Tuesday, August 19, 2008

The Banking Crisis and Your Money

With the likelihood that many more banks will fail as a result of the current banking crisis, it is a prudent time to review how safe your money is, how safe your bank is and what will happen if a bank where you have money fails.

First, as most know, almost all bank deposits in the United States are insured by the FDIC up to $100,000, with additional insurance of $250,000 for money you have at a bank in an IRA. Insurance coverage of more than $100,000 at a single bank in non-IRA accounts is possible when deposits are held in different "ownership categories," such as a single, joint and trust accounts. Although most banks are FDIC insured, to check to see if a specific bank is insured you can use the FDIC's Bank Find service or by calling the FDIC toll-free at 1-877-275-3342

You can increase your FDIC insurance beyond the levels set, by opening accounts at multiple banks. The same insurance levels will apply for each bank where you place money.

Thus, the most prudent step to take, is to make sure you never have more money than the maximum insured amount at any one bank. In fact, because you will be earning interest in most of these accounts it is best to keep your balances at least 10% below the maximum so that your interest is also insured in the event of bank failure.

If you have a business with a large payroll, it may be too complex to have multiple accounts, even though your balances may climb over $100,000. In these cases, you will have to examine your bank much closer to determine how vulnerable your bank is to a bank run.

It should be noted that the current structure of bank balance sheets in the United States, indeed the world, is faulty and makes all banks vulnerable to a bank run, because they borrow short-term and make long-term loans. So if for any reason a bank has trouble attracting depositors, a liquidity crisis may occur and the FDIC could be knocking at the door and taking over the bank. Again, THIS MAKES ALMOST ALL BANKS THEORETICALLY VULNERABLE TO A LIQUIDITY CRISIS.

That said, there are some banks that are more vulnerable to bank runs then others. Banks with "hot money" deposits are extremely vulnerable. "Hot money" deposits are deposits made by those seeking the highest yields in the country and the depositors are often delivered to a bank by brokers. Therefore, "hot money" deposits are also sometimes called brokered deposits. The money is "hot money" because a bank receives these deposits by only paying a top interest rate, if the bank stops paying a high rate the hot money will move on. Further, hot money deposits are often deposits over $100,000, thus this is very nervous money that can be pulled at the slightest negative news or rumor. At IndyMac, the California bank that failed recently, $1.3 billion in deposits vanished during the days before the bank failed. 37 percent of all IndyMac's deposits were brokered accounts

So if you are putting more than $100,000 in a bank, you certainly will want to find out if your bank is dealing with hot money. Ask the bank how much money it has from depositors outside the banks region. If a bank has a sizable amount of money from depositors outside the region of the branch system, this is a sign of hot money. Also find out how much of the money that is deposited at the bank is not covered by FDIC insurance, the higher the percentage, the more likely a small rumor could cause big liquidity troubles for a bank. Since money that is not insured, because a depositor has more than $100,000 at the bank, is likely to be pulled at the frst sign of trouble. Thus, you don't want to have your money at a bank where there is sizeable brokered deposits (measured by out of region deposits) or where a lot of deposits are over the single customer limit of $100,000.

Another factor to look for that may be a signal that a bank is more vulnerable than most to failure is to look at the number of "non-performing assets" a bank is reporting relative to its loan loss reserves plus common equity. This is known as the "Texas ratio".

Developed by Gerard Cassidy and others at RBC Capital Markets, the Texas ratio is calculated by dividing the value of the lender's non-performing loans by the sum of its tangible equity capital and loan loss reserves.

In analyzing Texas banks during the early 1980s recession, Cassidy noted that banks tended to fail when this ratio reached 1:1, or 100%. He noted a similar pattern among New England banks during the recession of the early 1990s.

“Non-performing assets” of a bank include bad loans, late loans, foreclosed assets. Divide the non-performing assets by loan loss reserves plus common equity. To be safe,a ratio above 40% would be considered the danger zone and somwhere you don't want to keep uninsured money.

Another test that can be performed is to compare non-performing assets of a bank by all of its outstanding loans. A ratio above 5 percent suggests danger. The overall industry ratio is below 2 percent.

An alternative to banks for large sums of money is to buy Treasury bills directly from the Treasury.

Treasury securities can be purchased on original issue directly from the Treasury after opening either an online TreasuryDirect account at http://www.savingsbonds.gov/tdhome.htm or a Legacy Treasury Direct account. Once an account has been set up, securities can be purchased through the account (TreasuryDirect) or by using Electronic Services to purchase by telephone or web (Legacy Treasury Direct.

Treasury securities are currently available to the general public in maturities ranging from 4 weeks to 30 years. Among bills auctioned on a regular schedule, there are four terms: 4 weeks, 13 weeks, 26 weeks, and 52 weeks. All Treasury bills are issued and held electronically.

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