Cyprus: could something like that happen in Canada?

Marc Faber contends that at some point, everywhere will become like Cyprus.

It will happen everywhere in the world. In Western democracies, you have more people that vote for a living than work for a living. I think you have to be prepared to lose 20 to 30 percent. I think you’re lucky if you don’t lose your life … If you look at what happened in Cyprus, basically people with money will lose part of their wealth, either through expropriation or higher taxation.”

But in Canada? No way!

Well… maybe. Check out page 144 of the 2013 “Economic Action Plan” (I hate that term):

The Government proposes to implement a “bail-in” regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada. Implementation timelines will allow for a smooth transition for affected institutions, investors and other market participants.

The details are not made explicit in the budget document. But remember, your deposit is the bank’s liability. When the budget talks about “certain liabilities” being converted into “regulatory capital,” it kinda sounds like Canadian government might be willing to enact a Cyprus-esque solution to a banking crisis.

Apparently, this is not what they mean. Instead, Ottawa wants banks to issue “contingent capital bonds,” something Carney has advocated. These bonds would provide an above-average return. The catch is that if the bank gets into trouble, the bond is converted into shares. The bank would then have emergency capital without a taxpayer-funded bailout.

I think this is a stupid idea. Sure, I suppose banks should be able to issue whatever kind of bonds they want. However, Ottawa claims it wants to “limit the unfair advantage that could be gained by Canada’s systemically important banks through the mistaken belief by investors and other market participants that these institutions are “too big to fail.” The contingent capital bond doesn’t really do anything about that. The moral hazard still is there, because there remains an implicit assumption — which seems to permeate all Western nations at this time — that if anything bad happens to a bank that made bad investments, the entire world will explode. So the government or the central bank will have no choice but to intervene to “save the world (banks)”! We don’t even know that the government itself would not buy these bonds. Or, in a serious crisis, why they couldn’t just buy preferred bank stocks, like a Paulson plan style of bailout/bail-in.

If the implicit guarantee is still there (and why would it not be? Canada’s banks were bailed out in the financial crisis), then contingent capital bonds don’t address the moral hazard issue. Instead, they just let the moral hazard continue with a wink and a nudge, while someone gets a higher yield bond out of the deal. Meanwhile, the explicit generators of moral hazard, like the BoC, CDIC, and the CMHC, continue to exist without change.

Canada’s Big Five banks hold nearly $3 trillion in assets. Their capitalization is about 8%.  So their leverage is so great that they would not withstand even a moderate crisis on a “bail-in” of converted contingent capital bonds. A 20-30% hit on assets would crush them. The idea is a joke.

Yet, the Canadian government, for all its ineptitude, must reasonably fear that a critical Canadian bank failure is a plausible situation. Whatever their “bail-in” plan entails, you must remember that CDIC insurance covers only $100,000 of your chequing and savings deposits, and short-term GICs. It doesn’t cover your stock account or your RRSP accounts. Don’t count on the ‘geniuses’ in Ottawa to regulate the economy so effectively that all your money will be safe.

— Read more at CBC —