Are Your Checking and Savings Deposits Safe?
Dan Harkey, at DanHarkey.com writes great articles about everything related to real estate on his website. You can read more articles by visiting his website. In this article, he asks the question: “Are Your Checking and Savings Deposits Safe?”
Here is the article in full:
“Most folks are under the assumption that federally chartered and federally insured banking institutions were established to collect deposits from the public and make loans to credit worthy consumers (borrowers) as a primary driver to grow the U.S. economy. This pattern was depicted in the 1946 movie “It’s a Wonderful Life.” James Stewart starred as George Bailey, the President of Bailey Brothers’ Building and Loan who took deposits and loaned out to community members. The business strategy of taking in deposits and loaning out corresponding amounts with adequate reserves became problematic when there was a run-on-the-bank. Community participants panicked over the fact that no money was available for them to take out of their accounts. The proceeds were all loaned out to others.
In 1933 the Federal Deposit Insurance Corporation (FDIC), an independent federal agency, was formed for the purpose of insuring deposits in the event of bank failures. The primary purpose of the FDIC is to prevent run- on-the-bank scenarios, which had devastated many banks during the 1929-1933 great depression. Depositors are now insured up to $250,000 for each separate account for institutions that participate in FDIC insurance. The assumption is that the government somehow, somewhere has the money to pay out insurance claims. It does not! New money must be freshly printed out of fiat and dumped on the taxpayers as future debt. In theory, checking, savings and certificates of deposit are insured. Financial instruments, such as stocks, bonds, U.S. Treasury securities (T-bills), safe deposit boxes, annuities, and insurance products and money market funds are not covered. Check with your bank representative for clarification.
What changed to allow major banks and financial institutions to make high risk leveraged financial bets (derivatives), versus what was expected from main street consumers for whom the deposits would be maintained with safety? It resulted from ferocious lobbying by large banks and financial institutions.
Derivatives were the catalyst for the 1998 collapse of Long-Term Capital Management, Inc. a large hedge fund and the 2008 near collapse of the entire world financial system. The Federal Reserve almost always caved in and provided bailout programs to large financial institutions, Wall Street trading houses, and large public corporations. Fed bailout programs came to approximately $29 trillion. Today, this bailout mechanism is being replayed in the short-term borrowing market by dealers in government securities using repurchase agreements (repos). In all cases financial risk is transferred to the taxpayer in the form of long-term public debt. Each new issuance of additional trillions of fiat money serves to erode or debase the purchasing power of the current dollars.
I believe the potential exists for a repeated financial earthquake and this time with a much larger seismic wave. It will be bigger, faster, and more ferocious.
A derivative refers to anything that “derives its value” based on pegging value movements to other financial assets. The process requires parties and multiple parties to agree to bet that certain fluctuations will or will not occur. These hedging contracts will be based on interest rate sensitive movements of underlying financial assets such as bonds, commodities, currencies, etc.
Derivative contracts are off balance sheet hedging bets. The profitability is very high, but the risk exposure is very high to the reversal and loss of bank capital. Additionally, bank checkers and savers in the public now have the risk if the banks sustain large losses.
What was once a government backed “bail out” of large banks and financial institutions who default resulting from derivative losses will become a “bail in”. What this means is that the Federal Deposit Insurance Corporation (FDIC) will oversee what may be called an “orderly liquidation” of the defaulting banks where depositors assets will be legally frozen and swept (confiscated) for the purpose of keeping the bank solvent. Also, stockholders’ capital could be wiped out to offset derivative losses. In exchange the depositor may be given equivalent amount of stock shares in the otherwise insolvent entities, and possible drawing rights for a percentage of the account not confiscated. Dodd Frank provides the right for the government to confiscate 50% or more of the account balances. Leaving a portion of the saving and checking available may reduce rioting and social discord.
Some simple math to help you relate to the magnitude while reading this article: one billion is 1,000 times one million; one trillion is 1,000 times one billion; and, one quadrillion is 1,000 times one trillion.
Now, on to Banking 101:
Banks were supposed to hold deposits from checking accounts, savings accounts, and time deposits in the form of certificates of deposit, received from individuals and entities in exchange for the payment of interest on the accounts (unless expressly excluded from earning interest by banking regulations, e.g., certain trust and fiduciary accounts).
Banks customarily were designed to use depositor proceeds to make loans to borrowers whom they charge market interest rates, typically in three categories; consumer installment, commercial business, or real estate. The ability to pool deposits and make loans to many different borrowers at interest rates higher than depositor interest rates payed out is intended to create a “positive spread” in the form of gross revenue for the banks. Banks also add charges, such as overdraft fees for banking services which are received from depositors which enhance the bank’s profits.
Bank balance sheets are different from other businesses because the capital (money) they loan out to borrowers is considered a bank asset and the deposits they receive from the public are considered liabilities or unsecured debt (presumably because the depositor may remove the money at any time, except for time deposits consistent with the then current banking regulations). Assets minus Liabilities equal the shareholder’s equity, or “bank capital”. The unsecured creditors (checkers and savers) have absolutely no legal recourse for losing access to their funds.
The derivatives market is largely unregulated. In fact, the U.S. Congress, on the advice from lobbing by investment banks, made it largely illegal to regulate derivatives. The Dodd-Frank Act, sometimes referred to as Wall Street Reform and Consumer Protection Act passed in 2010 has allowed future derivative claims from losses to have a super or senior priority over all other claims against the defaulted banks.
The Dodd-Frank Act also reorganized the priorities of all debts, after the costs of administration necessary in any liquidation process, first to the government, then to the banks, then to derivatives, then to secured and unsecured creditors (including checkers and savers) of the bank, and then finally to equity (stockholders). The shareholders could be subject to substantial losses when these financial institutions are liquidated to first pay the derivative claims. Counter parties to derivative losses will get to step in front and be paid back first before depositors.
Depositor’s savings could be reassigned to equity (stock) and, thus, wiped out or the repayment of amounts owing could be delayed for an extended period up to 30 years. Some observers believe that depositors may be given partial drawing rights or credit lines to be used only with government approval.
The consequence of a systemic meltdown will be much more severe for the lower and middle class, including retired folks, and those living off a pension with deposits directed into a bank account. A larger percentage of their available assets are kept in the bank. Also, contents of a safety deposit box in the bank may be confiscated and used.
The 2008-2019 economic meltdown and subsequent recovery was solved by the Federal Reserve creating $37 trillion in new money through fiat printing (digital entries) and using that money to bail out the large banks, trading houses, and large corporations. In other words, the Federal Reserve created new debt instruments to be owed by and payed back by the public in the future through additional taxation. That strategy is no longer required in the future because the depositors will lose their deposits (confiscated) in the event of systemic bank defaults.
In 2007 there were approximately $600 trillion derivatives outstanding worldwide. Many major banks became insolvent as did Lehman Brothers and American International Group (AIG), the leading international insurance corporation that insures against losses on derivative contracts.
Today, there are $630 trillion notational value derivatives (counter party bets) worldwide; most are highly leveraged and interest rate sensitive. Market value is the price at which a position can be bought or sold in the marketplace. Because of leverage participants can take a small amount of money and theoretically control a much larger number of contracts. Private crony capitalists now can make major leveraged financial bets with unheard of risk and expect to keep the profits. But if they lose then they can dump the losses on the back of the checking and saving public.
The USA has a gross domestic product (GDP) in 2019 of $21.44 trillion dollars, with total taxes collected to run the entire government of under 4 trillion. The entire world’s gross domestic product (GDP) is only $88 trillion dollars
The 6 too big to fail (“TBTF”) banks account for 67% of all outstanding bank assets in the USA.
The risk in the derivatives market is concentrated in the U.S. In 2011, four U.S. banks held 95.9% of U.S. derivatives. As previously noted in this article, depositors maintaining accounts with U.S. banks are subordinated to the risks presented by derivatives pursuant to the Dodd-Frank Act. Should derivative contracts fail causing bank defaults, minimal government insurance proceeds exist unless the government just prints additional money by issuing new debt to replace the funds paid out in insurance claims. Derivatives are not backed by the full faith of the government, but losses are transferred to the public. In effect, the Dodd Frank Act has shifted the ultimate risk for derivatives losses to depositors in U.S banks, which are typically members of the working middle class.
Warren Buffet has called derivatives “financial weapons of mass destruction.” The bank statistics below begin to explain why:
- Citicorp has a market cap of $177 billion and its total off-balance sheet notional trading derivatives is about $53 trillion, 300 times its market capitalization. Its net exposure and risk are in the trillions.
- J P Morgan has a market cap of $473 billion and its $17 trillion off-balance sheet notational derivatives, 36 times market capitalization. Its net exposure is in the trillions.
- Goldman Sachs has a market cap of $87 billion and its total off-balance sheet notational derivatives is $51 trillion, 587 times its market capitalization. Its net exposure is in the trillions.
- Bank of America has a market cap of $322 billion and its total off-balance sheet notational derivatives is $53.5 trillion, 166 times market capitalization. Its net exposure in the trillions
- Deutsche Bank has a market cap of $17.35 billion and its total off-balance sheet notational trading derivatives is $49 trillion-or-2824-times market capitalization, with unhedged derivative positions. The net exposure is in the trillions.
The above totals fluctuate over time. Consult your broker for exact figures.
FDIC government insured deposit accounts are specifically subordinated to derivative losses with banking participants in the event of a market collapse. The risk associated with the total sum of $288 trillion counter-party bets in the derivative market by these banks through Wall Street includes hedging interest rates, and depositor accounts held in the U.S. banking system carry the greatest risk exposure for total loss or for the potential of a long delayed or deferred recovery. If there are about 10 trillion of deposits currently held in commercial banks and that the bail-in provision would allow the government to confiscate one half or more, $5 trillion would not go very far for $10’s of trillions of derivative losses.
Remember the phrase, “you-can-take-it-to-the-bank.” Figuratively, this means that something is true and can be verified by a third-party source. Well, the new phrase should be “do-not-rely-on-receiving-your money back if you deposit it in the bank.”