March 22, 2023

One thing I noticed as a new immigrant to the United States almost 20 years ago was how great the security and protection was.  It was great because you usually didn’t have to worry about personally checking everything. But sometimes it seemed ridiculous – warnings that your Hot Coffee might burn you, or that you shouldn’t put a plastic bag over your head were common jokes in the immigrant community.  However, the cost of this safety convenience is that many Americans easily “check out” when they go off the beaten path (e.g., traveling to places of interest). This has other downsides as well – there is plenty of research that protecting children from all kinds of stressors, from allergens, dirt to social awkwardness, does not lead to the most robust adults.

With this mindset, it is quite interesting to watch the Silicon Valley Bank (SVB) collapse unfold.  As usual, the U.S. government jumped in and bailed out all depositors, showing that they were “just kidding” that there was a limit to the amount insured by the FDIC, and businesses should consider the risk of bank failure when managing their cash.  They also, as usual, position this bailout as “free,” without using taxpayer money. These things are never free, and even if the government forces other banks to cover the costs, not the taxpayers, it means that the customers and shareholders of those banks will have to bear some of the costs.

FDIC insurance as defined (and not in practice) is a useless joke as applied to businesses – while for most individuals it is possible to manage cash so that it stays within the insurance limit, even for medium-sized businesses it would require intervention in too many bank accounts, and while there are products that spread deposits among many banks to be within the FDIC insurance limit, I am not sure they have been well tested by actual bank collapse.

I think it would be much better if FDIC insurance was designed to allow some premium insurance (available explicitly and to everyone, even the smallest bank, rather than implicitly, although it is systematically an important bank that everyone assumes will be bailed out by the government).   I would also look for multiple levels of coverage in standard insurance – e.g., 100% under $250K, 95% under $5M, and 80% above – this would provide a balance between having skin in the game and being responsible for your choices.

Another angle though – one needs to look at the core of bank stress for Silicon Valley Bank, First Republic Bank, and others – They invested in risky assets (in terms of interest rate risk), which were only “risk-free” if hold to maturity – their customer deposits though were on demand, hence massive withdrawal as they had was not zero risk.

This behavior originates in legitimized scam of suspension of MTM (Mark to Market) rules – instead of having banks to have enough capitalization or invest in assets with stable market value, the Financial Accounting Standards Board (FASB) allowed them to play the pretense that market value does not really matter. Make the paper balance sheet look good but not to have the ability to meet depositor obligations. 

There are some articles out there saying “no bank can survive 25% assert withdrawal in 48 hours” – I beg to differ. I think every bank should be ready to fulfill all its promises,  including 100% withdrawal of immediately accessible deposits.   This would of course likely require a lower rate on on-demand deposits but if you are looking for real safety this is what it requires.  This article details such concepts in more detail.

I would prefer to see a system where “money in the bank” means that you can completely count on it as guaranteed by the US government, where regulators take on themselves (and taxpayers) risk of not regulating banks properly.  While this can be seen conflicting with free market idea, I think this is acceptable in case we only allow companies choosing to follow a set of regulations to call themselves “Bank” and let other types of organizations operate without such restriction giving free choice to consumers.  

Interestingly enough there is at least one bank in the US which operates in Full Reserve mode and (in theory) except theft, scam or mismanagement should not have problems traditional banks face.

There should be other (non-bank) financial organizations which do not have such a guarantee, which may be in position to offer higher rates but with risks of loss or principal or liquidity.  At this point, it looks like in USA  Checking Account Products (where you get card for on-demand spending) tend to be done in partnership with some banks (see ie M1, Betterment, etc). Though if you’re looking at Savings Account alternative, there are already solutions like Groundfloor Stairs  or Worthy Bonds offering somewhat higher rate without FDIC insurance.  If you’re looking for CD alternatives, where money is locked for a period of time there are many alternatives – Percent, Yeildstreet, Groundfloor etc. 

You can also buy US Treasuries directly  (T-bills and T-bonds) but it does not have great usability 

There is some blame in the market on the Federal Reserve for increasing rates too high,  I think the problem was the opposite – keeping rates too low for too long.  With so low rates it was not feasible for the banks to cover their (arguably too high) overhead with overnight lending and which customers accepted basically zero interest rates on their checking accounts for years, US banks did not go far as charging for the privilege to hold your money in the bank (as was the case in some European countries for years).

With continuing fallout with Credit Suisse pushed into UBS hands to prevent it from failing we’re likely to see significant changes in the bank regulation and consumer attitudes worldwide. I wonder if will it create more freedom and choice for consumer or creating bigger nanny state and world dominance of just a few “too big to fail” entities held on the tight rope by their governments. 

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