s argument for bail-outs can be depicted in the consequences of the Great Depression of the 1930’s where there was a severe and long standing road to recovery of the economy including the highest unemployment levels that that country had ever seen.
What is the difference between bail-in and bail-out?
So what is a bail-out? This is where the government of the day determines that it is more important that the banks succeed despite the gross business errors and unmitigated risks that they take on e.g. derivatives, and provides them with the funds to meet their debts.
In short, a form of corporate socialism. These funds are borne directly by the tax payer. Thus, the government has ‘bailed out’ the banks from ruin – usually at a very low to negligible interest rate to the detriment of the tax payer.
The other way where bank funds are protected is through legislation which gives the bank the right to garnish depositors’ funds and treat them as first line creditors should the bank default and not meet their debts. This method of funding is called a ‘bail in’.
Why Do Banks Fail?
So why do banks fail? They are given generous amounts by the likes of the Federal Reserve and their equivalent in other countries, at interest rates that are far more favourable than that provided to the public ostensibly for the purposes of keeping the economy going and liquid. What do these banks do with these generous funds?
Generally speaking, money is lent for mortgages and loans at higher rates than received, they develop asset management arms and run managed funds, short term money market trading, sophisticated securities and derivatives trading – retail, wholesale and proprietary trading, and special purpose vehicles (SPV’s).
Put simply, large financial institutions have not changed their risky practices yet are treated as generously by governments despite their lack of change and despite the introduction of the Dodd-Frank Act which was conceived to ensure the large financial institutions act responsibly.
The failures of the Dodd-Frank Act are many but at the end of the day there was no real broad implementation or regulatory enforcement allowing these institutions to grow larger and uncontained as we evidenced during the Global Financial Crisis.
In Australia after a Royal Commission into Banking; the Haynes Royal Commission’s recommendations to protect from retail clients from ‘predator lending’ amongst other things, were largely ignored or have not been implemented and enforced to this day.
The Australian banking regulator APRA, even cited the regulatory Covid phenomena part of their reasoning for the regulator to go back to relaxing mortgage standards in direct conflict with the Haynes Royal Commission recommendations. In other words, the government is supporting the status quo in relation to financial institutions.
Can a bank refuse to give you your money?
Sure, this has happened throughout history, more recently we saw the banks in Greece refuse to give their customers their money back. Not to mention what happened in Venezuela.
First world economies without exception are struggling to contain debt while at the same time offering banks near to zero cash loans which are passed on to retail customers at low interest rates. This has created a dangerous inflationary/stagflation environment while small to medium business crumble under Covid and thus a rise in employment.
Such overt contradictory economic policy is given rise to either bail-outs or bail-ins depending on the jurisdiction and the legislation they have in place.
Neither Keynesian theory, classical theory, the modernists nor Austrian schools of economics are recognizable during today’s economic environment. Already in Switzerland, deposit holders must pay a percentage of their deposits to the banks – in other words, negative interests are real and already in use in Europe.
In other western countries, low interest rates are harming the most vulnerable classes such as pensioners who lose all returns on their savings which was traditionally the case and punishes genuine savers who have not imbued themselves in self-indulgent debt.
Global Financial Crisis 2.0 is Coming
These conditions are ripe for another Global Financial Crisis. Coupled with dealing with a global pandemic, the only conclusion that can result is another crash of economies on a global basis. It is hard to imagine the severity of a down fall of financial institutions that in conjunction with government are ‘kicking the debt can down the road’.
Such a climate of extremely low cash rates, zombie stock market companies, quantitative easing (basically money printing) and the restriction of liquidity to those companies in most need as opposed to those mega companies who are provided with low to negligible interest rates, tax cuts and tax credits.
It is uncontroversial that the global economic policies and strategies of both sides of politics, especially the last decade, have proved to be unsuccessful, this has not motivated governments to change course or reassess the disaster that is written on the wall.
Scarcely thirteen years since a major global financial crisis, it is clear that any regulation of financial institutions or protection for the consumer has failed or been a non-starter. One needs look no further than the impotence of the Dodd-Frank Act in the USA.
It’s quite clear that the inability or lack of desire of first world governments not to address the same play book which led to the 2007-2008 Global Financial Crisis will result in the banks receiving either bail-ins or bail-outs depending on the relevant government.
The ‘too big to fail’ agenda will undoubtedly be invoked to yet again raid your savings accounts (bail-ins) or the federal budget (bail-outs) whereby the retail consumer will be punished yet again while the banks and other large financial institutions will be allowed fail yet thrive again.
How can I protect money from the government?
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