12/06/2011 – Money in the Bank: Does It Still Mean “Safe and Sound?”

Consider this May 25 post from author Kalyan Nandy, on the

popular Atlanta real estate site CityBiz: 

“Bank failures continue with no end in sight. Last

Friday, U.S. regulators closed down three more banks, taking

the total number to 43 so far in 2011…Looking back,

there were 157 bank failures in 2010, 140 in 2009 and 25

in 2008.

“Issues like rock-bottom home prices, still-high

loan defaults and deplorable unemployment levels are nagging

troubles for such institutions…

“The number of banks on FDIC’s list of problem

institutions shot up to 884 in the fourth quarter of 2010

from 860 in the previous quarter. This is the highest number

since the savings and loan crisis in the early 1990s.”

The following excerpt from Elliott Wave International’s

free report, Discover

the Top 100 Safest U.S. Banks, explains the true

risk that you may face when a bank fails.

Why do banks fail? For nearly 200 years, the courts have

sanctioned an interpretation of the term “deposits” to

mean not funds that you deliver for safekeeping

but a loan to your bank. Your bank balance, then,

is an IOU from the bank to you, even though there is no loan

contract and no required interest payment. Thus, legally

speaking, you have a claim on your money deposited in a bank,

but practically speaking, you have a claim only on the loans

that the bank makes with your money. If a large portion of

those loans is tied up or becomes worthless, your money claim

is compromised.

A bank failure simply means that the bank has reneged

on its promise to pay you back. The bottom line is that

your money is only as safe as the bank’s loans. In boom

times, banks become imprudent and lend to almost anyone.

In busts, they can’t get much of that money back due to

widespread defaults. If the bank’s portfolio collapses

in value, say, like those of the Savings & Loan institutions

in the U.S. in the late 1980s and early 1990s, the bank

is broke, and its depositors’ savings are gone…

The U.S. government’s Federal Deposit Insurance Corporation

guarantee just makes things far worse, for two reasons.

First, it removes a major motivation for banks to be conservative

with your money. Depositors feel safe, so who cares what’s

going on behind closed doors? Second, did you know that

most of the FDIC’s money comes from other banks? This funding

scheme makes prudent banks pay to save the imprudent ones,

imparting weak banks’ frailty to the strong ones. When

the FDIC rescues weak banks by charging healthier ones

higher “premiums,” overall

bank deposits are depleted, causing the net loan-to-deposit

ratio to rise. This result, in turn, means that in times

of bank stress, it will take a progressively smaller

percentage of depositors to cause unmanageable bank runs.

If banks collapse in great enough quantity, the FDIC will

be unable to rescue them all, and the more it charges surviving

banks in “premiums,” the more banks it will endanger.

Thus, this form of insurance compromises the entire system.

Ultimately, the federal government guarantees the FDIC’s

deposit insurance, which sounds like a sure thing. But if

tax receipts fall, the government will be hard pressed to

save a large number of banks with its own diminishing supply

of capital. The FDIC calls its sticker “a symbol of

confidence,” and that’s exactly what it is.