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Thursday, January 5, 2017

State Investment In Banks: Money Gone Up In Smoke?

My neighbor Yiannis, the theoretical Marxist, is furious. He has found out that most, if not all, of the 25 BEUR which the Greek state borrowed offshore in order to invest in Greek banks as part of the bank recapitalizations may turn out to be worthless. Let me clarify: only the investment may turn out to be worthless; the loans will continue to remain 100% obligations on the part of the Greek state.

Yiannis asks me two very simple questions: Where did that money go? And, as he suspects, if the money simply went up in smoke, why should Greek tax payers pay for it?

No money ever goes up in smoke; it only changes owners. But who are the new owners of that 25 BEUR which the Greek state is no longer owner of? That's where it gets a bit tricky.

The Greek state invested in banks, the value of which went towards zero and, in consequence, the value of the Greek state's investment also went towards zero. But who got that money?

Nobody got that money! The answer is that some parties who still have money today would no longer have that money if the Greek state had not invested the 25 BEUR. That's where the money is! Had the Greek state not invested the 25 BEUR, the 4 large Greek banks (and others) would have gone bankrupt and the creditors of those banks (bondholders, savers) would have lost a lot of money (in sum certainly more than the 25 BEUR which the state lost). Not to mention the collateral damage involved when the largest banks go bankrupt.

So I told Yiannis that he himself was one of the beneficiaries. Yes, as a tax payer he is now responsible for paying off that 25 BEUR in debt but, in exchange, the value of all his bank deposits remains in place.

Yiannis said he had no bank deposits. I told him he was out of luck.

11 comments:

  1. A technical point , "no money ever goes up in smoke" is not true , bank liabilities do to absorb a reduction in the assets. That why the Greek state cannot make a withdrawal of 25 BEUR.

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    1. Let me cite what my first boss in banking said to me shortly after I joined the bank as a trainee: "Remember, if an asset loses value, that loss goes directly against equity. The liabilities remain unchanged!"

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    2. The equity is the first to be effctected and then the other liabilities.

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    3. @Dinero at 10:16
      I think you confuse the balance sheets of different parties. As kleingut wrote, "if an asset loses value, that loss goes directly against equity". If you buy a house for 100'000 and you owe 80'000 to a bank as a loan against that house your equity is 20'000. Now if your house loses 30'000 in value eqity is -10'000 yet your liabilities are still 80'000. Your liabilities are an asset of your lender. Should you default on your loan again this loss would go directly against the equity of your lender.
      Urs

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    4. Its the equity and the liabilaties of the bank's
      balance sheet that are affected.

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    5. You seem to be referring to the new EU directive for bail-in's where the waterfall principal determines that equity holders suffer first, then subordinated creditors, junior creditors and, finally, senior creditors including savers. The Greek banks (as opposed to the Cypriot banks) were bailed-out and not bailed-in. The only ones that lost were the equity holders like the Greek state.

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  2. @kleingut: I think the wording "The Greek state invested in banks" is bit misleading (though technically correct). Greece helped to recapitalise banks that without this aid would have been on the verge of bankruptcy due to non performing loans and writedowns on collateral.
    Urs

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  3. Yiannis being presumably a Greek Taxpayer has invested and lost BEUR 25 in Greek Banks, so that a very large number of his compatriots, who funded their homes with mortgages and are unwilling or incapabable to service those mortgages, can continue living rent-free in their homes.

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  4. Klaus,

    You are a very experienced banker conversant with complex bookkeeping and balance sheet manipulation.
    Your technical answers are, without doubt and in banker's terminology, probably 100% correct.

    However, no one ever seems to be able to answer Yiannis in simple and practical terms.

    After the ECB has pumped billions of Euros into the EU "economy" etc, etc.....Where did all that money go?

    Most of us seem to be poorer now than we were a few year's ago!!!

    I can understand Yiannis' frustration and "out of luck" is hardly going to put food on his table.

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    1. There is a difference between the ECB billions for the EU economy and the Greek bank recaps. It's very easy to explain where the ECB money went: it went to all those who sold debt securities to the ECB (QE), mostly banks. In the morning, a bank had, say, 100 debt securities and 0 cash. In the evening, it would have had 0 debt securities and 100 cash.

      With the bank recaps, the state gave cash in exchange for equity securities of uncertain value. Had those equities increased in value, the state would have made a profit. As it turned out, they became almost worthless.

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  5. Tell your theoretical Marxist. From each according to his abilities, to each according to his needs. If his Marxist beliefs are not strong enough then tell him the meek will inherit the world.

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