Home > Economic Update > Are US Banks Safe=FDIC insured???

Are US Banks Safe=FDIC insured???

Risks in Banking
Excerpted from Bob Prechter’s Conquer the Crash n the United States closed their doors. President Roosevelt shut down all banks for a short time after his inauguration. In December 2001, the government of Argentina froze virtually all bank deposits, barring customers from withdrawing the money they thought they had. Sometimes such restrictions happen naturally, when banks fail; sometimes they are imposed. Sometimes the restrictions are temporary; sometimes they remain for a long time.

Why do banks fail? For nearly 200 years, the courts have sanctioned an interpretation of the term “deposits” to mean not funds that you deliver for safekeeping but a loan to your bank. Your bank balance, then, is an IOU from the bank to you, even though there is no loan contract and no required interest payment. Thus, legally speaking, you have a claim on your money deposited in a bank, but practically speaking, you have a claim only on the loans that the bank makes with your money. If a large portion of those loans is tied up or becomes worthless, your money claim is compromised. A bank failure simply means that the bank has reneged on its promise to pay you back. The bottom line is that your money is only as safe as the bank’s loans. In boom times, banks become imprudent and lend to almost anyone. In busts, they can’t get much of that money back due to widespread defaults. If the bank’s portfolio collapses in value, say, like those of the Savings & Loan institutions in the U.S. in the late 1980s and early 1990s, the bank is broke, and its depositors’ savings are gone.

Because U.S. banks are no longer required to hold any of their deposits in reserve (see Chapter 10), many banks keep on hand just the bare minimum amount of cash needed for everyday transactions. Others keep a bit more. According to the latest Fed figures, the net loan-to-deposit ratio at U.S. commercial banks is 90 percent. This figure omits loans considered “securities” such as corporate, municipal and mortgage-backed bonds, which from my point of view are just as dangerous as everyday bank loans. The true loan-to-deposit ratio, then, is 125 percent and rising. Banks are not just lent to the hilt; they’re past it. Some bank loans, at least in the current benign environment, could be liquidated quickly, but in a fearful market, liquidity even on these so-called “securities” will dry up. If just a few more depositors than normal were to withdraw money, banks would have to sell some of these assets, depressing prices and depleting the value of the securities remaining in their portfolios. If enough depositors were to attempt simultaneous withdrawals, banks would have to refuse. Banks with the lowest liquidity ratios will be particularly susceptible to runs in a depression. They may not be technically broke, but you still couldn’t get your money, at least until the banks’ loans were paid off.

You would think that banks would learn to behave differently with centuries of history to guide them, but for the most part, they don’t. The pressure to show good earnings to stockholders and to offer competitive interest rates to depositors induces them to make risky loans. The Federal Reserve’s monopoly powers have allowed U.S. banks to lend aggressively, so far without repercussion. For bankers to educate depositors about safety would be to disturb their main source of profits. The U.S. government’s Federal Deposit Insurance Corporation guarantees to refund depositors’ losses up to $100,000, which seems to make safety a moot point. Actually, this guarantee just makes things far worse, for two reasons. First, it removes a major motivation for banks to be conservative with your money. Depositors feel safe, so who cares what’s going on behind closed doors? Second, did you know that most of the FDIC’s money comes from other banks? This funding scheme makes prudent banks pay to save the imprudent ones, imparting weak banks’ frailty to the strong ones. When the FDIC rescues weak banks by charging healthier ones higher “premiums,” overall bank deposits are depleted, causing the net loan-to-deposit ratio to rise. This result, in turn, means that in times of bank stress, it will take a progressively smaller percentage of depositors to cause unmanageable bank runs. If banks collapse in great enough quantity, the FDIC will be unable to rescue them all, and the more it charges surviving banks in “premiums,” the more banks it will endanger. Thus, this form of insurance compromises the entire system. Ultimately, the federal government guarantees the FDIC’s deposit insurance, which sounds like a sure thing. But if tax receipts fall, the government will be hard pressed to save a large number of banks with its own diminishing supply of capital. The FDIC calls its sticker “a symbol of confidence,” and that’s exactly what it is.

Some states in the U.S., in a fit of deadly “compassion,” have made it illegal for a bank to seize the home of someone who has declared bankruptcy. In such situations, the bank and its depositors are on the hook indefinitely for a borrower’s unthrift. Other states have made it illegal for a bank attempting to recover the value of a loan to seize any of a defaulting mortgage holder’s assets other than the mortgaged property. In such situations, the bank assumes the price risk in the real estate market. These states’ banks are vulnerable to severe losses in their mortgage portfolios and are at far greater risk of failure.

Many major national and international banks around the world have huge portfolios of “emerging market” debt, mortgage debt, consumer debt and weak corporate debt. I cannot understand how a bank trusted with the custody of your money could ever even think of buying bonds issued by Russia or Argentina or any other unstable or spendthrift government. As At the Crest of the Tidal Wave put it in 1995, “Today’s emerging markets will soon be submerging markets.” That metamorphosis began two years later. The fact that banks and other investment companies can repeatedly ride such “investments” all the way down to write-offs is outrageous.

Many banks today also have a shockingly large exposure to leveraged derivatives such as futures, options and even more exotic instruments. The underlying value of assets represented by such financial derivatives at quite a few big banks is greater than the total value of all their deposits. The estimated representative value of all derivatives in the world today is $90 trillion, over half of which is held by U.S. banks. Many banks use derivatives to hedge against investment exposure, but that strategy works only if the speculator on the other side of the trade can pay off if he’s wrong.

Relying upon, or worse, speculating in, leveraged derivatives poses one of the greatest risks to banks that have succumbed to the lure. Leverage almost always causes massive losses eventually because of the psychological stress that owning them induces. You have already read of the tremendous debacles at Barings Bank, Long-Term [sic] Capital Management, Enron and other institutions due to speculating in leveraged derivatives. It is traditional to discount the representative value of derivatives because traders will presumably get out of losing positions well before they cost as much as what they represent. Well, maybe. It is at least as common a human reaction for speculators to double their bets when the market goes against a big position. At least, that’s what bankers might do with your money.

Today’s bank analysts assure us, as a headline from The Atlanta Journal-Constitution put it on December 29, 2001, that “Banks [Are] Well-Capitalized.” Banks today are indeed generally considered well capitalized compared to their situation in the 1980s. Unfortunately, that condition is mostly thanks to the great asset mania of the 1990s, which, as explained in Book One, is probably over. Much of the record amount of credit that banks have extended, such as that lent for productive enterprise or directly to strong governments, is relatively safe. Much of what has been lent to weak governments, real estate developers, government-sponsored enterprises, stock market speculators, venture capitalists, consumers (via credit cards and consumer-debt “investment” packages), and so on, is not. One expert advises, “The larger, more diversified banks at this point are the safer place to be.” That assertion will surely be severely tested in the coming depression.

There are five major conditions in place at many banks that pose a danger: (1) low liquidity levels, (2) dangerous exposure to leveraged derivatives, (3) the optimistic safety ratings of banks’ debt investments, (4) the inflated values of the property that borrowers have put up as collateral on loans and (5) the substantial size of the mortgages that their clients hold compared both to those property values and to the clients’ potential inability to pay under adverse circumstances. All of these conditions compound the risk to the banking system of deflation and depression.

About The Elliott Wave Theorist
Published continuously since 1979, Bob Prechter’s Theorist is more than the most trusted Elliott wave letter on the planet; it’s guaranteed to be the most thought-provoking, well-researched and insightful 10 pages you’ll read every month.

Start Your Risk-Free Subscription to the Theorist ($20/mo) Now:

Financial companies are enjoying big advances in the current stock market rally. Depositors today trust their banks more than they trust government or business in general. For example, a recent poll asked web surfers which among a list of seven types of institutions they would most trust to operate a secure identity service. Banks got nearly 50 percent of the vote. General bank trustworthiness is yet another faith that will be shattered in a depression.

Well before a worldwide depression dominates our daily lives, you will need to deposit your capital into safe institutions. I suggest using two or more to spread the risk even further. They must be far better than the ones that today are too optimistically deemed “liquid” and “safe” by both rating services and banking officials.

Safe Banking in the United States
Excerpted from Bob Prechter’s Conquer the Crash

If you must bank in the U.S., or if you prefer it, choose the best bank(s) available. I believe that even in a deflationary crash, many of the safest U.S. banks have a good shot at survival and even prosperity. The reason is that relatively safe banks, if they have the sense to inform the public of their safety advantage, are likely to become even safer during difficult times. Why? Because depositors in a developing financial crisis will move funds out of the weakest banks into the strongest ones, making the weak ones weaker and the strong ones stronger. One of the great ironies of banking is that the more liquid a bank, the less likely it is that depositors will conduct a run on it in the first place.

The Street.com Ratings, Inc., formerly Weiss Ratings, Inc., provides one of the most reliable bank-rating services in America. (See Chapter 18 of the last section of this book for contact information.) CEO Martin Weiss has graciously consented to provide a practical guide for this book. Table 19-1 lists what his researchers consider the two strongest banks in each state in the union. … For our purposes, I see little point in listing the weakest banks, but if you want to know which ones they are, you can find them listed in the brand-new Ultimate Safe Money Guide, by Martin Weiss (John Wiley & Sons, 2002). Weiss’ book is a good complement to this one for many reasons. Aside from banks and insurance companies (see Chapter 24), his firm also rates mutual funds, brokerage firms, HMOs and corporations with common stock.


Categories: Economic Update
  1. No comments yet.
  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: