Your Money is not Safe in an FDIC Insured Bank Account

Below are 3 articles about why the FDIC can’t actually protect your money at banks

Ellen Brown. July 5, 2013 Think Your Money is Safe in an Insured Bank Account? Think Again.

A trend to shift responsibility for bank losses onto blameless depositors lets banks gamble away your money.

The EU can mandate that governments arrange for deposit insurance, but if funding is inadequate to cover a systemic collapse, taxpayers will again be on the hook; and if they are unwilling or unable to cover the losses (as occurred in Cyprus and Iceland), we’re back to the unprotected deposits and routine bank failures and bank runs of the 19th century.

In the US, deposit insurance faces similar funding problems.

As of June 30, 2011, the FDIC deposit insurance fund had a balance of only $3.9 billion to provide loss protection on $6.54 trillion of insured deposits. That means every $10,000 in deposits was protected by only $6 in reserves.

The FDIC fund could borrow from the Treasury, but the Dodd-Frank Act (Section 716) now bans taxpayer bailouts of most speculative derivatives activities; and these would be the likely trigger of a 2008-style collapse.

Derivatives claims have “super-priority” in bankruptcy, meaning they take before all other claims. In the event of a major derivatives bust at JPMorgan Chase or Bank of America, both of which hold derivatives with notional values exceeding $70 trillion, the collateral is liable to be gone before either the FDIC or the other “secured” depositors (including state and local governments) get to the front of the line. (See here and here.)

Who Should Pay

Who should bear the loss in the event of systemic collapse? The choices currently on the table are limited to taxpayers and bank creditors, including the largest class of creditor, the depositors. Imposing the losses on the profligate banks themselves would be more equitable, but if they have gambled away the money, they simply won’t have the funds. The rules need to be changed so that they cannot gamble the money away.

With high-paid lobbyists contesting every proposed regulation, it is increasingly clear that big banks can never be effectively controlled as private businesses.  If an enterprise (or five of them) is so large and so concentrated that competition and regulation are impossible, the most market-friendly step is to nationalize its functions.

The Nationalization Option

Nationalization of bankrupt, systemically-important banks is not a new idea. It was done very successfully, for example, in Norway and Sweden in the 1990s. But having the government clean up the books and then sell the bank back to the private sector is an inadequate solution. Economist Michael Hudson maintains:

Real nationalization occurs when governments act in the public interest to take over private property. . . . Nationalizing the banks along these lines would mean that the government would supply the nation’s credit needs. The Treasury would become the source of new money, replacing commercial bank credit. Presumably this credit would be lent out for economically and socially productive purposes, not merely to inflate asset prices while loading down households and business with debt as has occurred under today’s commercial bank lending policies.

Anne Sibert proposes another solution along those lines. Rather than imposing losses on either the taxpayers or the depositors, they could be absorbed by the central bank, which would have the power to simply write them off. As lender of last resort, the central bank (the ECB or the Federal Reserve) can create money with computer entries, without drawing it from elsewhere or paying it back to anyone.

That solution would allow the depositors to keep their deposits and would save the taxpayers from having to pay for a banking crisis they did not create. But there would remain the problem of “moral hazard” – the temptation of banks to take even greater risks when they know they can dodge responsibility for them. That problem could be avoided, however, by making the banks public utilities, mandated to operate in the public interest. And if they had been public utilities in the first place, the problems of bail-outs, bail-ins, and banking crises might have been averted altogether.

How Safe is My FDIC-Insured Bank Account?

2008. Chris Martenson.

Your bank account may not be as safe as you think. Taking a deeper look at the legal details and the financial depth of the FDIC reveals several troubling details that call into question how the FDIC would fare during a true banking crisis. Bur first we probably should understand bit more about the FDIC.

What is the FDIC?   Wikipedia on the FDIC :  The Federal Deposit Insurance Corporation (FDIC) is a United States government corporation created by the Glass-Steagall Act of 1933. The vast number of bank failures in the Great Depression spurred the United States Congress into creating an institution which would guarantee deposits held by commercial banks, inspired by the Commonwealth of Massachusetts and its Depositors Insurance Fund (DIF). The FDIC provides deposit insurance which currently guarantees checking and savings deposits in member banks up to $100,000 per depositor.

Accounts at different banks are insured separately. One person could keep $100,000 in accounts at two separate banks and be insured for a total of $200,000. Also, accounts in different ownerships (such as beneficial ownership, trusts, and joint accounts) can be considered separately for the $100,000 insurance limit. The Federal Deposit Insurance Reform Act raised the amount of insurance for an Individual Retirement Account to $250,000.

The two most common methods employed by FDIC in cases of insolvency or illiquidity are the:

Payoff Method in which insured deposits are paid by the FDIC, which attempts to recover its payments by liquidating the receivership estate of the failed bank.

Purchase and Assumption Method in which all deposits (liabilities) are assumed by an open bank, which also purchases some or all of the failed bank’s loans (assets).

If your bank gets in trouble, the FDIC will ride in and either pay off your account (up to $100k), or sell your bank off to another bank. Under normal circumstances, a bank failure should not impact you in the least. But these are not normal times. We might reasonably ask how the FDIC would respond during a major banking crisis. After all, this is our money we’re talking about. Faith and hope are great at weddings and sporting events, but they should not form the basis of our strategy for handling our finances.

How many bank failures could the FDIC handle at once?

When we take a look at the financials of the FDIC there is a line item called “Fund as a Percentage of Insured Deposits (Reserve Ratio) of 1.22%.  

The 1.22% Reserve Ratio means that for every dollar in your bank account, the FDIC has 1.22 cents “in reserve” ready to cover your potential losses.

My note: Where will the other 98.78 cents come from?

Consider the collapse of Bear Stearns. In order to assume that bank, JP Morgan asked for, and received, a special waiver from the Federal Reserve to keep $400 billion of suspect of Bear Stearn’s assets off the books of JPM. While JPM may have been padding the books a little bit here, due to the uncertainty of how bad the wreckage might turn out to be, $400 billion dwarfs the $52 billion reserves of the FDIC.

If one medium-large bank collapse could wipe out the FDIC by a factor of nearly 8, what do you suppose would happen if there were multiple, simultaneous bank failures? At this point, my guess would be that Congress would be sorely tempted to borrow additional funds to remedy the situation, but I worry that hardship and losses might result while the laws were amended and sufficient funding avenues identified. So how many bank failures could the FDIC endure? The data suggests slightly fewer than one big one.

I thought the FDIC has full faith and credit backing by the US treasury?

Actually, no, it does not. The language in Section 14 of the FDIC Act is clear and unambiguous (emphasis mine):

(a) BORROWING FROM TREASURY.– The Corporation is authorized to borrow from the Treasury, and the Secretary of the Treasury is authorized and directed to loan to the Corporation on such terms as may be fixed by the Corporation and the Secretary, such funds as in the judgment of the Board of Directors of the Corporation are from time to time required for insurance purposes, not exceeding in the aggregate $30,000,000,000 outstanding at any one time, subject to the approval of the Secretary of the Treasury: Provided, That the rate of interest to be charged in connection with any loan made pursuant to this subsection shall not be less than an amount determined by the Secretary of the Treasury, taking into consideration current market yields on outstanding marketable obligations of the United States of comparable maturities.

Now that’s pretty interesting. First,  any additional money from the federal government is not a guarantee, but rather a loan, which will only be made subject to the approval of the Secretary of the Treasury. Further, that the loan is to be made at “current market yields.” What do you suppose would happen to US Treasury yields during a true emergency? I can imagine a few scenarios where they might skyrocket, and this would serve to compound the difficulty of keeping the FDIC fund solvent.

How long does the FDIC have to repay me if things go bad?

Here things get murky. We turn to Section 11 of the act and find this (emphasis mine):

(f) PAYMENT OF INSURED DEPOSITS.– (1) IN GENERAL.–In case of the liquidation of, or other closing or winding up of the affairs of, any insured depository institution, payment of the insured deposits in such institution shall be made by the Corporation as soon as possible , subject to the provisions of subsection (g), either by cash or by making available to each depositor a transferred deposit in a new insured depository institution in the same community or in another insured depository institution in an amount equal to the insured deposit of such depositor.

That only says “as soon as possible” and sets absolutely no time limit or maximum. Taken to the extreme, it might be impossible for the FDIC to ever make depositors whole again, and this is one of dozens of such “outs” that exist in the document. Remember, this act was written in 1933 when money was gold, times were uncertain, and government lawyers were exceedingly careful to avoid locking the government into any possible financial black holes.

And the FDIC Act is very clear to spell out that the only insurance funds available to depositors are those that exist within the fund itself:  (f)(1)(A) all payments made pursuant to this section on account of a closed Bank Insurance Fund member shall be made only from the Bank Insurance Fund 

So, if the fund runs dry, there isn’t another possible source of funds that can be legally tapped without changing this wording. And that would take – wait for it – an act of Congress.

Surely Congress would appropriate the necessary funds to keep the FDIC solvent?

Here your guess is as good as mine. I would personally expect the US Congress to do everything in its power to the keep the FDIC well funded, especially during an emergency. I would not fault their desire here. But I can also think of a few scenarios or circumstances under which their ability could be taken away. For example:

  • If the banking crisis came at the same time as an interest rate spike and general funding emergency
  • If we were at war with Iran and things were not going well
  • If China suddenly started dumping their Treasury holdings in the opening gambit of an economic war

Other articles about the solvency of the FDIC

Rolfe Winkler. March 2, 2009  FDIC: $19 billion now backs over $4.8 trillion


Ellen Brown.  April 9, 2013. Winner Takes All: The Super-priority Status of Derivatives

Most people would be surprised to learn that they are legally considered “creditors” of their banks rather than customers who have trusted the bank with their money for safekeeping, but that seems to be the case. According to Wikipedia:

In most legal systems, . . . the funds deposited are no longer the property of the customer. The funds become the property of the bank, and the customer in turn receives an asset called a deposit account (a checking or savings account). That deposit account is a liability of the bank on the bank’s books and on its balance sheet.  Because the bank is authorized by law to make loans up to a multiple of its reserves, the bank’s reserves on hand to satisfy payment of deposit liabilities amounts to only a fraction of the total which the bank is obligated to pay in satisfaction of its demand deposits.

The bank gets the money. The depositor becomes only a creditor with an IOU. The bank is not required to keep the deposits available for withdrawal but can lend them out, keeping only a “fraction” on reserve, following accepted fractional reserve banking principles. When too many creditors come for their money at once, the result can be a run on the banks and bank failure.

The New Zealand OBR said the creditors had all enjoyed a return on their investments and had freely accepted the risk, but most people would be surprised to learn that too. What return do you get from a bank on a deposit account these days? And isn’t your deposit protected against risk by FDIC deposit insurance?

That situation could be looming even now in the United States.  As Gretchen Morgenson warned in a recent article on the 307-page Senate report detailing last year’s $6.2 billion trading fiasco at JPMorganChase: “Be afraid.”  The report resoundingly disproves the premise that the Dodd-Frank legislation has made our system safe from the reckless banking activities that brought the economy to its knees in 2008. Writes Morgenson:

JPMorgan . . . Is the largest derivatives dealer in the world. Trillions of dollars in such instruments sit on its and other big banks’ balance sheets. The ease with which the bank hid losses and fiddled with valuations should be a major concern to investors.

Pam Martens observed in a March 18th article that JPMorgan was gambling in the stock market with depositor funds. She writes, “trading stocks with customers’ savings deposits – that truly has the ring of the excesses of 1929 . . . .”

The large institutional banks not only could fail; they are likely to fail.  When the derivative scheme collapses and the US government refuses a bailout, JPMorgan could be giving its depositors’ accounts sizeable “haircuts” along guidelines established by the BIS and Reserve Bank of New Zealand.

Why Derivatives Threaten Your Bank Account

The big risk behind all this is the massive $230 trillion derivatives boondoggle managed by US banks. Derivatives are sold as a kind of insurance for managing profits and risk; but as Satyajit Das points out in Extreme Money, they actually increase risk to the system as a whole.

In the US after the Glass-Steagall Act was implemented in 1933, a bank could not gamble with depositor funds for its own account; but in 1999, that barrier was removed. Recent congressional investigations have revealed that in the biggest derivative banks, JPMorgan and Bank of America, massive commingling has occurred between their depository arms and their unregulated and highly vulnerable derivatives arms. Under both the Dodd Frank Act and the 2005 Bankruptcy Act, derivative claims have super-priority over all other claims, secured and unsecured, insured and uninsured. In a major derivatives fiasco, derivative claimants could well grab all the collateral, leaving other claimants, public and private, holding the bag.

The tab for the 2008 bailout was $700 billion in taxpayer funds, and that was just to start. Another $700 billion disaster could easily wipe out all the money in the FDIC insurance fund, which has only about $25 billion in it.  Both JPMorgan and Bank of America have over $1 trillion in deposits, and total deposits covered by FDIC insurance are about $9 trillion. According to an article on Bloomberg in November 2011, Bank of America’s holding company then had almost $75 trillion in derivatives, and 71% were held in its depository arm; while J.P. Morgan had $79 trillion in derivatives, and 99% were in its depository arm. Those whole mega-sums are not actually at risk, but the cash calculated to be at risk from derivatives from all sources is at least $12 trillion; and JPM is the biggest player, with 30% of the market.

It used to be that the government would backstop the FDIC if it ran out of money. But section 716 of the Dodd Frank Act now precludes the payment of further taxpayer funds to bail out a bank from a bad derivatives gamble. As summarized in a letter from Americans for Financial Reform quoted by Yves Smith:

Section 716 bans taxpayer bailouts of a broad range of derivatives dealing and speculative derivatives activities. Section 716 does not in any way limit the swaps activities which banks or other financial institutions may engage in. It simply prohibits public support for such activities.

There will be no more $700 billion taxpayer bailouts. So where will the banks get the money in the next crisis? It seems the plan has just been revealed in the new bail-in policies.

All Depositors, Secured and Unsecured, May Be at Risk

The bail-in policy for the US and UK is set forth in a document put out jointly by the Federal Deposit Insurance Corporation (FDIC) and the Bank of England (BOE) in December 2012, titled Resolving Globally Active, Systemically Important, Financial Institutions.

In an April 4th article in Financial Sense, John Butler points out that the directive does not explicitly refer to “depositors.”  It refers only to “unsecured creditors.”  But the effective meaning of the term, says Butler, is belied by the fact that the FDIC has been put on the job. The FDIC has direct responsibility only for depositors, not for the bondholders who are wholesale non-depositor sources of bank credit. Butler comments:

Do you see the sleight-of-hand at work here? Under the guise of protecting taxpayers, depositors of failing institutions are to be arbitrarily, de-facto subordinated to interbank claims, when in fact they are legally senior to those claims!

. . . [C]onsider the brutal, unjust irony of the entire proposal. Remember, its stated purpose is to solve the problem revealed in 2008, namely the existence of insolvent TBTF institutions that were “highly leveraged and complex, with numerous and dispersed financial operations, extensive off-balance-sheet activities, and opaque financial statements.” Yet what is being proposed is a framework sacrificing depositors in order to maintain precisely this complex, opaque, leverage-laden financial edifice!

If you believe that what has happened recently in Cyprus is unlikely to happen elsewhere, think again. Economic policy officials in the US, UK and other countries are preparing for it. Remember, someone has to pay. Will it be you? If you are a depositor, the answer is yes.

The FDIC was set up to ensure the safety of deposits. Now it, it seems, its function will be the confiscation of deposits to save Wall Street. In the only mention of “depositors” in the FDIC-BOE directive as it pertains to US policy, paragraph 47 says that “the authorities recognize the need for effective communication to depositors, making it clear that their deposits will be protected.” But protected with what? As with MF Global, the pot will already have been gambled away. From whom will the bank get it back? Not the derivatives claimants, who are first in line to be paid; not the taxpayers, since Congress has sealed the vault; not the FDIC insurance fund, which has a paltry $25 billion in it. As long as the derivatives counterparties have super-priority status, the claims of all other parties are in jeopardy.

That could mean not just the “unsecured creditors” but the “secured creditors,” including state and local governments. Local governments keep a significant portion of their revenues in Wall Street banks because smaller local banks lack the capacity to handle their complex business. In the US, banks taking deposits of public funds are required to pledge collateral against any funds exceeding the deposit insurance limit of $250,000. But derivative claims are also secured with collateral, and they have super-priority over all other claimants, including other secured creditors. The vault may be empty by the time local government officials get to the teller’s window. Main Street will again have been plundered by Wall Street.

Super-priority Status for Derivatives Increases Rather than Decreases Risk 

Harvard Law Professor Mark Row maintains that the super-priority status of derivatives needs to be repealed. He writes:

. . . [D]erivatives counterparties, . . . unlike most other secured creditors, can seize and immediately liquidate collateral, readily net out gains and losses in their dealings with the bankrupt, terminate their contracts with the bankrupt, and keep both preferential eve-of-bankruptcy payments and fraudulent conveyances they obtained from the debtor, all in ways that favor them over the bankrupt’s other creditors.

. . . [W]hen we subsidize derivatives and similar financial activity via bankruptcy benefits unavailable to other creditors, we get more of the activity than we otherwise would. Repeal would induce these burgeoning financial markets to better recognize the risks of counterparty financial failure, which in turn should dampen the possibility of another AIG-, Bear Stearns-, or Lehman Brothers-style financial meltdown, thereby helping to maintain systemic financial stability.

In The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences, David Skeel agrees. He calls the Dodd-Frank policy approach “corporatism” – a partnership between government and corporations. Congress has made no attempt in the legislation to reduce the size of the big banks or to undermine the implicit subsidy provided by the knowledge that they will be bailed out in the event of trouble.

Undergirding this approach is what Skeel calls “the Lehman myth,” which blames the 2008 banking collapse on the decision to allow Lehman Brothers to fail. Skeel counters that the Lehman bankruptcy was actually orderly, and the derivatives were unwound relatively quickly. Rather than preventing the Lehman collapse, the bankruptcy exemption for derivatives may have helped precipitate it.  When the bank appeared to be on shaky ground, the derivatives players all rushed to put in their claims, in a run on the collateral before it ran out. Skeel says the problem could be resolved by eliminating the derivatives exemption from the stay of proceedings that a bankruptcy court applies to other contracts to prevent this sort of run.

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