Banking Deposit Insurance: The New Game, Your Money At Risk

By John Schroder - July 15, 2015 
There is a popular saying that history does not always repeat itself, but the past often rhymes too very well with the present. And this is quite clear to us as we peer down the proverbial kaleidoscope of the past so-called economic depression of the 1930's and see some comparisons to our present situation in 2015. Of course many people will say it is different this time and to some respect it certainly is, albeit not necessarily as the pundits would have you believe. The last economic depression of roughly 60 years ago certainly left an indelible mark on the public and political landscape as well. From that economic trauma so many decades ago came a number of various initiatives and government laws intended to make sure the most economically vulnerable would not have to suffer again in the future as they did back then. But like many of these things that government attempts to do, while absolutely well intended, the actual delivery and execution leaves something to be desired.

One of these programs coming out of the so-called Great Depression of the 1930's is of course the idea of government provided banking insurance for banking account holders. A noble cause to be sure, but considering it has been around for some 80 years or so, you would think they would have gotten their act together by now. Unfortunately, many of these government insurance schemes are grossly underfunded and modern day depositors are also very unaware their status has been changed from insured depositor to unsecured lender. In other words, the game has been changed.

Many countries have enacted some kind of government banking insurance program and in the United States of course we have the FDIC or Federal Deposit Insurance Corporation, a federal government insurance program theoretically funded by the banks themselves in the form of insurance premium contributions. The beneficiaries of such insurance is not the corporate banking entity itself, but rather the individual account owners that might have a savings account or other type of deposit account with the banking institution. In other words, the entire premise is that a government run insurance entity will step in and make the depositors whole (up to a certain account balance amount of course) should their bank fail and have to close it's doors. It all sounds like wonderfully good stuff, does it not?


However, as we already alluded, the execution does not always live up to the hype and in the case of the FDIC specifically (a US government institution meant to protect the entire retail banking sector of the United States), it is woefully under-capitalized. How under capitalized is it? According to the  US General Account Office in a report issued on February 12, 2015 – the insurance fund held a balance of US$62 Billion Dollars (which is an improvement from the 2013 year end balance of US$47 Billion). However, with that might seem like a sufficient balance for an insurance company to have as a fund to meet it's potential liabilities, keep in mind this amount is supposed to cover or guarantee an estimated US$6 Trillion Dollars worth of bank account deposits in the United States. In other words and to put this into perspective, for your US Bank Savings Account with US$10,000 in it, the FDIC has about US$10 to cover your back. That's right, 10 bucks to cover your 10 grand. But it gets even more interesting in that while US bank failures have been on the decline in 2014 in comparison to 2013 and prior years, currently there are supposedly 329 banks currently on the problem list. However, just those 329 banks alone (never mind all the other 6,260 banks covered by FDIC) could conceivably wipe out the current FDIC DIF (DIF = deposit insurance fund) of US$62 Billion.

Coming out of the most recent Great Recession of 2008 (or whatever you want to call it), many of the US investment banks (and commercial banks also) were criticized for using excessive leverage on their balance sheets. Lehman Brothers supposedly was operating with leverage of 50 to 1 and many other firms not far behind. In contrast of course we have a US government managed banking insurance entity that is 99 percent underfunded, now in 2015. The US Congress recently passed a law requiring that the FDIC get their fund balance up to 1.35 percent of all bank accounts covered by the year 2020. But honestly we have to ask: Are they kidding? Is this some kind of bad joke? If a surgeon told you that you had a 2 percent (or less) chance of surviving an operation, would you go through with it? And yet the US Federal Government wants you to sleep well at night knowing this government insurance entity has less than 2 percent worth of cash to cover ALL the potential bank accounts out there. Perhaps that explains why politicians have now embraced this Bail-In paradigm recently tested out in Cyprus (to see if they could get away with it, in our opinion). Maybe, just maybe, they know all too well that if the you know what hit the fan, there is nothing else. Of course the entire premise behind the government banking insurance is that the banks themselves are paying into an insurance program meant to protect the depositors. The bail-in paradigm, on the other hand, is meant to take money AWAY from depositors to shore up the capital of the banks.

To be fair, insurance companies operate under the premise that not all of the insured will put in claims at the same time. Ergo, it certainly is true that no insurance firm has 100 percent of all potential liability claim funds sitting around in cash waiting to be disbursed in full at a moment's notice. However and on the other hand, any insurance firm will find it prudent to keep at least some percentage or portion of it's assets in cash to cover any potential claims. In terms of a government insurance entity created to protect individual banking customers and perhaps prevent a more major systemic risk in a nation's banking system, how much is enough? Ten percent, twenty percent, more? Considering just one or two very large financial firms supposedly could have pulled the entire house of cards down back in 2008, one rule of thumb might be an amount at least equal to the deposit liabilities in the nation's three largest banking concerns, with an additional cushion beyond that just in case.

However, it would seem the mindset has gone from protecting individual citizens to now protecting financial corporate entities instead. There has been a profound paradigm shift here in terms of whom is to be protected. Ironically, we have the tendency to believe that most people opening a savings account at a local bank in their home country are doing so under the impression that the bank is acting as a fiduciary, offering low interest in exchange for some implied guarantee of capital. Otherwise, why not put those funds into other kinds of things that historically have been considered to carry the risk of capital loss, albeit with the potential for higher return? If the citizenry with savings accounts clearly understood they were loaning money to the bank, or otherwise said legally considered as unsecured creditors, would they still continue to deposit money into such an account? We think not, and yet that is exactly the legal premise being used to permit this new bail-in scheme.

Last but not least on the menu of modern day banking paradigm changes is a case whereby no bank is formally declared insolvent, no government insurance fund tapped into and no bail-in (at least not yet), but rather the banks are simply closed for business. Obviously we refer to the recent situation in Greece whereby it has now been 2 weeks (as of the date we write this) that depositors cannot access the funds in their account because their local bank branch is closed. We suppose there is some solace in that account holders get to withdraw 60 Euros a day (as opposed to 300 Euros per day when there was a problem in Cyprus) but that will not get you too far when you have bills to pay. Granted, some will say all of this has become a self fulfilling prophesy in the sense that that reason the Greeks banks were closed was because they ran out of cash. Indeed, while thousands lined up previously to take out money from their accounts (because they were afraid the banks would be closed, or at worse be subject to a bail-in), it would seem those fears had become a reality because depositors did what they thought prudent to protect themselves. Never the less, we think there is no more clearer and blatant reason why you should consider keeping assets in another jurisdiction and quite possibly in another currency as well.

In addition to or in tandem with that, we can foresee the strong possibility of not only banking bail-ins, but government bail-ins as well. As we have pointed out in some other articles, it was already proposed by the government of Germany back in 1921 that the government confiscate (read steal) 20 percent of the stock and bond holdings of the citizenry in order to finance the government budget. That did not happen to the relief of business owners and the more solvent, but the fact that it was even tabled as an idea was bad enough in our opinion. And if you think about it, what are we slowly moving towards today in terms of how some government view their citizenry and so-called social obligations? Indeed it was the esteemed and learned politicians that mismanaged government finances to a point where we are today, just as one can argue it was management at certain financial firms that mismanaged their own respective businesses that lead them to the current state of affairs. Just as it is unfair to place this burden on account holders we think it equally unfair to consider confiscation, forced voluntary contributions (there is an oxymoron if there ever was one) or otherwise said government bail-ins of one sort or another. Just as the case if one was simply unfortunate enough to have opened a savings account at such a financial institution subject to this new bail-in paradigm, it would seem to be the case because of one's unfortunate birth in one country versus another that you are expected to be held captive as well (the US tax authorities versus London's Mayor Boris Johnson is just one case in point regarding such nonsense). As such and in short, not only would it seem a financial relationship elsewhere be prudent, but perhaps another citizenship and passport as well (albeit from a nation that does not consider you chattel property). We live in interesting times indeed, but the answer not lie in blind faith in this or that government insurance scheme, but rather a program or initiative put in place by yourself.