September 3, 2014 – The bank bailout of 2008, in which banks received $700 billion in emergency loans to keep them afloat, touched a nerve among the American people. Never in my time working for Dr. Paul had I seen such vehement resistance to a bill. At the time, our email system still operated by printing out individual emails before answering them, and the stack of emails opposing the bank bailout was probably three or four feet high. In fact, the popular opposition to the bank bailout was one of the primary influences leading to the initial development of the Tea Party movement in early 2009.
The outrage over the bailouts hopefully will mean that we will never see banks being bailed out again. But instead of bailouts, we may see an even more insidious practice replacing them – bail-ins. Federal Reserve Vice Chairman Stanley Fischer’s speech in mid-August in which he mentioned bail-inable bond issuance by banks got tongues wagging about just what the Fed is planning regarding possible future bail-ins. Bail-ins are a method of restructuring an insolvent bank’s liabilities by forcing creditors and shareholders to take losses rather than using taxpayer funds to bailout the institution. The most well-known example of bank bail-ins was the case of the banking crisis in Cyprus in 2013.
The problem with bank bail-ins, however, is that in practice the creditors who suffer the most are those who shouldn’t, namely depositors. When you deposit money into your bank account, you are treated as an unsecured creditor. You are essentially loaning your money to the bank with no strings attached. The bank uses that money to fund their loan operations, but if their loans go bad and the bank goes under, you as the depositor are not first in line to recoup your money. The order of priority in bankruptcy is generally secured creditors, unsecured creditors, and stockholders. That means the bank’s bondholders normally get paid first, then depositors, then stockholders. In an actual crisis, however, all bets are off.
Take for example the case of the Cypriot bank bail-in, where depositors of uninsured deposits above a certain level were all but guaranteed to lose that money. Most of it was going to be converted into equity, shares in the bank. Don’t be surprised to see that happen again in future banking crises, or perhaps something even worse. The danger is that in any future financial crisis, regulatory authorities will come up with a target for the amount of money needed to bail-in the banks, and they will use any means necessary to hit that target. If that means that depositors bear the brunt of the losses, then that is what is going to happen.
But who wins in such a situation? As usual, the bankers. Just as the bailout of 2008 enabled the banks to continue operating as though nothing has happened, bail-ins are intended to allow banks to continue operating through a crisis without shutting their doors. Sure, their bondholders may take some losses, their depositors may lose their money, and their stockholders may see their equity wiped out, but the bankers will still remain in business.
Regardless of whether the banks are being bailed out or bailed in, the bankers always come out on top, while depositors will suffer. Heads, the banks win; tails, you lose. Depositing your money in a bank is like gambling at a casino – the house always wins. That makes it all the more important to reform the banking system so that neither bailouts nor bail-ins will ever again be necessary. Bankers need to be held responsible for their actions and depositors, the lifeblood of the banking system, should not be treated like cash cows. Favoritism towards bankers needs to end.