Rodney Johnson | Thursday, December 20, 2012 >>
Do you worry about banks?
Are you fearful that they are really just warehouses for sour loans and will one day just fall apart?
Well then welcome to the club. You’re not alone, but you might be surprised to find out who’s in the club ahead of you…
At the height of the financial crisis very large companies had epiphanies about banks. If a large company had $10 million in the bank for payroll and the bank went under, the large company would lose $9.75 million.
That seemed like a bad deal, but what to do? They would still have to write checks to employees and vendors.
So the large companies had an incentive to move their funds to the largest banks that had implicit, and sometimes explicit, guarantees. Sometimes, the motivation was to move out of large banks as well.
This became a problem…
When a large depositor leaves a bank, he leaves behind a hole in the bank’s capital account. Remember, deposits are the basis of lending. If deposits walk, then loans have to be curtailed or sold. The more deposits you lose, the more loans you have to shed. In a tough credit environment, this sort of cycle can quickly kill a bank.
To keep this sort of thing from ramping up, the federal government instituted TAG, or Transaction Asset Guarantee. Basically, depositors have unlimited federal insurance against losses in non-interest bearing accounts.
At least they do right now… this is set to expire on 12/31/12.
Then large companies will be back in the game of worrying about their banks, just like you.
So what are you to do? Where is a safe place to park your cash?
Well, there are a few options. The first is to split up your funds so that each account you have is under the $250,000 FDIC insurance limit.
A couple can have three accounts – a joint account and then one in each person’s name – which would give them up to $750,000 insured in one bank. If you use two or three banks, this can give you up to $2.25 million insured under the FDIC program.
This is good for people, but not really an option for large companies. They have to take a different route.
A common strategy for those worried about banks – and with so little faith or so much money that splitting up accounts isn’t an option – is to use government securities as a parking place.
The process is to buy U.S. Treasury bills that mature in one month, two months, etc., building a ladder of bonds that all mature in less than six months. Every month a set of bonds will mature. And the process simply rolls over every month.
By doing this the investor is no longer taking bank risk, he is instead taking country risk. As long as the Fed keeps the printing presses rolling, the U.S. government will make good on its obligations. The minute the U.S. government is in trouble, well, that means FDIC insurance is worthless as well.
This leads me to the third option: diversify outside the U.S. dollar. The process is the same using foreign government bonds, like English, Swiss, or even Australian bonds.
Should you choose this route, don’t worry… you’ll have a lot of company.
Because the TAG program is set to expire at the end of the year, there will be a lot of people with very large balances doing the exact same thing.
This will most likely drive short-term interest rates even lower, possibly into negative territory, as they already have in parts of Europe where investors and companies have been even more worried about banks than we are.
Ahead of the Curve with Adam O’Dell
Aussie Dollar in a Precarious Position
With post-TAG money potentially fleeing the U.S. dollar, I suspect many investors will look to the Aussie dollar as an alternative. The case for the Australian dollar seems strong, on the surface.