Plan B – How to loot nations and their banks legally

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?

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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.

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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.

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What was this ammendment? The ammendment 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.

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.

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When MF Global went down it did so because its repo, derivaitve and hypothecation partners essentially foreclosed on it. And when they did so they then ‘looted’ the company. And because of the co-mingling of clients money in the hypothecation deals the ‘looters’ also seized clients money as well. The co-mingling story is what brought the whole thing into the light but also provided a wonderful distraction.

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If a bank or nation was to default on you as a mere bond holder, you would have to wait in a the queue of creditors to see what you were going to be given back. And some ‘hair cut’ would be likely. But if you had done rather a lot of derivatives trading (CDS insurance and currency swaps are both derivative trades) then you would not have to wait. You would seize all the collateral the bank had pledged to you for repo lending or derivative trading and walk away. Now you will say that if you had done CDS insurance then you might well have to pay back out the money you had seized. Except that possession is nine tenths of the law. While lawyers set about arguing about what you owe, the critical fact is that in the mean time, in the height of the crisis you HAVE the money. JP Morgan allegedly has MF Global money while other people’s lawyers can only argue about it.

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If I am right then MF Global was the first hint of Plan B in action. The bankruptcy laws allow a mechanism for banks to disembowel each other. The strongest lend to the weaker and loot them when the moment of crisis approaches. The plan allows the biggest banks, those who happen to be burdened with massive holdings of dodgy euro area bonds, to leap out of the bond crisis and instead profit from a bankruptcy which might otherwise have killed them. All that is required is to know the import of the bankruptcy law and do as much repo, hypothecation and derivative trading with the weaker banks as you can. To me, this gives a possible answer to why there has been such a surge in derivatives trading.

If I am right about all this, I think this means that some of the biggest banks, themselves, have already constructed and greatly enlarged a now truly massive trip wired auto-destruct on the banking system. If they have and they have explained any of this to our politicians then it would explain why our governments have been so abjectly willing to bail out any and all of the biggest banks and sacrifice anything else in the process. Any hint of relucatnace and the banks can make veiled reference to the extreme ‘risk’ of systemic ‘panic’ and forced liquidations. None of which is really a panic, since they have engineered it.

Are the banks threatening us? No, no, good lord no! Just pointing out the reality of the state of the system. There just happens to be a gun pointed at our head and the banks just happen to find their finger on the trigger. All they ask is that we do nothing to make them feel that their best interests are served by pulling it. And all we have to do to avoid that is stick to plan A. Simple.

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But now I come to the really ugly part.

For the last four years who has been putting money in to the banks? And who has become a massive bond holder in all the banks? We have. First via our national banks and now via the Fed, ECB and various tax payer funded bail out funds. We are the bond holders who would be shafted by the Plan B looting. We would be the people waiting in line for the money the banks would have already made off with.

It is the money we have been putting in to bail out the biggest banks which they have then been using as collateral for offering weaker banks in weaker nations, repo loans or hypothecation. And the money or government bonds the weaker banks are using to pledge as assets and collateral for those loans or in derivative deals with the bigger banks is also from us. We have and are funding both sides of the deal.

The result is that the assets which the big banks would be legally allowed to seize and keep in the event of the failing bank actually going under would be ours.

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The largest banks, those with the greatest exposure to bank and sovereign bonds from the most indebted euro nations, have the most to gain from doing derivative. repo and hypothecation deals with the troubled euro area banks and nations. The more assets the weak banks and nations have pledged in deals with teh Big banks, the more theBig banks will walk away with in the event of a crash. I suggest this is why, even as this crisis has worsened, the Big banks have been increasing by 18% their trade in derivatives and why Repo and hypothecation is as large or larger than even before the crash.

I am sorry this has been such a long piece but I wanted you to see exactly how I came to this because I hope you can show me how I am wrong. Please do so politely and I will go downstairs and celebrate my stupidity with a cup of tea, before apologizing to you all. I would very much like to be wrong.

But if I am not wrong, then the banks have created a financial Armageddon looting machine. Their Plan B is a mechanism to loot not just the more vulnerable banks in weaker nations, but those nations themselves. And the looting will not take months not even days. It could happen in hours if not minutes. Our leaders would have only a few hours to decide who they would side with: the banks or us. The past four years give me no faith they would chose us.

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