Are Your Bank Accounts Safe?

by Malcolm Katt
June 2008

Your bank accounts may not be as safe as you think. If you look at the legality and the financial structure of the Federal Deposit Insurance Corporation (FDIC) there are troubling facts that raise questions about how the FDIC and your accounts would fare during a full-blown financial crisis.

Overview Of FDIC Protection

Following a substantial number of bank failures in the Depression, Congress enacted the Glass-Steagall Act of 1933. This act created the FDIC, an institution that would guarantee deposits held by commercial banks. The FDIC provides deposit insurance which currently guarantees checking and saving deposits in member banks up to $100,000 per depositor (up to $250,000 for an Individual Retirement Account).

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 with different ownership (such as beneficial ownership, trusts, and joint accounts) can be considered separately for the $100,000 insurance limit.

What happens in cases of bank insolvency or illiquidity? The two most common methods employed by FDIC in cases of insolvency or illiquidity are:

The Payoff Method--insured deposits are paid by the FDIC, which attempts to recover its payments by liquidating the failed bank, and The Purchase and Assumption Method--all deposits are assumed by an open bank, which also purchases some or all of the failed bank's loans.

What Are FDIC Insured Accounts?

FDIC insurance covers ''deposit accounts'':

1. Demand deposit accounts (''checking accounts''), Negotiable Order of Withdrawal accounts called NOW accounts (checking accounts that earn interest), and money market deposit accounts, called MMDAs (savings accounts that allow a limited number of checks to be written each month).
2. Savings accounts that can be added to or withdrawn from at any time.
3. ''Money market'' accounts, essentially high-interest savings accounts (while the name is similar to ''money market funds,'' only these accounts and not funds, not insured).
4. Certificates of deposit (CDs), which generally require funds be kept in the account for a set period.
5. Outstanding Cashier's Checks, Interest Checks, and other negotiable instruments drawn on the accounts of the bank.

Use the Electronic Deposit Insurance Estimator (www.fdic.gov/edie), an interactive online tool, to determine the extent of your personal protection.

What Are Non-FDIC Insured Accounts?

Only the above types of accounts are insured. Some types of uninsured products, even if purchased through a covered financial institution, are not covered by FDIC protection. These include:

1. Stocks, bonds, mutual funds, and money market funds. The Securities Investor Protection Corporation (SIPC), a separate institution chartered by Congress, provides protection against the loss of many types of such securities in the event of a brokerage failure.
2. Investments backed by the U.S. government, such as U.S. Treasury securities.
3. The contents of safe deposit boxes. Even though the word “deposit” appears in the name, under federal law a safe deposit box is not a deposit account--it's a well-secured storage space rented by an institution to a customer. You can protect the contents by carrying personal insurance; your homeowner’s policy may provide protection or you may need a separate policy for this purpose.
4. Losses due to theft or fraud at the institution. These situations are often covered by special insurance policies that banking institutions buy from private insurance companies.
5. Accounting errors. In these situations, there may be remedies for consumers under state contract law, the Uniform Commercial Code (UCC), and some federal regulations, depending on the type of transaction.
6. Insurance and annuity products, such as life, auto, and homeowner's insurance.

Should You Be Worried About FDIC Insurance?

The FDIC has $52 billion in reserve to cover claims and a reserve ratio (the percentage of insured deposited compared with FDIC insurance) of about 1.2% reserve ratio--for every dollar in your bank account, the FDIC has 1.2 cents in reserve available to cover your potential losses. This seems to be an ample amount during periods of stability, but may not be sufficient if there’s a new run on the banks.

For example, JP Morgan received a waiver from the Federal Reserve to keep $400 billion of Bear Stearn's assets off JP Morgan’s books. The $400 billion dwarfs the $52 billion reserves of the FDIC. If one large bank collapse could wipe out the FDIC, what would happen if there were multiple, simultaneous bank failures? Congress could borrow additional funds, but losses could result while Congress was fighting to amend the law and find additional funding.

Does The FDIC Have Full Faith And Credit Backing By The US Treasury?

Most people think yes, but actually it doesn’t. The FDIC is authorized to borrow from the Treasury, up to $30 billion, but the Treasury is not required to make the loan. Thus, 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.

What’s The Timeframe For Repayment From The FDIC?

The FDIC is supposed to make good on its insurance protection “as soon as possible” following the liquidation or closing and winding up any insured depository institution. There’s no time limit or maximum.

In some cases, it may be impossible for the FDIC to ever make depositors whole again. Also the FDIC Act says that the only insurance funds available to depositors are those that exist within the fund itself; if the fund runs dry, there isn't another possible source of funds that can be legally tapped without an act of Congress.

Would Congress AppropriateThe Funds Needed To Keep The FDIC Solvent?

Expect Congress to do everything in its power to keep the FDIC solvent. However, there could be circumstances under which it funding ability could be restricted. For example, if a banking crisis were to occur at the same time as a general funding emergency, there may not be enough money to go around.

Required Reading

To gain an understanding of our precarious financial situation, read George Soros’ latest book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means. George Soros is a legendary financier, philanthropist and bestselling author, in addition to being one of the world’s richest men. The opening sentence of his new book conveys the urgency surrounding the turmoil in the financial world: “We are in the midst of the worst financial crisis since the 1930s.”