December 21, 2011
Let’s speak plainly. If you are in the United States or Western Europe, chances are incredibly high that your bank is simply not safe. In other words, your money is at risk. Big time. Let’s review some of the chief concerns:
1) A black box of assets
Banking is a complicated industry… and especially when larger banks are concerned, nobody really knows what’s under the hood. Can we say with any accuracy what’s on Bank of America, Deutsche Bank, or Citi’s balance sheets?
No way. There’s $8.5 trillion worth of mortgage-backed securities floating around the system. Not to mention, tens of trillions of dollars worth of derivatives contracts tied to mortgage-backed securities on top of that.
These assets are all highly susceptible to downturns in housing, a rise in interest rates, and a host of other systemic risks. Yet we have no earthly idea who owns what, or who the counterparties are. It’s all a black box of assets.
In a world where the most basic foundations of the financial system can no longer be accepted as truth, we cannot assume away that bank balance sheets are healthy without more careful investigation and transparent information.
2) The assets that we do know about aren’t winning any beauty prizes
When governments auction-off tens of billions of dollars worth of bonds, it’s often the banks that buy. Large banks wielding hundreds of billions, trillions of dollars have few options where they park capital. They require enormous liquidity, and it’s ironic that the most liquid bond markets are the most dangerously indebted nations.
When $13 billion worth of 30-year bonds were sold last week at record low yields as low as 2.815%, your bank may very well have been one of the buyers.
In the all-too-likely event that price inflation surpasses 2.815% thanks to all the easing, twisting, and printing going on, your bank will essentially be sitting on even more worthless paper. And this doesn’t take into account the possibility of an all-out default.
3) Core banking business has all but shuttered
Do you remember the good old days when banks used to be responsible stewards of capital, paying depositors a fair rate (which exceeded inflation) and making sensible loans to creditworthy businesses and individuals?
I don’t either. But I’m told that’s how banking used to be. These days, banks hardly loan to anything that doesn’t come with a government guarantee.
This is not a well-functioning system. “Safe” banks are profitable… and in order to be profitable in the long-term, banks must engage in sound deposit and lending practices. This is no longer part of the banking landscape.
4) Lies, regulatory loopholes, and accounting tricks
Banks are adept at hiding the true nature of their financial condition. They conjure fake profits out of thin air and stuff their liabilities into off-balance sheet entities. And it’s all legal.
A recent paper by the Adam Smith Institute shows how banks book ghost profits from assets that are clearly toxic. The paper, appropriate entitled “The Law of Opposites,” discusses the material flaws in IFRS accounting and mark-to-market profit recognition on uncertain future cash flows:
“Much of the activity in the banking sector is aimed at nothing more than exploiting these accounting rules to register inflated fake profits and hence convert shareholders’ equity and, in extremis, debt-holders’ and taxpayers’ funds into executive bonuses.”
Government legislators and regulators are willing accomplices in the fraud. For example, risk-weighted capital adequacy ratios are the industry standard in assessing a bank’s safety. Even the Federal Reserve acknowledges that insufficient capital ratios portend bank failure.
Current regulations, however, allow banks to materially misstate the real risks on their books. Government bonds are assigned a risk weighting of zero… hardly a fair assessment in today’s environment.
As such, a bank filled with worthless government paper can legally tell its depositors, “we are completely safe.”
5) The backstops need backstopping
Today, “government-guaranteed” anything is a joke. Federal deposit insurance is just another false promise like social security. Deposit insurance funds are even more poorly capitalized than the banks, and the ultimate backstop (the government) is completely insolvent. The buck stops nowhere, and depositors assume 100% of the risk.
6) No one is isolated
Even if your bank has acted responsibly, the issues are global. Given the derivatives exposure that cascades across the entire system, no bank is credibly isolated from the misfortunes of the others.
Here’s the bottom line: money is serious business, and the decisions we make should not be taken lightly. We don’t buy a stock without conducting a lot of research about the company and its growth prospects. Yet we make banking decisions without the most cursory consideration of the institution’s creditworthiness.
I want to urge you to think about options overseas, especially if you’re in the US or Western Europe. These banks are in precarious shape, and there are better options abroad where banks are much better capitalized.
You may want to consider Sharia-compliant banks in places like Abu Dhabi or Singapore (which has never had a bank failure) since Islamic code requires financial institutions to maintain significantly higher liquidity ratios.
You could also consider physical precious metals as they carry no counterparty risk. There are security risks with gold and silver, however such risks pale in comparison to the systemic risks in today’s banking environment.