Thinking like Riad

A lot of people are wondering about the ubiquitous circulars issued by the central bank of Lebanon, Banque du Liban. Some are contradictory with the legislative branch’s proposed capital control law, while others contradict its very own earlier circulars. Is it confusion or is there a plan? 

Two weeks ago, the World Bank published a report that received a lot of mileage in the press, because of a snippet that described the Lebanese crisis as one of the worst in over a century. In terms of size, i.e. relative to current and projected GDP, there’s no question they’re right. A journalist talked to me last week, quoting this report, but he couldn’t reconcile the incongruity between the report and what he saw in the overflowing bars of Gemmayzeh, restaurants and beaches. In some ways, Lebanon is Caracas on weekdays and spring break in Florida on weekends. I told him that to understand the situation better, he should go back to a previous World Bank report, the title of which is way more accurate, albeit less melodramatic, which is why it didn’t earn its rightful place in the media coverage pecking order. It described the situation as a “deliberate depression.” 

When you think about it, at the peak, an estimated 6,000 accounts owned almost $90 billion or 52 percent of deposits. That means that the losses in the banking sector are really all about these 6,000 people, with an average account worth $15 million. The problem at its core is really a crisis of the wealthiest segment of Lebanese society and this whole thing could be solved quite easily in a way that shields the rest of the population from their current excruciating misery … such as the dollar-lira rate flirting with 16,000 … or the massive shortages of medicine and fuel. We’ve said before that the solution to this problem is the “equitable distribution of losses.”

Thus if 6,000 people own 52 percent of bank deposits, then these same 6,000 should bear 52 percent of the losses. Maybe even more, because, on average, a millionaire account earned fake interest rates way higher than the $10,000 accounts, thus creating a much larger fake liability. Not to mention the benefits they already received in the days when this interest was paid out and spent on their lavish lifestyle and conspicuous consumption. In fact, many old accounts had already recovered their original investment through old interest payments, sometimes many times over. These payments to old depositors, of course, were financed by the acquisition of new depositors, hence the Ponzi scheme characterization.

The current plan of the governor of the central bank, Riad Salameh, in conjunction with the banking cartel, aka the Association of Banks in Lebanon, and the generally passive acquiescence of the judicial system, is actually a form of distribution of losses. It’s just not equitable. The essence of the plan is the “lirafication” of deposits. Thus, every withdrawal at the rate of 3,900 is a voluntary haircut of 75 percent. Lollar checks are now selling for 20 percent (in real dollars) of their face value.

In a respectable and just system, as soon as banks stopped paying their customers the amount demanded from their current account in the same currency, they should have been declared insolvent and all assets of their senior management and board members seized, which is in accordance with Lebanese law, by the way. Banks would have been bailed in by depositors (who would have become the new shareholders), which as a first result, means that when a bank sells its branch overseas, say in Egypt or Jordan, those real dollars could go to depositors, who now have a say in their allocation. As it happens, in the current system, banks are protected by the central bank from this eventuality, allowing them to do as they wish with their scarce remaining dollars, which means a chunk was smuggled out as their shareholders’ private wealth, as well as that of friends and family — especially politically exposed persons (PEPs), to help with the legal cover for this travesty.

The strategy of lirafication is betting that at some point, once claims by depositors are reduced to a manageable level (they’re already down 30 percent from their high), then any real dollars held by current shareholders could cheaply recapitalize themselves, and remain in existence despite losing most of their depositors’ wealth. This would be an unprecedented instance of moral hazard, namely banks losing most of their depositors’ money, yet with no repercussions whatsoever for their owners or managers.

One manifestation of this plan is various acrobatics, aka the last BDL circulars. If lirafication is the plan, then it’s pretty clear that $140 billion of it (i.e. the total deposits in lira and dollars) would decimate the lira’s value. How? Since most of the people will still go to the black market to convert these amounts in real dollars (for saving or consumption) this could end with a lira pulled down to the level of six figures. This is being postponed through the fake scarcity value created by capital controls on lira and has already created a spread between lira in the bank (“bira”) and lira cash. That spread is projected to widen to 25 percent or more if this current policy continues.

Expats are currently sending roughly $6-7 billion in remittances per year, which is, on average, almost $600 per month per family, or 10 times the minimum wage. This is one of the reasons that the country isn’t sliding into traditional forms of meltdown that would have happened when a currency loses 90 percent of its value. On the other hand, these families are not living at a standard of living commensurate with this huge level of remittances, because a large chunk of that money is being siphoned off to the central bank, through the artificially low current level of the currency. To better understand this, let’s start with a simple case, the aid from NGOs: more than two-thirds of the aid was being siphoned off to banks or the central bank by paying it out at LL3,900 to the recipients, while the lira was trading at over LL12,000. (and a similar trick was attempted with the World Bank via the infamous LL6,240 rate). In some ways, this is also true from the remittances people receive directly in “fresh” dollars (through their “fresh” account or money transfer companies): as soon as they go to the black market to sell it, they lose the difference between the artificially low rate applied and the actual real value of the lira – and that same difference is pocketed by BDL (which, in case you don’t know it, is the final buyer of some of these dollars — the rest going back out for imports).

The only challenge to this plan is that BDL reserves will most certainly be depleted before deposits are down to a manageable level. Thus, here’s where the interests of Riad Salameh and naive bankers who believe in this plan diverge. Riad must survive for two more years, until the end of his term, without running out of reserves, while, if continuing with this plan until reserves run out, bankers must deal with the aftermath of Riad’s departure and a runaway lira, and possible breakdown of law and order.  

Dan Azzi’s column appears monthly in L’Orient Today and L’Orient-Le Jour.

Dans la tête de Riad Salamé