The Gulf Investor Deception

The Gulf Investor Deception
By Robert Sharratt

How Barclays and Credit Suisse avoided a govt bailout during the 2008 financial crisis

Nothing illustrates the fact that banks can create their own credit money better than the “investment” in Credit Suisse and Barclays Bank by Gulf investors during the 2008 financial crisis.

In 2008, like many banks, Credit Suisse and Barclays were technically bankrupt by the financial crisis: their liabilities exceeded their reserves. In the crisis, insolvent banks had three options:

  1. get an explicit government bail-out (take government money, which is what many banks did);
  2. raise capital from private investors (which is what a few, mainly better-capitalised banks did); or
  3. receive an implicit bail-out (the government offers some guarantees, the central bank buys your not-so-good assets for cash, etc. This is what the rest received).

Credit Suisse and Barclays came up with a better plan: they created their own money and “loaned” it to “investors” from the Gulf. As with normal credit money creation, on the banks’ books, there was an asset (a loan, based on expected future cash flows) and a deposit (of the loan amount, for the use of the investors; this is FV money). The investors then used this newly created FV money to purchase newly issued preference shares in the banks. So, on the liabilities side of the balance sheet, the banks no longer had a deposit obligation; instead, they had brand new capital in the bank! What collateral did the Gulf investors put up as security for the “loan”? Well, they put up their newly received preference shares. Does anyone else see this as an illusion or is it just me?

Try not to laugh, but there is an entire regulatory regime for calculating “capital adequacy ratios” for banks.[1] The same banks that can create their own money and their own capital. To make sure that the banks have sufficient “tiers” of capital for the risk they undertake. So, don’t worry, the regulators have it all under control.

The Wizards of Capital Creation
The Wizards of Capital Creation

Wait a minute, you may be asking: even if these Gulf investors didn’t put up a penny of the billions of new “capital” that was created, they still have to pay the interest on the billions in loan “money” they received, right? The answer is no. Don’t worry about the Gulf investors. Barclays made a transfer to the investors of £322 million as part of the “investment”. You read that right: the only physical cash transfer in relation to the investment of £3 billion in Barclays went from Barclays to the Gulf investors. What was the £322 million for? Well, Barclays doesn’t need to tell you that. For Credit Suisse, there were convertible elements to the loan too complex for you to understand, gentle reader.[2]

The bail-out of UBS during the financial crisis used up almost all of the funds available to the Federal treasury in Switzerland, at a significant cost to every single Swiss taxpayer. When it came to Credit Suisse’s deception, the regulator allowed it to pass. If Swiss citizens knew how their two global banks actually functioned and the risk that is borne by the Swiss people, they would never support these banks.

In the United Kingdom, something strange happened: the Serious Fraud Office called it a fraud. The SFO is a minor regulator and doesn’t usually get involved in such matters. The main British bank regulator is the Financial Conduct Authority, which did nothing. Undoubtedly, it found Barclays conduct to be just fine. Eventually, the British courts examined the “loan”, found nothing wrong with it, and dismissed the SFO’s case. The traditional British sense of fair play prevailed.

Why did this “loan” for capital injection work? Because of confidence. Because people believed in this self-created “money”. To make it believable, you need believable investors, of course. When you want to arrange something like this, you are better off calling people from the Gulf rather than from, say, Mauritania. Actually, in some ways, you could say that the Gulf investors provided an extremely valuable service. Just not in cash. They provided confidence capital.

For Barclays and Credit Suisse, rational actors in the economy, this confidence capital was obviously more valuable than a government bail-out. Whether you want to call it a con game, an illusion, or a fraud, it is on confidence that the fractional reserve banking system exists and nothing else. It makes people dishonest, in a way, because Barclays and Credit Suisse cannot just come out and tell the truth about why it was really done: to encourage depositors to believe that the banks were solid, that their money is there and safe, to prevent a bank run. It is the intrinsic nature of “fractional” reserve banking. Your money cannot be “there” and also lent out. No bank is “solid”. If you lose the confidence of depositors, any fractional reserve bank would just collapse.

The Gulf Investor Deception

[1]Capital adequacy standards are overseen by the Bank for International Settlements in Basel, Switzerland.

[2]The heart of the loan-investment in bank capital are summarised here. Of course, if you do something so plain vanilla, it is obvious to many, even those who are not financial specialists. So, naturally, the overall dealings between these two banks and the Gulf investors was made much more complex, involving: offshore companies; other, complex financing instruments; detailed legal documents, etc. The core issue is that the banks created their own money to facilitate believable “investors” to purchase shares, so that the banks’ capital adequacy ratios could be reported at higher, adequate levels but with no true change in value.

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