I’m getting worried about more than just the stockmarket. More than the bond market – sovereign and corporate. More than just my family’s health.
It’s the government’s coming response that’s giving me goosebumps today. Its response to the economic fallout of coronavirus could be downright dangerous. And we’re not talking hypotheticals.
After the 2008 financial crisis, governments legislated for all sorts of measures. Measures designed to deal with the fragility of the financial system during a crisis. Coronavirus could mean they’re finally used, on you.
I’m talking about things like BRRD (2014/59/EU).
Did you know that, under this law, if your bank fails, depositors’ money can be taken to recapitalise the bank? One day you’re a depositor, the next you own almost worthless shares in the bank instead.
In other words, it won’t be the government paying for the next bank failure. It’ll be the people who sold out of the stockmarket, but forgot to move their money out of the bank.
But why would a bank fail? Well, they’ve just suspended mortgage payments in Italy. And some UK banks are allowing certain borrowers to do likewise.
Who is going to pay the banks’ bills?
At what point will renters demand the same relief, and receive it?
Or what about the banks that lent to oil companies and airlines? How will they cope with the coming losses?
Bloomberg has this headline: “Coronavirus Could Bankrupt Most Airlines by End of May, Consultant Warns”.
And what about all the people being laid off? Swedish Airline SAS is “temporarily laying off” 90% of its workforce! Will they keep paying their mortgages?
Bank bail-ins are just one crackdown to worry about. It’s the growing length of the list that’s the real concern. Let’s look at another 2008 crisis fallout policy we might see.
Is a return to austerity in the cards? Or should I say “austerity”, as the spending cuts were hardly drastic by financial measures.
If the government tries to live within its means after the coronavirus shock, what’ll the budget look like then? How will your government services hold up?
Which tax breaks will have to go and how will this change your financial affairs?
Or if the government doesn’t impose austerity, what’ll the UK’s debts balloon to? After the shock to GDP, what’ll the debt-to-GDP ratio hit? Will the UK join Italy and Greece’s side of the sovereign debt market?
If you’re worried about the stockmarket panic, well, stockmarkets can be closed to stop panic selling. Then your money will be stuck inside.
Or companies can suspend your access to your stocks. JP Morgan’s electronic trading platform for wealthy clients recently froze, as did fintech stock investing provider Robinhood.
Bank holidays are a long-standing favourite of governments in financial difficulty. As are ATM withdrawal limits – all perfectly legal and with precedent these days.
Ironically, our banks tend to teeter because government finances are looking so shaky. And, right now, bond yields are diverging. The likes of Italy have bond yield spikes while the US has bond yields plunging. It’s the divergence that’s dangerous. I’ll try to explain…
Over the past few decades, at the regular Basel meetings in Switzerland, governments created rules that force banks to hold vast amounts of sovereign bonds. This helps finance the deficits of the very politicians who makes the rules. But it also means the banks and governments are tied at the hip.
The problem with this is how the banks were incentivised to do it. The government created capital adequacy rules designed to make banks safer. These rules then assigned a zero risk weighting to government bonds, meaning the bank must treat them as safe and thereby the bank is considered safe if it buys a lot of those bonds.
When analysts tell you that the banking system is much safer than it was, this is what they’re referring to. Designating government bonds as risk free and encouraging banks to buy them.
The flaw is that it’s government bonds which keep struggling because of government debts. At some point we’ll see a Basel Bust, just as we saw a Basel Boom – demand for government bonds from banks bidding up their prices.
It’s the sub-prime equivalent of 2008, but even better than AAA rated. We’re talking risk free, by law. But the law isn’t reality. That’s why European bank stocks are back to the levels of 1988.
Thinking of opting out of all these crackdowns? Trying to escape the government’s grasp when it imposes bank bail-ins, shuts markets, freezes withdrawals and imposes austerity? But how are you going to do it?
Gold gets banned by the authorities when financial crises become severe. Have you already bought all the gold you need to prepare?
Large holdings and transactions of cash are already banned in many countries. Doesn’t coronavirus rather nicely fit the bill to ban cash here?
What about sending your capital overseas for safe keeping? To diversify?
Well, capital controls can see to that nice and quickly. They did for the likes of Cyprus and Greece.
Have you heard about Unexplained Wealth Orders (UWOs) or Account Freezing Orders (AFOs)? It turns out the government can freeze your bank account for up to two years and confiscate property you thought was yours.
Is that a distant measure of the future which no government bureaucrat would actually be willing to use? A financial crime expert and blogger wrote otherwise at the FCPA Blog a few weeks ago: “Recent UK Government data shows how while just 15 UWOs were issued in the two years to April 2019, a total of 670 AFOs were granted over the same period.”
But who can freeze your bank accounts? According to the blog, apart from the obvious contenders, the Food Standards Agency, the Post Office and Transport for London can all apply for AFOs.
What’s the threshold for the AFO? Innocent until proven guilty? Balance of probabilities that you’ve done something wrong? A warrant or evidence of wrongdoing?
Nah… they only have to suspect the money may be used for some unlawful way at some point. Then the Magistrate decides.
In order to obtain an AFO the applicant need only show reasonable grounds for suspecting that money held in an account is either recoverable property (property obtained through unlawful conduct), or is intended for use in unlawful conduct. The account holder themselves does not need to be under suspicion, nor does any criminal offense have to have been proved.
The trouble with this is simple. If the government controls what is unlawful conduct, it can use AFOs and UWOs to confiscate wealth en masse during a crisis.
The point of today’s Exponential Investor is simple. The legal mechanisms for a severe financial crackdown are already in place thanks to the response to the last crisis. You won’t have to see any great change in policy – no controversial new laws would have to be passed. They’re already on the books. Waiting to be used.
And the weaknesses that require their use are already built into the foundations of the banking system and government bond markets too. The crisis is baked in.
Just as we’ve seen quarantines, lockdowns, shuttered stores, public gatherings banned, travel bans and plenty more, we’ll see the financial equivalent in coming months.
That’s why stocks are crashing.
Until next time,
Editor, Southbank Investment Research