Monday, May 6, 2013

Do You Know What a Bail In Is?


Most of us are familiar with the term "bail out", as we have watched governments give almost endless amounts of money to large (too big to fail) banks to avoid them from becoming insolvent. Large bets made and balance sheets that are leveraged 40 to 1, in some cases, have destroyed the books of many large financial institutions. Much of that is hidden from the public due to the absolute panic that it would cause among the population.
Well, if you don't know what a "bail in" is, this would be a good time to become acquainted with it. The reason is because of what happened in Cyprus recently. How does a bail in work and who will be affected by it, is the question at hand.
For this example we will use an account balance of $150k. $250k is the current FDIC insurance amount in the US, but that was only done during the financial crisis of 2008 so that it would calm the fears of large account holders and not start a rush of money out of those accounts. Traditional FDIC has been $100k and that is the case for most of Europe. The $100k number will be coming back, make no mistake.
Okay, so you have $150K in a bank account, and the insured level of that account is $100K. You now have $50K in that bank that is above the insured limit. The not so unthinkable happens and your bank is found to be insolvent or bankrupt. What happens?
In some cases the bank would be flushed down the toilet, accounts would be transferred to other banks that would buy them, and the FDIC would cover the rest of the money exposed. Recently the government chose to extend credit or a loan (TARP) to those banks to make them whole again (bail out). Taking the example in Cyprus which has already been used and was explained by the Dutch Finance Minster as the new template going forward, this is what you should expect.
Of the 100 percent of money that is above and beyond the $100k, in this example $50K, 37.5% of that money would be taken from your account and converted into class a shares of stock in the bank itself. You just received stock in a bank that failed so what that is worth is basically nothing. Another 22.5% would have been held as a buffer for possible conversion to stock at a later date. An additional 30% percent would then be held as a frozen deposit, meaning it will show on your statement, but you cannot touch it. If your money is frozen in an insolvent bank, it is gone for the most part.
So 90% of your $50K is gone. Sounds bad right, but what if you had $300k or more in the account. Some of the depositors in Cyprus had hundreds of thousands and some millions or more. All gone. You now have $100k in your account and a boat load of worthless stock. That is the basic parameters of a bail in. The idea is that the depositors will now share in the loss that the banks have incurred due to bad investments on their part. This is what happened to the people of Cyprus.
The next question would be what if that amount of insured deposits is lowered? What then? Now, it is understood that you run a risk when you put more money into an account than it is insured for, but when did we get to the point when your money could be removed or frozen and that was that.
Remember this happened almost overnight in Cyprus, and even though there were signs of it coming. Many account holders that inquired about the instability in the system were told that there accounts were safe and that they had nothing to worry about. A complete bold-faced lie just days before this took place.
This legislation has been slipped into the system in many countries including the US and you have not heard a word about it. They call that a media blackout on the subject.
This may only affect a small portion of personal account holders. However, what about business accounts holding that much money and more? One must keep in mind the term "slippery slope" and how your relationship with your bank is changing by the day. Banks were once safe havens for depositors, but it would seem those days are over.

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