Should you care if your bank is unstable?

by Pop on July 27, 2010

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Jimmy Stewart is dead.

There’s a great scene in It’s a Wonderful Life when the bank of the protagonist, Jimmy Stewart, suffers a bank run. Fearing that Stewart’s bank might be going under, many of its customers come running, asking to withdraw all their savings, lest they be the ones left holding the bag when the bank doesn’t open. Sure enough, the bank gets down to its last few dollars before closing time arrives, but the bank makes it.

Bank runs were a fact of life toward the beginning of the last century—a problem that was supposed to be solved by FDIC insurance. But just a couple years ago, we were treated to some similar behavior. When IndyMac failed, customers waited hours in the heat to withdraw their deposits. A few of them had deposits in excess of $100,000, which was the FDIC limit at that time. A lot didn’t, but were just as worried.

Every time news of bank stress tests or yet another failing bank come out, I see stories about how to check up on your bank’s stability, as if having an average or below-average rated bank is an awful thing. I’ve seen arguments made on both sides. How much should you care about the stability of the financial institutions you use?

FDIC limits and your liquid accounts

You probably know that the Federal Deposit Insurance Corporation protects up to $250,000-worth of deposits you make with each financial institution. Congress recently made permanent the higher, $250k limit, as up until the financial crisis, the limit was set at $100,000.

Easy message here: Don’t keep more than $250,000 in checking accounts, CDs, and savings accounts with one bank. Honestly, unless you were close to or in retirement and have a great need for really safe savings, I don’t see why you’d have that much at a bank anyway.

But (maybe) a more surprising message, as long as you have less than $250,000 in cash to park, look for unstable banks. They’re the ones that need your money the most and will pay you the best rates to get it. According to a recent search of the best 1-year CD rates at, nine of the 12 banks with the top offered savings rates came from banks rated three stars or fewer in stability.

Those banks are afraid of going under, but you don’t need to be afraid of those banks. If you have less than $250,000, even the tiniest increase in yield you get from going with a less stable bank is worth it, because with FDIC insurance backing you up, that two-star bank is no less safe than the five-star bank. Obviously, make sure that the bank you put your money is, in fact, covered. And if you’re especially worried, you can use this FDIC tool to make sure you’re not over the limit.

No one should own a money market fund right now.

The chances of your money market fund “breaking the buck” and losing money are very low. But it is a risk, and there have been a couple high-profile cases of money market funds going under in the last couple years. Money market funds are meant to be short-term savings vehicles, that offer a low yield but never lose value. To achieve that, the firm you put the money with is supposed to invest in safe, short-term bonds. The problem, as the funds that did lose value found out, is that humans aren’t always good predictors of what bonds are “safe”.

But let me say it again: I don’t think your money market fund is likely to lose money. But I also think it’s silly to own one right now.

In this regard, I am a hypocrite. I have thousands of dollars in Vanguard’s money market fund, earning 0.12%. Imagine if David Bach tried to sell The Latte Factor using that rate. “If she just skipped her $5 per day latte, in 20 years at 0.12% compound interest, her savings would become more than $28,000!” Not quite as compelling as a million dollars, eh. And just for context, according to Crane Data, the top yield for a money market fund right now is 0.26%.

And yet, because it’s Vanguard and because a mutual fund is an “investment”, I’m for some reason keeping this stash sitting there, when I could get a much better rate at a money market account. How much better? Well, according to Bankrate, I could get a money market account at Sallie Mae with an annual yield of 1.39%, which is more than ten times higher than what I get with Vanguard. What’s more, it would be FDIC-insured. Lower risk, higher return. Sorry, Vanguard, it’s time to transfer those funds.

The confusion over brokerage account insurance

Bernie Madoff was the most high-profile case, but there have been several accounts of brokers running investment scams that resulted in their investors losing billions of dollars.

Of the kinds of accounts I’m going to write about today, this is where I think you need to be the most careful. Yes, brokerage accounts are “insured”. But in these cases, you run the highest risk of having assets beyond the insurance limit.

First, it’s important to note that the Securities Investor Protection Corporation, which covers your brokerage accounts, isn’t a federal agency. It’s a nonprofit, funded by the securities broker-dealers who are its members. Its sole responsibility is to facilitate the transfer of customers’ assets from one broker to another in case the broker goes bankrupt. So if you owned 100 shares of Bank of America at Broker X, which went bankrupt, SIPC would make sure those 100 shares made its way to Broker Z.

SIPC’s insurance limits only come into play when those 100 shares end up missing, which sometimes happens with bad record keeping, but, in this digital age, most often happens when a broker ends up being corrupt. For individuals, SIPC will replace up to $500,000-worth of securities, including up to $250,000-worth of cash. That sounds like a lot, and indeed, it’s above the FDIC limits. But whereas you’re unlikely to have more than $250,000 at a bank, you’re very likely to have more than $500,000 at a brokerage if you’re well into saving for retirement.

Spreading your investments between brokerages is probably not worth the effort. If you handle your investments yourself with a well-known brokerage like Vanguard or Fidelity, I probably wouldn’t even worry about it. But if you have a financial advisor who invests directly for you, run the simple checks listed here to make sure he or she actually buys the securities he says he’s buying.


{ 8 comments… read them below or add one }

Kyle July 27, 2010 at 1:01 pm

Good point about bank runs. In general, I think it’s silly in the FDIC era to be rushing to the bank because you’re concerned about losing the money you’ve deposited. There’s just one detail I’m curious about. How long does it take to get your money back if a bank collapses?

If you don’t have cash in your wallet, losing the ability to get your money out of the bank for just a couple days could be devastating. I rely almost entirely on my debit card. What would I have to do if my bank collapses? I don’t own a credit card.

patrick July 27, 2010 at 7:32 pm

have you looked into the stability of the FDIC? it doesn’t have enough money to cover all the banks or even a majority of banks if they collapse. even though it sounds good that the US government is backing up the banks, the FDIC is not really able to do so if everything fails. If you really want to secure your money, you should not only diversify amongst US banks but you should consider banks in another country as well, to protect against the FDIC failing.

Pop July 27, 2010 at 9:17 pm

@patrick Hey! Thanks for your comment. Here’s my take on that.

The federal government wouldn’t allow the FDIC to fail, because it would cause widespread financial panic, not only here but across the globe. So, I guess if you’re going to be worried about anything, it should be the stability of the U.S. government as a whole, and since your bank money is denominated in dollars, I don’t see how the U.S. would be in a situation where it couldn’t just create more money to pay you in a worst-case scenario.

But even if you’re worried about that extreme solution, I’m not sure diversifying into foreign banks makes sense. Is there a scenario where the U.S. financial system could collapse and another banking system could survive? Not sure, maybe if it was in a third-world economy disconnected from the U.S. economy. But even then, the chances of a third world banking system collapsing is very real and happens frequently in good times.

All that’s to say that diversifying into foreign banks for “safety” doesn’t make much sense to me.

K Smith July 28, 2010 at 3:34 am

The Fed has announced it is considering eliminating the reserve requirement. If there is no reserve requirement, it doesn’t matter whether banks are insolvent or not. The FDIC insurance pool becomes irrelevant.

Regulators will chose which institutions live and which ones die. Looming commercial real estate defaults will be used to justify the shuttering of community and regional banks nationwide. The FDIC will supervise their orderly dissolution, making all depositors whole. I believe this will be hailed by regulators, politicians, and the financial press as a good thing – fewer institutions to police. I wonder which institutions will be permitted to survive? Hmmm…

I think JP Morgan Chase will be one of the chosen survivors. In my community they are building new freestanding branches at just about every major intersection. The fix is in.

Methinks we are in store for a handful of mega-banks. With solvency a non-issue, the fear of bank failures is eliminated. But with no reserve requirement, banks will not need to attract deposits by paying interest. Instead of paying depositors to park money in the bank, banks will charge fees to handle cash. Then the case will be made to completely eliminate cash from the banking system.

Ain’t banking wonderful!

Ronnie Sue Ambrosino July 28, 2010 at 10:00 am

SIPC, severely underfunded from years of charging its broker/dealers only $150 per year does not have enough funds to pay the Madoff victims. This fact was confirmed in July 2009 by Mary Schapiro, chairman of the SEC. So, the Trustee assigned to the case, Mr. Picard needed to do some creative accounting in order to preserve the SIPC funds, which is totally outside the Federal Mandate.

As a result, thousands of victims are being robbed of their SIPC protection.

The Madoff victims, while continuing to fight for their due justice are also concerned with ensuring that all American investors are aware of the fact that promise of SIPC insurance is indeed a farce and a facade.

Historically, SIPC has prospered more than the victims in the cases they have handled.

Ronnie Sue Ambrosino
Madoff Victims Coalition

K Smith August 1, 2010 at 5:18 am

Your bank does not suddenly become insolvent and get shut down. The FDIC works from its own a “watch list” of shaky institutions. Your bank may in fact be insolvent as I am typing this, but before it is officially declared insolvent, the FDIC convinces another bank to “assume” its deposits and healthy assets. This means that on a Friday your account will be held by First National Bank of Insolvency, and the following Monday you read online that your bank is now Zombie National Bank (the FDIC conducts these switcheroos over the weekend).

Your money is still in your account, so it is accessible with your debit card. You can walk in or log on or call and transact business as usual. The employees of the former bank are now employees of the new bank. A temporary sign with the name of the new bank will be put up over the old sign until a permanent one can be installed.

The thing that concerns me is not what happens in the event of an insolvency – it is any bank’s obligation to give me my cash even if the bank is not declared insolvent. Earlier this year Citibank sent its deposit customers a notice saying they can wait 7 days from the day you ask before giving you any money in your checking account. Many have questioned the legality of this policy, which turns demand deposits into time deposits – a checking account in effect becomes a CD. If they can do this, what is to stop them from deciding the delay will be 14 days, or 21 days, or 6 months?

And in the event of a threatened run on a money market mutual fund, new SEC rules permit these funds to suspend redemption. This means if the economy slides into a panic, access to your money could be blocked indefinitely.

The mattress is looking better and better.

APRIL GARDNER January 13, 2012 at 8:20 am

The gov’t hasn’t any money to pay to anyone if a bank collapses. The money is printed and devalued. When the system collapses, and it will, it will be signaled by hyperinflation (already begun) and then followed by a “Bank Holiday”. You have to be a bonafide creton to think your money is “insured”. When the “Holiday” is instituted, by the FED/Federal Gov’t, you will be given perhaps 1 dollar for every 4 deposited. It may also be an laternate currency. Go to the grocery store, invest in canned vegetables. They have skyrocketed 33% in 6 months. This is a better investment…and it is safe in your pantry. Another good investment would be booze because once the system implodes, and it will a lot sooner than you think, everyone will want to get drunk to escape the horror of what will occur in our society.

dave March 11, 2013 at 3:41 am

Don’t let Ronnie Sue scam you. Her demands are nothing short of criminal and she is wants to stick it to the tax payer. Reports claim she lost 1.5 million and claims to have been with Madoff for 25 years. She had an average return of 10-12% which some how she claims to paid have normal taxes on. With that kind of return she doubled her money at least 3 1/2 times to get to 1.5 million in 25 years. Now lets figure out how much she actually invested. So we have to half her money 3 1/2 times.. That means she initially only invested $140,000. Now she wants the taxpayer to pay her the full amount of her last statement of 1.5 million or at least the limit of $500k. If you subtract what she paid for a luxury RV and staying at luxury RV resort I suspect she spent a good portion of that $140k. Now you can see she actually invested very little, but still wants to stick it to the taxpayer with her righteous attitude. The trustee is doing the right thing and figuring out actual loss and not loss of fictitious gains. SIPC is there for ACTUAL loss and not loss of fictitious gains. A concept that Ronnie Sue can’t grasp. Do you really think a data entry clerk and yogi instructor could save enough to amass $1.5 million dollars?

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