FDIC: Can We Hit You Back Next Year?

I came across a pretty scary story this morning regarding the Federal Deposit Insurance Corporation (FDIC). From Bloomberg:

March 4 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Sheila Bair said the fund it uses to protect customer deposits at U.S. banks could dry up amid a surge in bank failures, as she responded to an industry outcry against new fees approved by the agency.

“Without these assessments, the deposit insurance fund could become insolvent this year,” Bair wrote in a March 2 letter to the industry. U.S. community banks plan to flood the FDIC with about 5,000 letters in protest of the fees, according to a trade group.

“A large number” of bank failures may occur through 2010 because of “rapidly deteriorating economic conditions,” Bair said in the letter. “Without substantial amounts of additional assessment revenue in the near future, current projections indicate that the fund balance will approach zero or even become negative.”

So, in everyday speak: “Uh, look. We promised you that the money you have your bank would be insured up to 250,000 if the bank goes under. Will you be cool if we went back on that promise?”

This is not trivial. Remember how the FDIC works. Say you have a bank account with $120,000 in it. (First of all, if you are in this situation, what are you doing?!) The FDIC will (currently) insure all of this. So if your bank fails (like IndyMac did last year); the government (usually) steps in, takes over the bank, and tries to sell the bank after writing down the losses. If the FDIC goes insolvent however, they won’t be able to pay these obligations. So your entire balance will be uninsured.

And What is the FDIC doing to meet this shortfall?

The FDIC last week approved a one-time “emergency” fee and other assessment increases on the industry to rebuild a fund to repay customers for deposits of as much as $250,000 when a bank fails. The fees, opposed by the industry, may generate $27 billion this year after the fund fell to $18.9 billion in the fourth quarter from $34.6 billion in the previous period, the FDIC said.

The fund, which lost $33.5 billion in 2008, was drained by 25 bank failures last year. Sixteen banks have failed so far this year, further straining the fund.

Any takers that this won’t be a “one-time” thing?

What should YOU do?

I don’t have all the answers, but what I’m doing is making sure that funds are spread across several banks. If you have a very large amount of money in one big bank, it’s best to spread it around. Even if you have a small amount of cash, stay informed about your bank's operations, especially if it's a big bank.

(Cross-posted at Swords Crossed, Facebook, and Wealth Weekly).

Financial Markets--What Just went Down Last Week?

AND WHY IT IS EXPECTED TO CONTINUE...

I want to keep this one simple this week. The following is my attempt to explain what's going on with the government bailouts and explain if it will have a direct effect on you. This week, I hope to explain how everyone--the mortgage borrowers, the mortgage lenders, investment banks, and even the federal government have some of the blame in the debacle we have now. it almost reads like a script with the way all the pieces to this issue fall into place:

The Backdrop
It started when the government started to put more pressure on lenders to help increase home ownership among Americans and end borderline racist processes like redlining (where lenders couldn't give you loans if you lived in certain zip codes). The government also promised to guarantee (co-sign) on the loans. Lenders then aggressively started seeking ways to give our risky loans and to make nice profits while spreading the risk. Thus you saw the re-emergence of adjustable-rate mortgages, intro (teaser) rates, and sub-prime mortgages among buyers. Also, construction companies begin to build lots of homes in anticipation of buyers filling them.

The Ingenious Plan
Buyers applied and refinanced for home loans they couldn't possibly afford, and lenders were eager to give them out. You see, financial engineers had a genius idea: local banks could collect all the loans they gave out (good and bad) sell them to investment banker firms who would "package" and sell them as an investment. Buyers of these packaged, of 'securitized' loans were then sold on the secondary market--businesses like Bear Sterns, AIG, Lehman Brothers, Freddie Mac, Fannie Mae, and Eula Jean (well, maybe not that last one) spread the risk of these securities among investors (remember, they are a collection of mortgages). Investors would make money as people paid their mortgages, and as people sold their homes for a profit (because housing prices ALWAYS go up, right) investors got paid too. These securities were sold everywhere. Investment banks. Businesses. People who owned mutual funds bought them if their mutual fund invested in it.

Trouble
Then, problems started to arrive. Anticipating a sharp rise in the number of homes needed, contractors and construction companies built. And built. And built. And you know what happens to the value of product if the market is flooded with it right? Prices fall. And people were not about to move out of a house that's losing value right? So houses continued to fall in value. No one was moving/upgrading to newer houses because the prices were too expensive and the housing inventories got larger. Then, those teaser rates expired. The adjustable rate mortgages..adjusted up (they were already at 40-yr lows and had nowhere to go but up). Suddenly, people couldn't afford those mortgages they had anymore.


The Perfect Storm Develops
More trouble developed--the economy started to slow down and companies began to cut jobs in manufacturing--people then got under-employed and still couldn't keep up with house payments. They tried borrowing against the increased value of their home, but remember there were too many houses on the market so it wouldn't go up much. Up the chain, those people who were holding on to those mortgage-backed securities saw that people were not paying up, and so they began to bail. However, some of these companies were so heavily invested in these securities that they didn't have the cash on hand to pay everybody who wanted their investments back.

Remember how a bank works? Simplified, a bank takes the money you deposit and keeps maybe about 10% and lends the remainder to other banks and business. So if you deposit $100, they may keep $10 on hand and lend $90 to another bank, who keeps $9 and lends $81, and so on. So your $100 in this could easily turn into $1000. Back to our story.

What happens when a bank can't cover all it's deposits? Who do banks, keepers of money, turn to? Other banks. As long as they trust each other, banks can borrow money from other banks so they can continue making loans to people and businesses and (by extension) keeping the economy going. So we're cool, right?

Trust
Except that the trust was beginning to disappear. Soon banks stop believing other banks would pay the loans back after customers and businesses--even big businesses began filing for bankruptcy because they couldn't pay their loans back. Banks started raising the interest rates (the cost of lending out the money). Some banks stopped lending money altogether, which is bad. The federal reserve stepped in and tried to calm things by lowering the interest rate, but the problem continued to worsen.


And Now?
Well, last week we dodged a huge bullet. When you hear people talk about the "credit tightening up in the market," it refers to money banks lends to corporations (and each other). Basically, companies large and small go to banks all the time to get money to run their everyday operations until the money they get for their transactions come in. Companies depend on banks extending these lines of credit, called commercial paper, to start new businesses and ventures. Well, last week, the banks ran out of this commercial paper. The federal reserve stepped in at the last minute and (ahem) "made more money available." without it, US company operations would have started shutting down pretty quickly.


So I'll leave it there for this week. Next week, we'll get into what's next and the ideas people have on how to fix this problem. If you need a funny summary of this issue, click here (warning, there is strong language there).

Will You Be OK If Your Bank "Fails"?

If you haven't heard, a major West Coast bank IndyMac has been taken over by the government. There has been a small panic as many customers made a "run" on the bank--meaning they withdrew large amounts of money at once. Most banks cannot sustain such a large withdrawal amount over a small time period.

Not long ago, when banks failed, they went away. In today's age, the government tries to stem public panic by taking over the bank when it fails. Usually the FDIC (Federal Deposit Insurance Corporation) sends officials to assume the roles of executives (like CEO, CFO, etc) until the government can find another bank to purchase the assets of the failed bank.

You may be familiar with the FDIC--this is a government-run insurance corporation. Usually they have a sticker on the outside of your local bank, assuring that your accounts are insured up to at least $100,000. If you have an IRA (Individual Retirement Account) the government bumps it up to $250,000. There is also a lesser-known SIPC (Securities Investor Protection Corporation) which insures any stocks, bonds, CDs, etc up to $500,000.

So what does all that mean to you? Well..

It's time for this weeks episode of 'What Do We Learn'?

SCENARIO 1
Let's say you have $400,000 in cash in one account at JustTrustUs (JTU) Bank. If you're a regular reader here I don't know why you'd do that, but follow me. If JTU fails and is taken over by the government, how much money would you get back?

If you got the same deal the IndyMac customers got, you'd get $100,000 + 50% of the balance--in other words $100,000+($400,000-$100,000)*0.5 = $250,000. So you won't be starving, but you'll be out $150,000, which is nothing to sneeze at.


SCENARIO 2
Let's say that instead you take your $400,000 in cash and take half of it out of JTU bank and you deposit it into GiveusSome (GUS) Bank across the street. Now you have $200,000 each in JTU and GUS. Now what happens?

If only one bank fails (JTU):
JTU (failed) will give you 100K + (200K-100K)*0.5 = 150K
GUS (OK) will still have: 200K
You now have 350K!

If both fail:
You'd have 300K (through similar math).

So basically, you save 50-100K of your money by simply splitting. Not bad, but you can see where we are going here. If you have large amounts of cash and don't want to invest it, never have more than 100K in one account in one bank. Spread the wealth across several banks. With securities that you have invested, you should talk to your account holder about splitting the account if you are worried that it will fail --but be assured that established national companies most likely (emphasis on most likely) will not fail.

What do we learn?
- Never keep more than $100,000 in cash in one bank.
- Be cautious when keeping millions of dollars in one mutual fund or IRA.
- And if you have significantly less than 100K, let alone in one bank..relax, you're insured.