BAIL IN

Did An Obscure IMF Document Start A Global Bail-In Revolution?

by Daniel R. Amerman, CFA
When revolutions start, it's not uncommon for almost nobody to notice. It may take years or even decades before historians can look back, point a finger and say "that's where it really began."
An obscure International Monetary Fund "Staff Discussion Note" may have already started a "Bail-In" financial revolution that could transform the global investment world.
In this quite remarkable document, the staff discusses a world where risks to the global financial system have not gone away – but are worse than ever. As candidly discussed, the "SIFI" (systemically important financial institution) problem has not been improving, but instead has been getting worse than ever – and there doesn't appear to be any solution under existing contract law and bankruptcy law.
More risk than ever is concentrated in fewer financial institutions, while there is no way under existing law to unwind a failure of one of these institutions without risking triggering global financial chaos. Moreover, there is a deadly feedback loop between these "too-big-to-fail" institutions and sovereign governments. That is, as the IMF staff discusses, the bailing out of these massive institutions can bankrupt sovereign governments, and sovereign governments going bankrupt can wipe out the "too-big-to-fail" institutions.
So the IMF staff has come up with an audacious plan for how the globe can emerge from this seemingly impossible situation. The key word is "insurance".
The proposal is to take selected classes of investments, and retroactively decide that these assets aren't really assets at all. Indeed, the owners of these assets have – without realizing they've done it – agreed to provide insurance for the global financial system. So if a major crisis arises, the global financial system merely goes to these unknowing "insurance" providers and helps itself to their assets effectively, and the crisis is dealt with. It's a miracle solution!
Now there is the issue that some investors might actually object to this taking of their investment assets for the greater good of society. Which is exactly why the IMF staff recommends that this be done by way of statutory law, in a manner that overrides contract law – and is involuntary, with no investor permission needed. It would also be retroactive as needed, thus applying to people who already own these classes of investments.
After the bail-ins of the Cypriot banks and the Polish retirement system, the development of bail-in procedures is spreading rapidly around the world, including the EU, Canada and the United States.  What is fascinating and troubling - though perhaps not surprising - is how global politicians are in practice completely changing the "bail-in" concept, setting aside the IMF-proposed changes that could have forced genuine banking reforms and potentially increased global financial stability, and instead are creating a broader threat to investors.
Moody's Investors Service has already lowered the credit ratings of Morgan Stanley, Goldman Sachs, JP Morgan Chase and Bank of New York Mellon in anticipation of possible future bail-ins.  Moody's accompanying statement explained: "Rather than relying on public funds to bail out one of these institutions, we expect that bank holding company creditors will be bailed-in and thereby shoulder much of the burden to help recapitalize a failing bank."

A World At Risk

The IMF Staff Discussion Note is titled, "From Bail-Out To Bail-In: Mandatory Debt Restructuring Of Systemic Financial Institutions".  Originally released in 2012, it could be viewed as a source document for the global movement to bail-ins.