Davos 2010: a "cunning" plan how we will all pay for "the largest heist in history"

According to Wall Street Journal, "top bankers and senior government officials from major economies held informal private talks on regulation that participants called 'constructive' but which produced little concrete result. (…) [The] only one concrete proposal was discussed in depth, according to a European CEO who took part: the idea of converting some of banks' debts into equity if their capital reserves are insufficient to cover writedowns, a proposal aimed at increasing banks' ability to absorb heavy losses.". Conspiracy? Of course not, just "a working meeting", but nevertheless let us forensically examine what this is likely to mean in practice.

The current financial crisis was caused by the banks engineering and operating a massive, global pyramid scheme. As a results the banks debt and potential liabilities became too large for underlying cash reserves. Or, more technically, the Money Multiplier became too high. Effectively, banks lost liquidity.

To save such pyramid from collapse governments injected trillions of dollars to improve banks liquidity, or, more technically, to reduce the Money Multiplier. This was done in two ways: by injecting cash (and giving governments' guarantees which are as good as cash) and taking banks’ equity for that and by quantitative easing, i.e. generating additional liquidity by printing money. The former risks putting governments' debt onto unsustainable level, whilst the latter carries high risk of backfiring with hyperinflation. Despite the massive amounts injected, testing the public financing and markets to the limits, those actions did not bring about the desired results. The banks' liquidity remains dire. This is a testimony to a massive scale of the pyramid (i.e. a level of Money Multiplier) engineered and operated by the financial industry.

Nearly a year ago, Professor Nouriel Roubini suggested converting banks debt and liabilities to equity. This idea reappeared at the meeting in Davos. Banks will be allowed to issue their own shares and settle their debt with them. Whilst it may not apply to individual depositors who have government guarantees (although this is also far from being certain as it is not known how the system may be developed in the future), in practice it would mean that a depositor or a creditor may receive in return a bunch of bank's shares having demanded a payment in cash. The practicality is that such solution will not cost governments directly (i.e. it will not be reflected as a part of governments’ debt) and will not carry a risk of high inflation as no new cash will be printed.

So what are the pitfalls? Issuing new shares will dilute their value. As the size of the pyramid is massive, we really talk about massive dilution. Therefore the depositors and creditors will be paid with practically worthless shares and, on top of that, existing shareholders will lose the value of their holding. It is likely to be very similar to Zimbabwe-style hyperinflation but not of cash currency but of share value of a bank being diluted (i.e. hyperdevaluation of the share value). It is not really a concern for short-term speculative investors as they always find a way to make money on the margins of fluctuations. Apart from affecting depositors and creditors of a bank, it will affect long-term investors, cumulatively large-scale through pension funds, endowments and unit trust investments. They are mainly middle class, responsible people who took care about their financial planning, their children education and pension. They have been the pillars of the free market economy for a century. They cannot do much to escape a beating if "banks' debt to equity plan" goes ahead: their funds' shareholding of banks is substantial so even if they try to escape by selling it out, they will be punished. This appears to be another way of making taxpayers pay for the largest heist in history. This time round, rather than through governments' finances or inflation, the toxic waste will be unloaded on depositors and creditors with additional diluted worthless shares. Clever, eh?

This kind of shareholding dilution strategy has been associated with companies regarded as rather dodgy, trading on OTC or AIM in London. (No doubt other countries have their equivalents.) Some City lawyers joke that "a criminal record" is a mandatory entry on their Board Directors' CV's. Now this kind of "unorthodox" financial practices looks destined for mainstream markets with governments' blessing. Similarly to governments' stimuli and quantitative easing it will make ordinary folk who worked, saved and paid for his/her pension poorer.

One way or another, the outcome of this crisis is not going to be any different than when pyramids collapsed in Albania in 1997 impoverishing the entire nation. The difference is that at least some of the perpetrators there languish in jail and some of the wealth gained was confiscated.