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Monday, March 18, 2013

How Black Accounts Work – A Cyprus Connection?

 

A central criticism of the decision to seize a portion of the bank accounts in Cyprus is that the “bite” hits small guys who have accounts with a balance of less than E100k. As I write, it appears that there will be some revisions to the deal that was announced over the weekend. Those changes will likely minimize or eliminate the hit on these “smaller” accounts.

It is a travesty (and a crime) if Cypriots who live and work in the country have a portion of their accounts clipped. The small guys were not part of the problem, so they should not have been part of the solution. This obvious conclusion begs the question, “Why did they do it in the first place?” There are two possible answers:

 

The folks who put the original plan together were a bunch of misinformed idiots. They did not consider the fairness aspect, nor did they consider the deposit rules on <E100k sized accounts. The plan was hatched and announced before the big Finance Ministers, politicians and the ECB had a chance to consider the broader Macro issues and the possibility of a deposit run in other EU countries.

Given how so many other aspects of the EU financial story have been mismanaged, there is some possibility that this is how it played out. The whole process was bungled; no one ever considered the contagion risks. It was a complete screw up from beginning to end.

 

I have a very hard time believing that this scenario is correct. I think all of the EU deciders were involved with the choice. There was consideration of the related risks, the decision was made to go forward in spite of those risks.

 

NOTE: It’s my bet that the decision was communicated to key US officials. Bernanke, Jack Lew and Obama were all informed before it was public.

 

To me, the only possibility for including the sub E100k in the haircut was because many of the smaller accounts, were also hot money accounts from foreign depositors. The folks in the EU must have understood this when they pulled the plug. (That, or we go back to the “idiots” answer)

 

Note: I have never had a black account in a Cypriot Bank. I have no black accounts, period. Never had.  I have no direct knowledge of how black accounts were managed in Cyprus. BUT, I do know how black accounts were/are managed in other hot money havens. I strongly suspect that what happens outside of Cyprus also happens within Cyprus.

 

Assume you’re a crook of some sort. You have ill gotten gains. Extortion money? Dictator/Politician who stole money from the national treasury? Maybe a pirate, a drug lord or a kidnapper? An Oligarch perhaps? How about a simple jewel thief or bank robber? A tax cheat? Or even just some poor guy who is trying to hide some loot from a wife?

 

WHAT’S THE MOST IMPORTANT THING TO YOU?

 

Access to your money of course. What’s the fun of having a few mil stashed away and not being able to enjoy what that money can bring? You want bling! $5,000 a night hotel suites, 1st class travel all the time, $1000 bottles of wine, $8g for shoes – you can’t have enough of this stuff! And you must have some cash in your pocket. For you, a minimum of $5g in the wallet is necessary. You need to have access to $5g pretty much every day to keep up with all the fun.

How do you do all that? Simple! A credit card tied to a bank is all you need. It’s no regular CC. This one is imbedded with a chip. It’s better than “smart”.

There is no credit involved; behind the CC is a special account. That account is like a checking account. When you hit the VISA for $50k for some bauble, the transaction clears, as there is cash money behind the card. To have the ability to spend serious money on a CC you need a balance of at least $100k in the account. In addition, many banks require that you maintain a minimum amount, say $50k.

How do YOU feed the CC clearing account? Simple! You have on line banking! When inserted into a special reader that you have, the chip produces a one-time code/password, (the code changes every 30 seconds, so log on quick!). The “bank” has a similar code reader device, and it “knows” what that password will be for those thirty seconds. With the account now opened, you can transfer more money to the transaction account. Party on!

Wives/girl friends can get a card too! Those don’t have chips, so you can cut them off at will! Cash is a problem, but with a couple of cards, $4k can be had every twelve hours or so.

What does this cost you? To start with, you must have a couple mil in another account. Call that “key money”. On each CC purchase you make, the bank takes an extra 1% right off the top. Call that a “service fee”. You spend a million on a CC, it costs you $10g – who cares?

Do you live in a City? Pretty much anywhere on the globe? When you walk around today and see all the tourists living it up and shopping like crazy – understand that “hot” cards are a significant portion of that activity. The problem with hot cards is that you don’t want to use them in your home town. That draws attention, and YOU don’t want that, right? So travel well!

AGAIN – I don’t know what happened in Cyprus. However, if a significant number of the “smaller” accounts that are subject to the deposit theft are connected to CC clearing accounts of non-residents, then you have a possible explanation for the actions that were taken.

 

NOTE:

I AIN’T TAKING SIDES! I’m reporting some information that may or may not be relevant to the discussion on Cyprus. I’m not trying to justify the actions that the EU has taken. I’m trying to understand what motivated them to take such drastic and dangerous action.

That said, if you still need to shoot the messenger, please feel free to do so. BK

 

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Comments

  1. “NOTE: It’s my bet that the decision was communicated to key US officials. Bernanke, Jack Lew and Obama were all informed before it was public.”

    I have to disagree with you on that statement. They did not have to be informed. IT WAS THEIR PLAN!

    The plan was laid out three weeks ago in the WSJ…

    “…any plan to inflict haircuts would need to be hatched in secret to avoid bank runs”

    Keep the public assured…

    “I want to be absolutely clear. Absolutely no reference to a haircut on public debt or deposits will be tolerated. Such an issue isn’t even up for discussion,”
    President Nicos Anastasiades three weeks ago.

    Note Pimco’s involvement…and the usual suspects Bank of America/Merrill Lynch and Morgan Stanley have their foot prints were all over this.

    http://tinyurl.com/cgbe3uh

  2. I think at 3am, after negotiating for 10 hours, people were just tired. Alcohol was consumed. Maybe some key people snoozed off, and the people at the negotiating table didn’t think about every ramification.

    The Germans said “take it or leave it, it’s your problem how to come up with EUR 6bn”. As Schaeuble said on German TV “It was their decision to haircut the small savers. They have to explain it to their people”. Also, it’s easier to explain to a Russian account holder that ‘everyone’ got a haircut, and you might not find yourself with a hole in your head.

    In hindsight, haircutting those with under 100,000 just 3 years after introducing a 100,000 EU-wide guarantee doesn’t look like the smartest thing to do, especially since capital flight from the periphery had just calmed down a bit.

  3. The more the politi-crooks try to explain their actions, the worse this fiasco sounds. Its a lot like the government in Spain insisting al-qaeda had nothing to do with the Madrid train bombings or the explanations over the US embassy in Benghazzi. Smarter people would just keep quiet — talking is making the EU sound guilty.

    This “hot money” thing sounds like a lie. As BK explained, the hot money crowd is burning through at least 5,000 per day (I think Bruce is dating himself / hasn’t been to a 5-star resort in a long time). That means the hot money accounts have EUR300,000 in cashflows per month (30 days times EUR 5K, times two because the money is wiring in and then being sent out via credit card).

    Mom and pop customers don’t have that kind of money, nor that kind of monthly cashflow. Mom and pop also have an address on Cyprus (not a trust account at a law firm). In short, even a stupid eurocrat could very quickly identify which accounts are Russian mobsters and which are locals.

    That means the EU regime either is too lazy to bother (aka they don’t give a shit about their own citizens), or they are deliberately targeting their own citizens. If Brussels wanted to protect “the little guy”, there were (and are) plenty of options. The EU apparently ring-fenced Greek banks from being robbed, because the EU would end up eating the cost via existing Greek bailout programs. The EU knows they are stealing from ordinary citizens (not just mobsters) — and they are doing it on purpose.

    The big question I have, as a global investor, is what possible excuse would a portfolio manager have to invest in a quasi-government (the EU) that is at war with its own citizens?

    The short term problem is that Russian mobsters (if they are a significant factor in Cyprus outside the newspaper sensationalism) are not going to take this theft lying down. And there are too many easy ways for the Russians to extract revenge — from jacking up energy prices to ramped up cyber-theft to whatever form of violence. And guess where the mobsters spend their EUR 5,000 per day? European hotels and high end shops perhaps? Guess who will do their shopping elsewhere? The EU leaders (assuming they aren’t completely stupid) would have to expect heavy retaliation from mobsters.

    Longer term: whatever “gain” the Eurocrats might get from stealing their own citizens, the cost (a loss of trust / respect in the system) overwhelms the gain. A mobster (if he was smart) would know that stealing from your own gang means your gang is going to split up. Stealing from others is part of the game, but the gang isn’t going to trust Don Corleone if he steals from his own family. Even pirates have “honor codes” about stealing from their own crew — pirate captains that robbed their own crews ended up with mutinies.

    Is the EU leadership just stupid or are they trying to incite mutiny? Why would anyone want to join their gang / invest in Europe? This decision by Brussels to steal from their own citizens should cause a run on all of Europe, never mind EU banks. Any portfolio manager that stays in Europe isn’t qualified to be a crime boss, never mind a PM, if foolish enough to stay.

    Time is no longer on the EU’s side. Even if the dumb crooks in Brussels are forced to scale back their theft (I agree with Bruce that they will scale it back) — it doesn’t matter. The loss of trust is much worse and it is fatal. The EU just proved that the real problem in Europe is not Greece or Ireland or Spain or Italy or Portugal or Cypus — the real underlying problem with the EU is Brussels itself.

    PS — for those of us in the USA, we really should ask why we continue to work for a crime boss (Bernanke) who is stealing off the top before he divides the loot?

  4. a different tom says:

    My guess is the “hot money” knew far in advance something like this was in the works. By the time things went critical there were not enough deposits above 100K to rob, hence they had to rob all the accounts. Drudge also had an article up that said senior bond holders would not lose anything – if true that’s really egregious.

    • Heavens! Senior bond holders don’t take a hit? Reality check:

      The Junior Subordinated Debentures of both Fannie Mae and Freddie Mac were bought out at a significant premium to par.

      Bond holders only take a hit when there is a bankruptcy. A court can blow off a bondholders claim. But absent that, the obligations stick, and continue to accrue interest. It’s hard to get rid of a bond. Rule of law and all that.

      • a different tom says:

        Right, but I thought non-interest-bearing depositors were “first in line” ahead of everyone else when it comes to liquidation and cram downs (at least in the US, unless you had MF Global accounts). I realize in the EU depositors and bondholders are pari-passu, but in that case shouldn’t the bond holders get an equal haircut?

  5. @Greg – “The loss of trust is much worse and it is fatal.”

    This is so true. I remain forever amazed at how so many people don’t realize that basic concept.

    It’s really simple — you either trust or you don’t. And once you don’t….everything changes/declines dramatically.

  6. “”That said, if you still need to shoot the messenger, please feel free to do so. BK”"
    Is it OK to cheer on the messenger?
    cheers!

  7. Sitting here in the cheap seats (NZ) this looks like someone has deliberately pulled the pin then stuffed the grenade down their own pants. What rational person is going to leave $1.00 in liquid assets anywhere in tier 2 Euro countries after today?
    Game on!

  8. Bruce,
    Why is everyone so deathly afraid of giving bond holders haircuts? Just curious why the little guy keeps catching it in the shorts, but the bond holders(who should’ve known better) keep getting 100 cents on the dollar they recklessly loaned out.

    • been happening since Continental Illinois in 1984. The free market has been enslaved to Fed/government intervention ever since Volcker created the biggest bond bubble in recorded history (some call it a 30 year bond rally) and he’s still viewed as a genius like Greenspan was in the mainstream before the housing meltdown. For a good laugh read Alan Blinder’s paper titled “Understanding the Greenspan Standard” written in 2005.

  9. Conscience of a Conservative says:

    Money Laundering.
    This is what the Cyprus bank levy is about.
    Europe is bailing out Cyprus and the issue of Russian money is very much a behind the scenes discussion.
    Upon researching the web for articles several came up and the discussion seems to be bailing out non-legit money. While the situation is more complex and one can’t paint all depositors with the same brush, money laundering is the elephant in the room here.

    • 1) There are ways to identify probable money launderers vs probable mom and pop accounts. It would be rather expensive to launder a million Euro through 10,000 accounts, EUR100 at a time — just as one obvious (though incomplete) example. Throwing the baby out with the bath water is just plain stupid; or as you phrased it: painting everyone with the same brush. Any government planning to remain in office must create at least the appearance (if not reality) of trying to distinquish friend from foe, money launderer from honest citizen.

      EU/Cyprus will have millions of enemies (who vote) if they go through with their theft on Friday. Once you make stealing “OK”, its OK for everyone: government and citizen alike. It will be impossible to put the genie back in the bottle. No one wants to put money in a offshore finance center known for theft.

      2) Have to disagree on the bailout argument. Bailouts are not required in any way shape or form. Indeed, before the criminals Paulson/Geithner made it popular to bail out cronies, bailouts were the exception. Different jurisdictions had different names for the process, but pre-2007/8 … governments provided something like debtor in possession financing. Just enough liquidity to keep the doors open while the bank got wound down, parts sold off, and the doors closed for good. See Continental Illinois for example of a major money center bank that collapsed — it was painful, but the sky did not fall and there was no attempt made to lie that it was just a temporary liquidity crisis. The bank was insolvent, and the government provided a line of credit for a period long enough to wind the thing down.

      If Paulson / Geithner weren’t trying to sooth the egos of their crony friends, that is how this crisis should have gone as well. Get the bad management out. Shut down the banks that don’t work (or no longer work). Geithner created the too big to fail problem in order to protect his kleptocrat friends.

      Now European crooks are emulating Geithner’s disgusting behavior to protect the egos of their crony friends. Bailouts are not necessary, not appropriate, and they undermine people’s basic sense of right and wrong — they undermine confidence in the entire financial system as people realize it is rigged to benefit a select few kleptocrats.

      Bailouts are not necessary — they are morally wrong. The whole world needs to stop regurgitating Geithner’s bullshit excuses.

  10. The stuff I have been reading suggests that the underlying mover behind the decision to tax the <100k accounts were the Cypriots. Why would they do this? Well a lot of people work in banks or own banks or are lawyers or accountants. They need the place to remain an offshore banking system. If they p*ss the Russians off too much then the Russians will change the law back home and wipe Cyprus off the Offshore banking map. So the Cypriots have been willing to take a bit of a haircut themselves to keep the russian haircut down to 10% of account balances.

    Now do bear in mind that just cos the money here is Russian, doesnt mean that it is dirty, other than in the sense of avoiding taxes (legitimately). Its no different to US corporations keeping cash in the Virgin Islands or the Caymans. Lots of Russian companies keep a Cypriot subsidiary to manage their tax affairs more "efficiently". Now Im not saying that dodging taxes is an activity I bless. But where does this "holier than thou" attitude come from? Google and Starbucks funnel their profits through Ireland and Holland to avoid paying tax in Europe. Why the hell the EU allowed the Irish banks to get away with it but not the Cypriot? Well I guess its ok to screw Russians but less ok to screw Americans right?

    I would suggest that the Russians are not gonna be ok with this. And they wont sit still and take it.

  11. Conscience of a Conservative says:

    Bruce, How does Cyprus’ gas fields play into all of this? What’s your opinion

  12. Hello Bruce. New reader here.
    I don’t understand this.
    You feed money into CC clearing account, but that money comes from some account right? What account is that ?

    Can you explain more things.
    How FED purchases work, the primary dealers thing ?
    How Cross currency swaps work ?
    How Repo works ? And how they make money with this.
    How repartition works why does it affect the currency pairs ?

    Ok I know its too much, but do you know any book on this kinda of stuff, I want to learn ?
    You’re opinions are very interesting and new to me! love them.