Protect Your Cash from Bank Runs
Global Financial System Teeters Dangerously on Edge of Stability
Banks that practice fractional-reserve lending – which, today, means virtually all banks – are inherently vulnerable to bank runs. Even the strongest, soundest banks are unable to honor a sudden spike in demand withdrawals. In theory, some banks could perhaps pay out 5 cents to as much as 10 cents on the dollar, but in practice the margin of error is much narrower for most banks, which lack actual cash reserves and must borrow to cover daily needs.
If an abnormally large portion of depositors walked into banks one day and demanded their money, banks would quickly freeze up. The whole system is latently insolvent.
Fractional-Reserve Euro Banking Multiplies Risk
The system rests on confidence. The European Central Bank has sought to restore confidence in the system by making massive emergency loans to banks to keep them from going under and avert a direct public perception of a systemic problem. More debt to solve the problems created by too much debt.
In the United States, Federal Reserve backstopping and FDIC insurance have served to keep bank depositors mostly complacent and prevent a mass-psychological trigger for bank runs.
But the mega-banks are so heavily leveraged that if a relatively small portion of one bank’s derivative book blew up, for example, it could be enough to collapse the entire system. The amount of risky derivatives exposure in the banking system could ultimately prove “too big to bail” (out): Goldman Sachs is exposed to $44.2 trillion in derivatives; Bank of America, $50.1 trillion; Citibank, $52.1 trillion; JP Morgan Chase, an astounding $70.2 trillion in derivatives – roughly equal to total world GDP!
The FDIC, with about $19 billion in cash, is ill-equipped to mop up the mess created by the failure of a mega-bank, let alone a domino effect of successive bank failures, even though it does enjoy a line of credit with the U.S. Treasury. More debt to solve the problems created by too much debt is no long-term solution. The Federal Reserve has already tripled the size of its balance sheet – from about 6% of GDP before the 2008 financial crisis to 17% of GDP today.
What You Can and Should Do: Know Your FDIC Coverage Limits
When Congress hiked FDIC coverage limits from $100,000 to $250,000 per account following the 2008 mortgage meltdown, it did temporarily help quell depositor fears and keep capital from fleeing the banks. The $250,000 FDIC coverage limit is slated to revert back to $100,000 at the end of 2013. If that happens – or perhaps well in advance of that happening – large numbers of people with more than $100,000 on deposit could take their money and run.
It is not advisable to exceed FDIC limits on any account at any bank – no matter how safe it may appear. The safest banks today are only “safe” under normal conditions. No bank whose outstanding liabilities to depositors are multiples of its actual assets, as is the nature of fractional reserve banking, is impervious to bank runs.
Although FDIC insurance only covers up to $250,000 in deposits per individual account, an individual can open multiple $250,000 accounts at different banks in order to get Federal Deposit Insurance on each of them. Consider also that since joint accounts cover two depositors, you can effectively get $400,000 worth of coverage on such an account (the FDIC’s current coverage limits, which expire on January 1, 2014, extend $200,000 worth of coverage per co-owner of a joint account).
Tips for Staying Safe
Besides heeding FDIC coverage limits, heed the principle of diversification. Whether your liquid net worth is $10 million or $10,000, don’t entrust too big a portion of it to a bank account or any combination of bank accounts.
Here are a few tips for your consideration:
Hold ample reserves of cash in the form of $20s, $50s, and $100s – a bank failure or a national “banking holiday” could render your ATM card inoperable.
Consider opening a Treasury-only money market fund account that offers check-writing privileges. Treasuries may one day default, but the government will let the banks collapse long before it reneges on its own debt.
Broaden your operating definition of “cash” to include foreign currencies and precious metals. When all else fails, there is gold. It cannot default.
Only deposit funds with banks or credit unions that are rated relatively highly for financial strength. You can get your bank’s safety rating via a ratings service such as Weiss Ratings (877-934-7778; www.weissratings.com) or Veribanc (800-44-BANKS; www.veribanc.com).