The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks

The Detroit bankruptcy is looking suspiciously like the bail-in template originated by the G20’s Financial Stability Board in 2011, which exploded on the scene in Cyprus in 2013 and is now becoming the model globally. In Cyprus, the depositors were “bailed in” (stripped of a major portion of their deposits) to re-capitalize the banks. In Detroit, it is the municipal workers who are being bailed in, stripped of a major portion of their pensions to save the banks.

Bank of America Corp. and UBS AG have been given priority over other bankruptcy claimants, meaning chiefly the pensioners, for payments due on interest rate swaps they entered into with the city. Interest rate swaps – the exchange of interest rate payments between counterparties – are sold by Wall Street banks as a form of insurance, something municipal governments “should” do to protect their loans from an unanticipated increase in rates. Unlike ordinary insurance, however, swaps are actually just bets; and if the municipality loses the bet, it can owe the house, and owe big. The swap casino is almost entirely unregulated, and it is a rigged game that the house virtually always wins. Interest rate swaps are based on the LIBOR rate, which has now been proven to be manipulated by the rate-setting banks; and they were a major contributor to Detroit’s bankruptcy.

Derivative claims are considered “secured” because the players must post collateral to play. They get not just priority but “super-priority” in bankruptcy, meaning they go first before all others, a deal pushed through by Wall Street in the Bankruptcy Reform Act of 2005. Meanwhile, the municipal workers, whose pensions are theoretically protected under the Michigan Constitution, are classified as “unsecured” claimants who will get the scraps after the secured creditors put in their claims. The banking casino, it seems, trumps even the state constitution. The banks win and the workers lose once again.

Systemically Dangerous Institutions Are Moved to the Head of the Line

 

The argument for the super-priority of derivative claims is that nonpayment on these bets represents a “systemic risk” to the financial scheme. Derivative bets are cross-collateralized and are so inextricably entwined in a $600-plus trillion house of cards that the whole financial scheme could go down if the betting scheme were to collapse. Instead of banning or regulating this very risky casino, Congress has been persuaded by the masterminds of Wall Street that it needs to be preserved at all costs.

The same tortured logic has been used to justify the fact that the federal government deigned to bail out Wall Street but not Detroit. Supposedly, the mega-banks pose a systemic risk and Detroit doesn’t. On July 29th, former Obama administration economist Jared Bernstein pursued this line of reasoning on his blog, writing:

[T]he correct motivation for federal bailouts — meaning some combination of managing a bankruptcy, paying off creditors (though often with a haircut), or providing liquidity in cases where that’s the issue as opposed to insolvency – is systemic risk. The failure of large, major banks, two out of the big three auto companies, the secondary market for housing – all of these pose unacceptably large risks to global financial markets, and thus the global economy, to a major industry, including its upstream and downstream suppliers, and to the national housing sector.

Because a) there’s not much of a case that Detroit is systemically connected in those ways, and b) Chapter 9 of the bankruptcy code appears to provide an adequate way for it to deal with its insolvency, I don’t think anything like a large scale bailout is forthcoming.

Holding Main Street Hostage

Detroit’s bankruptcy poses no systemic risk to Wall Street and global financial markets. Fine. But it does pose a systemic risk to Main Street, local governments, and the contractual rights of pensioners. Credit rating agency Moody’s stated in a recent report that if Detroit manages to cut its pension obligations, other struggling cities could follow suit. The Detroit bankruptcy is establishing a template for wiping out government pensions everywhere. Chicago or New York could be next.

There is also the systemic risk posed to the municipal bond system. Bryce Hoffman, writing in The Detroit News on July 30th, warned:

Detroit’s bankruptcy threatens to change the rules of the municipal bond game and already is making it more expensive for the state’s other struggling towns and school districts to borrow money and fund big infrastructure projects.

In fact, one bond analyst told The Detroit News that he has spoken to major institutional investors who have already decided to stop, for now, buying any Michigan bonds.

The real concern of bond investors, says Hoffman, is not the default of Detroit but the precedent the city is setting. General obligation municipal bonds have always been viewed as a virtually risk-free investment. They are unsecured, but bondholders have considered themselves protected because the bonds are backed by the “unlimited taxing authority” of the government that issued them. Detroit, however, has shown that the city’s taxing authority is far from unlimited.  It already has the highest property taxes of any major city in the country, and it is bumping up against a ceiling imposed by the state constitution. If Detroit is able to cut its bond debt in half or more by defaulting, other distressed cities are liable to look very closely at following suit. Hoffman writes:

The bond market is warning that this will make Michigan a pariah state and raise borrowing costs — not just for Detroit and other troubled municipalities, but also for paragons of fiscal virtue such as Oakland and Livingston counties.

However, writes Hoffman:

Gov. Rick Snyder dismisses that threat and says the bond market is just trying to turn Detroit away from a radical solution that could become a model for other struggling cities across America.

A Safer, Saner, More Equitable Model

Interestingly, Lansing Mayor Virg Bernero, Snyder’s Democratic opponent in the last gubernatorial race, proposed a solution that could have avoided either robbing the pensioners or scaring off the bondholders: a state-owned bank. If the state or the city had its own bank, it would not need to borrow from Wall Street, worry about interest rate swaps, or be beholden to the bond vigilantes. It could borrow from its own bank, which would leverage the local government’s capital into credit, back that credit with the deposits created by the government’s own revenues, and return the interest to the government as a dividend, following the ground-breaking model of the state-owned Bank of North Dakota.

There are other steps that need to be taken, and soon, to prevent a cascade of municipal bankruptcies.  The super-priority of derivatives in bankruptcy needs to be repealed, and the protections of Glass Steagall need to be restored. While we are waiting on a very dilatory Congress, however, state and local governments might consider protecting themselves and their revenues by setting up their own banks.

_________________

Ellen Brown is an attorney, president of the Public Banking Institute, and author of twelve books, including the best-selling Web of Debt and its 2013 sequel, The Public Bank Solution. Her websites are http://WebofDebt.comhttp://PublicBankSolution.com, and http://PublicBankingInstitute.org.

28 Responses

  1. […] This piece first appeared at Web of Debt. […]

  2. […] This piece first appeared at Web of Debt. […]

  3. […] The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks […]

  4. […] Ellen Brown Writer, Dandelion Salad webofdebt.com August 5, […]

  5. Time to tax derivative gains at 90%. They have zero economic value & put our financial system at extreme risk.

  6. […] http://webofdebt.wordpress.com/2013/08/05/the-detroit-bail-in-template-fleecing-pensioners-to-save-t… […]

  7. […] By Ellen Brown, Published in Web of Debt […]

  8. Talk about blowback! If a bunch of smartass Wall St speculators hadn’t tried to destroy the euro by attacking Greece, with, it should be added, Ms Brown cheering them on wildly, the Cyprus banks wouldn’t have got into difficulty and the precedent of a levy on large deposits would not have been set. In Cyprus, the “victims” were essentially Russian oligarchs and few in Europe feel much sympathy for them. The situation which Ms Brown is now criticising is the logical knock-on consequence of the failed attack on the euro, which she thought was such a wonderful idea at the time.

  9. Before we shed too many tears for public sector pensioners, we should be looking at the generosity of their payouts compared to private sector workers (whose wealth creation supports the public sector). The litany of excesses is outlined in such books as Plunder (Greenhut) or for Canadians, Pension Ponzi (Fairbanks, Tufts).

  10. Reblogged this on thejumbledmind and commented:
    Another excellent article by Ellen Brown.

  11. […] The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks | WEB OF DEBT BLOG. […]

  12. […] The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks […]

  13. […] From Ellen’s post, The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks: […]

  14. this talk of bail-ins makes me wonder if the only safe place is a credit union.

  15. Too big to fail — The solution is to break up any organization that is too big to fail by law. Where to set the limit? Any organization that gets in financial trouble and is too big to be allowed to fail would then be taken over and broken up by the monitoring group (an outsider from the industry failing). And then the law governing “too big to fail” would automatically include the “prior to breaking up” value of the organization as it’s new limit. From there, any firm valued at more than the limit would be FORCED to split up within 5 years, or monitoring group again would take over and do it themselves. The details need to be worked out but in general that is what needs to be done.

    • Interesting: like anti-monopoly laws, there need to be anti-systemic risk laws.

  16. totally off topic but wanted to bring this to Ms. Brown’s attention. I don’t understand surety bond business, but do know it sounds like big bucks to construction companies, and it sounds like there is some real fraud and rip-offs of contractors. There were falsified Chubb bonds found recently and this story.

    Again, seems like something that could be provided in a much more clean, sure manner at much less costs if parasites not circling.

    http://enr.construction.com/policy/legal/2013/0819-Links-to-Players-in-Surety-Fraud-Drama.asp?page=2

  17. […] http://webofdebt.wordpress.com/2013/08/05/the-detroit-bail-in-template-fleecing-pensioners-to-save-t… […]

  18. […] full report: http://webofdebt.wordpress.com/2013/08/05/the-detroit-bail-in-template-fleecing-pensioners-to-save-t… . General obligation municipal bonds have always been viewed as a virtually risk-free investment. […]

  19. […] is but one example of how the bankers screw the people and how our government lets them. The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks | WEB OF DEBT BLOG The Detroit bankruptcy is looking suspiciously like the bail-in template originated by the […]

  20. Yes the banks are screwing the people over

  21. […] The Detroit bankruptcy and the drive toward dictatorship. And Ellen Brown, of Web of Debt writes The Detroit Bail-In Template: Fleecing pensioners to save the banks. Banks will be integrated into the government and be known as government banks or Govbanks for […]

  22. […] The Detroit Bail-In Template: Fleecing Pensioners to Save the Banks […]

  23. Ellen posted this article over a month ago and it has haunted me ever since. The damage the Banksters have done and continue to do with their Interest Rate Swaps is simply beyond belief. As Ellen first warned, me at least, there is not one shred of honesty connected to Interest Rate Swaps. The fact Interest Rate Swaps even exist blows the mind. It appears this country is going to allow Goldman and crooks get paid for their Interest Rates Swap scam before pensioners. This is end of story. The Peeps are gone and the game is over. The Banksters have won. $600Trillion in Interest Rate Swaps basically means the Banksters have stolen it all. I’ve written the governor of my state and when I run for political office I bad mouth Interest Rate Swaps and basically no one knows what they are. Lame theft really irritates me. 911 is about a lame as things get. Just like the shipyard shooting is a lame scam. But to give Goldman the world with the Interest Rate Swap scam, the lamest scam in the history of the world, leaves me speechless. Bail in. Who needs bail in when if Banksters get paid for their Interest Rate Swap scam before everyone else. Thank God Alabama had the guts to stand up to Goldman. Detroit is simply insane if it pays Goldman for Interest Rate Swap fraud before everyone else. I can remember years ago when I first started ranting about the Federal Reserve being the biggest bunch of thieves in the history of the world and people had the same blank faces as they do now when I bad mouth Interest Rate Swap scam. Unless everyone understands the wrong of Interest Rate Swap scam like they understand the wrong of the Fed, the Peeps are walking dead.

  24. […] (Here) […]

  25. […]   “Swaps are actually just bets; and if the municipality loses the bet, it can owe the house, and owe big. The swap casino is almost entirely unregulated, and it is a rigged game that the house virtually always wins. Interest rate swaps are based on the LIBOR rate, which has now been proven to be manipulated by the rate-setting banks; and they were a major contributor to Detroit’s bankruptcy” : (Here) […]

  26. The “state” is not able to run a city properly but the solution is a state-own bank. Oh boy … who voted Snyder into office? The bank?

  27. […] kollektive Schulden-Machen System der öffentlichen Finanzen zusammen. Ellen Brown hat auf ihrem Blog die Hintergründe […]

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