STOCK MARKET WATCH - Monday, 6 February 2012

[Demeter]

33. Plan B – How to loot nations and their banks legally

http://www.golemxiv.co.uk/2011/12/plan-b-how-to-loot-nations-and-their-banks-legally/

Is there a plan B? That question is usually asked of governments regarding their attempts to ‘save’ the banks domiciled in their country. But has anyone asked if the banks have a plan B? Does anyone think that if our governments fail to keep to their austerity targets and fail to keep bailing out the banking sector, that the banks will just shrug and say, “Well, thanks for trying” and accept their fate? Or do you think the banks might have a Plan B of their own?

First let’s be clear about Plan A. That plan is to enforce an era of long-term austerity cuts to public services, in part to cut public expenditure so as to free up money for spending on the banks, but perhaps more importantly to further atrophy public services so that private providers can take over. A privatization of services which will bring great profits and cash flow to the private sector and to the banks who finance them, and a further general victory for those who feel that private debts rather than public taxes should be what underpins our national life and social contract. Plan A therefore requires that governments convince their populace that private debts should be taken on to the public purse and that once taken on, the contracts signed by governments on behalf of the tax payers/citizens, are then sacrosanct and above any democratic change of mind. If governments can hold their peoples to this,then the banks are ‘saved’ with the added bonus that democracy and the ‘Rights’ it once guaranteed will all have been redefined as subordinate to finance and its contracts, and our citizenship will have become second to one’s contractual place in a web of private debts. Debts to the private lenders will become more important than taxes to the public exchequer. And as they do the State will wither away, leaving free-market believers and extreme libertarians exactly where they have always wanted to be – in charge – by dint of being rich. It is, in my view, a bleak future which I once described as A Toxic Debt Wasteland.

BUT it does all depend on governments being able to suppress discontent and to outlaw opposition in the sense of saying to people you may disagree but we have now declared these debts and their repayment to be outside democratic control and immune to any attempt to rescind or repudiate the agreed debt contracts. As the severity of the austerity cuts to social services (health, education, pensions etc) becomes painfully clearer to people and the ‘necessity’ for them is ‘regretfully’ extended year after year, it will become harder and harder to justify, let alone impose, such suffering. We will enter an era of vicious sectarian blame. We are already in it, but it will get much darker. The banks and those whose wealth and power is tied to them, would obviously prefer Plan A to succeed. It makes governments do all the dirty work and it would profit the banks far more in the long run. If you want to bleed a man – kill him and you get about 5 litres/quarts. But strap him to a gurney with a catheter in his arm and a drip feed in his nose, and he will bleed for you for as long as his system can stand it. That is Plan A. But what if it fails?
I cannot believe the banks, with everything at stake, have not thought it prudent to have a plan B. So here are my thoughts on what that plan could be. Let me say now, I do not think this plan was a long term conspiracy. I do not think the end game was in mind when the first elements were put in place. It has, I think, been constructed opportunistically. But the end result is no less dark and threatening. What I offer from here on is thinking out loud. I obviously have no proof at all that there is a plan B. All I can hope to do is show you the elements which I think could make a Plan B for the banks. Then my argument is that if the mechanism I describe could work, if I have not simply misunderstood something, then I think the banks will surely have thought of it before me. And so it either already exists or it will. I think there are scraps of information that suggest it does exist and the collapse of MF Global might even be the first example of Plan B in action. The MF Global case certainly contains all the clues. MF Global imploded when it could not get the short term funding it needed. There were two kinds of funding MF Global relied upon for its liquidity/cash flow: repo and hypothecation. For those not familiar, Repo is when a bank or brokerage ‘sells’ an asset for cash but with the agreement that it will re-purchase – hence ‘repo’ – the asset at an agreed date for an agreed price. It is not really a sale but a loan. Repo is the oxygen the financial world breathes. Repo is a $10 Trillion market....The other main source of the essential short term funding was Hypothecation. This is when a bank or brokerage pledges an asset to a ‘lender’ in return for cash but the asset remains in the possession of the borrower. What the ‘lender’ gets is hypothetical control of the asset. Although the asset never actually changes hands, the new ‘owner’s’ hypothetical control of the asset allows her to do what she wishes with the asset. Including re-hypothecating the asset to another bank or brokerage. If she does so then the hypothetical control passes to yet another ‘owner’. Even though physically it remain where it started. Like repo – hypothecation and re-hypothecation are truely massive parts of modern debt-based banking. So the first thing the MF Global case tells us is that what happened is not due to some peripheral, parochial rogue trader-esque, isolated problem. What happened was as a result of a mechanism right at the very heart of the financial system.

In the MF Global collapse what ZeroHedge, and following them, I and others wrote about, was the way in which not only did MF Global go bankrupt, but so also did some of their clients when they found the money they thought MF Global was holding for them, went unaccountably missing. Client’s money went missing because it was ‘mingled’ with the brokerage’s money when it should not have been. Brokers should keep them separate. But it seems in the ‘re-hypothecation’ of assets it was mingled. Former CEO of MF Global, Mr Corzine has sworn under oath he knew nothing about his co-mingling nor the irregularities with his company’s re-hypothecation. It has been rumoured the client’s money may now be, possibly, in the hands of JP Morgan. This hint of illegality has grabbed everyone’s attention. But I think it is actually the legal part of the story not the possibly illegal part which is by far the more important.

In my opinion the key to the bank’s Plan B is in understanding why any money/assets were taken from MF Global after it had gone bankrupt and how exactly it went under in the first place. We all know MF Global had huge holdings of dicey European sovereign debt. But those debts have not become worthless so what caused MF to collapse? . The answer to all these questions lie in a change to Bankruptcy laws that happened around the world between 2002 and 05. This might seem like a detour into nerd city but it is not. It is the key. When a company declares bankruptcy there is what the Americans call an ‘automatic stay’, which means all the assets left in a company at the moment it goes bankrupt are protected from the rush of creditor’s demands until appointed auditors can sort out who should get what. The automatic stay prevents a first come first served disorderly looting where those with the most muscle getting everything and everyone else getting nothing. As we are all painfully aware now, there is a legal pecking order to who gets paid before who, with Senior bond holders at the top. But, in America culminating in 2005 with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) the order was changed. And that change is the crucial event. At the time the law was being passed few were aware of this change and even fewer were aware of how important it would become. At the time the furore was all about changes to personal bankruptcy. The Credit Card industry (AKA Banks) had spent more than a decade and its rumoured as much as $100 million lobbying to make bankruptcy much harder and more punitive for ordinary debtors.

An article from 2005 in the Boston Globe quoting a very senior Republican Senator, gives a flavour of what was then being said about ordinary people who fell into debt....Senator Orrin Hatch (R-UT) has said that millions of Americans are bankrupt or near-bankrupt because “they run up huge bills and then expect society to pay for them.”

After 4 years of bailing out banks who did exactly that the irony is enough to gag on.

But what was not talked about was an amendment which was put into the bill and, as far as I know little debated. Don’t let the word ‘amendment’ mislead you. Amendments are generally not there as refinements and improvements on the original idea. Whenever a bill goes through Congress every lobby group and industry with something it wants done, gets their tamed/owned/ political friends to tack on the change in the law that suits them in return for supporting the original bill. The bill emerges from this process festooned with ‘amendments’ to other vaguely related laws. Amendments are the price of getting the original bill passed. They are often little understood, written by and for the benefit of the sponsoring lobby group and can be far more influential than the bill they are smuggled in on. This is certainly the case here.

According to a scholarly article in the American Bankruptcy Law Review,

“the provisions [in the amendment] were derived from recommendations from the President’s Working Group and revisions espoused by the financial industry”

The President at the time was Bush and one of the most vociferous sponsors of the amendment was none other than Senator Leach whose other claim to fame was the Gram-Leech-Bliley Act which repealed most of the Glass Steagal Act of 1933 whose repeal virtually assured that the present debt crisis would happen. When bankers play pocket billiards, Senator Leach is what they prod their balls with. Ribaldry aside Senator Leach can certainly be described as one of the principle architects of our present global misery. But I digress.

What was this amendment? The amendment exempted repos (and hypothecated and re-hypothecated assets) and a whole range of derivatives from the automatic stay. It also allowed lower quality assets to qualify for the exemptions. Which means the special bankruptcy treatment given repos and derivatives means that repo lenders and parties to derivative contracts can keep the collateral if their trading partner becomes insolvent. This exempts them from the “automatic stay” rule in bankruptcy, which prohibits most creditors from trying to collect ahead of others.

Or as the official report from the US Financial Crisis Inquiry Commission said,

under a 2005 amendment to the bankruptcy laws, derivatives counterparties were given the advantage over other creditors of being able to immediately terminate their contracts and seize collateral at the time of bankruptcy. (p. 48)

So when a bank goes bankrupt, BEFORE even the most senior bond holders, the repo lenders and derivatives traders can remove, or keep all the assets pledged to them. This amendment which was touted as necessary to reduce systemic risk in financial bankruptcies also allowed a whole range of far riskier assets to be used, making them too immune from the automatic stay in the event of bankruptcy. Which meant traders flocked to a market where risky assets would be traded and used as collateral without apparent risk to the lender. The size of the repo market hugely increased and riskier assets were gladly accepted as collateral because traders saw that if the person they had lent to went down they could get your money back before anyone else and no one could stop them. It also did one other thing. Because the repo and derivatives traders ran no risk – they could get their money out of a failing bank before anyone else, it meant they had no reason at all to try to stop a bank from going under. Quite the opposite. All other creditors – bond holders – risk losing some of their money in a bankruptcy. So they have a reason to want to avoid bankruptcy of a trading partner. Not so the repo and derivatives partners. They would now be best served by looting the company – perfectly legally – as soon as trouble seemed likely. In fact the repo and derivatives traders could push a bank that owed them money over into bankruptcy when it most suited them as creditors. When, for example, they might be in need of a bit of cash themselves to meet a few pressing creditors of their own.

The collapse of both Bear Stearns, Lehman Brothers and AIG were all directly because repo and derivatives partners of those institutions suddenly stopped trading and ‘looted’ them instead.

THERE'S MORE...AND THE COMMENTS ARE MANY TIMES MORE