Wednesday, December 28, 2011

Beware those acting in interest of the greater good

Gonzalo Lira wrote an interesting post yesterday about the MF Global collapse, here is part of it (read the entire post here):
Rather than being treated as a bankruptcy of a commodities brokerage firm under subchapter IV of the Chapter 7 bankruptcy law, MF Global was treated as an equities firm (subchapter III) for the purposes of its bankruptcy.
Why does this difference of a single subchapter matter? Because in a brokerage firm bankruptcy, the customers get their money first—because after all, it’s theirs—while in an equities firm bankruptcy, the customers are at the end of the line.
In the case of MF Global, what should have happened was for all the customers to get their money first. Then everyone else—including JPMorgan—would have picked over the remaining scraps. And the monies MF Global had already pledged to JPMorgan? They call it clawback for a reason.
The Chicago Mercantile Exchange, which handled the bankruptcy, should have done this—but instead, the Merc was more concerned with making JPMorgan whole than with protecting the money that rightfully belonged to MF Global’s 40,000 customers.
Thus these 40,000 MF Global customers had their money stolen—there’s no polite way to characterize what happened. And this theft was not carried out by MF Global—it was carried out by the authorities who were charged with handling the firm’s bankruptcy.
It means that nobody’s money is safe. It means that regulators care more about protecting the so-called “Systemically Important Financial Institutions” than about protecting Ordinary Joe investors. It means that, when crunchtime comes, central banks and government regulators will allow SIFI’s to get better, and let the Ordinary Joes get fucked.
So far, so evil—but here comes the really troubling part: It is an open secret that there are more paper-assets than there are actual assets. The markets are essentially playing musical chairs—and praying that the music never stops. Because if it ever does—that is, if there is ever a panic, where everyone decides that they want their actual asset instead of just a slip of paper—the system would crash.
Now, question: When is there ever a panic? When is there ever a run on a financial system?
Answer: When enough participants no longer trust the system. It is the classic definition of a tipping point. It’s not that all of the participants lose faith in the system or institution. It’s not even when most of the participants lose faith: Rather, it’s when a mere some of the participants decide they no longer trust the system that a run is triggered. Gonzalo Lira
If the above is true (MF Global was placed in bankruptcy under the wrong law) then it's clear that market regulators are prepared to act in the interest of the greater good. In this case it meant putting the financial well being of JP Morgan (Too Big Too Fail) above that of 40,000 customers. This is not particularly surprising given that if JPM failed it would probably take down the entire US investment banking system, if 40,000 investors lose some or all of their capital it is of little consequence to anyone else or the system.

Government or regulators acting in the interests of the greater good is not something that Australia is immune to. For example as I've discussed before, during the GFC the government and regulatory bodies imposed new rules, laws and guarantees to ensure that our banking system was protected. Individual companies acted in the same way, for example to protect some mortgage funds during the GFC there were strictly enforced withdrawal limits put in place. This ensured sufficient liquidity to allow the fund to continue, rather than resulting in run on their funds and collapse, this from December 2009:
INVESTORS trying to reclaim up to $15 billion frozen for the past year in a range of mortgage funds have been unable to recover all their money, with redemption requests vastly overwhelming the money funds have at hand.

Perpetual, one of the industry's giants, said yesterday that investors, mostly retirees, who sought to redeem their holdings this year had received 91¢ in the dollar.

Others have paid out a lower proportion of claims to retail investors, who bought the assets for their higher returns and perceived safety.

Investors in AXA Asia Pacific's mortgage funds have been able to reclaim no more than 22.8 per cent of their holdings in the past year.

Australian Unity, a smaller fund, has paid out 55 per cent of the value of redemption requests.

Colonial has paid out around 20 per cent of its funds under management, but the wealth giant did not say what proportion of requests it had met.

These companies say none of their investors have incurred losses because the capital is intact, albeit unavailable.

Up to $30 billion worth of mortgage funds were frozen last year, affecting 150,000 investors, after the bank deposit guarantee sparked a mass rush to safety. The Age
Although we have a government guarantee on funds in Australian banks ($1m per customer, per ADI, dropping to $250k in February 2012), there is no guarantee that you will have easy and instant access to these funds in the case we saw a run on Australian banks. If the liquidity of our banks was threatened you could expect the government, regulators and our banks to act accordingly (in the interest of the greater good) by freezing accounts, limiting withdrawals, enforcing temporary bank holidays, basically whatever it takes to ensure the banks remained solvent.

It would be prudent to ensure that you have sufficient hard assets and physical cash outside of the banking system to rely on in case such events took place. The MF Global collapse shows there are even circumstances where an investor might believe they hold title over physical metals with a receipt, but this ends up irrelevant:
The trustee overseeing the liquidation of the failed brokerage has proposed dumping all remaining customer assets—gold, silver, cash, options, futures and commodities—into a single pool that would pay customers only 72% of the value of their holdings. In other words, while traders already may have paid the full price for delivery of specific bars of gold or silver—and hold "warehouse receipts" to prove it—they'll have to forfeit 28% of the value. Barron's
Another reason to reconsider allowing a third party to store your metals.


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  1. Great to keep flagging this meme, BB.

    It's something I bang on about, too, both in writing and to people I speak to about this stuff: before those who are/will doing things "for the greater good"...

    Never a better reason to transfer wealth, power and influence from the masses to the privilaged - AND, all without even having a bad motive...just ignorance!

    Yes, good motives (protection of the people via "prevention" from the consequences of the inevitably crumbling status quo) will yield unintended consequences.

    I honestly see this as the single greatest Humanistic meme going forward, as we get deeper and deeper into this "crisis", as it truly morphs from an polito-economic issue, into a political issue, to a social issue, and so on...


  2. The ironic thing is that as things get worse we will probably have the masses calling for intervention to save the ailing systems. Right now there is a lot of anger directed toward the bailouts, but if the bailouts stop and markets are allowed to tank, banks allowed to fail it, wouldn't be long until the public was begging for the support back IMHO.

  3. Totally agreed, BB; I 99.9% expect precisely that to happen.

    In fact, it's why i'm not really worried as to why my significant PM holdings are now getting deflated - deflation now, inflation later, not really from printing, but mainly from the masses increasingly losing faith in govt (read: fiat decree) as they see that the govt interventions are not "working"...

    ...and, so, faith moves from fiat money (representing the trustworthiness and faith of govt decree) to hard money (that which govts cannot screw with nearly so easily).

    Nasty scenarios, really...but i can't see how that sort of thing won't happen



  4. its always better to eat at home (and store your valuables there) ... but just keep in mind the recent article in the SMH discussing burglaries where people didn't know they'd been robbed and the 6.2 million haul in cash and bullion. They got that from somoneone.

  5. I think the safest option is organising a safety deposit box for yourself (rather than leaving the storage management to someone else), this would avoid the risk of a MF Global type seizure and keep your valuables safe.