Posted on August 5, 2013 by Ellen Brown Original here
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.
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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.com, http://PublicBankSolution.com, and http://PublicBankingInstitute.org.
