Failure of a Bank

Quick trivia: Who is famous for the saying, “It’s only when the tide goes out that you learn who’s been swimming naked”?? Ironically just last week Warren Buffett’s 58th annual “Letter to Shareholders” was reviewed by TGIF 2 Minutes, and, yes, Warren E. Buffett first famously uttered these words back in 1992.

The timing of his utterance was, as CEO of the insurance conglomerate Berkshire Hathaway, just following Hurricane Andrew when the inadequacies of the insurance industry were negatively exposed. Buffett was describing “the rosy appearances that can mask financial recklessness until the good times end.”*

It was true then, and it is true now. The recent failure of not one but three (3) banks was mainly due to “naked swimmers”, meaning all of the following:

  • absent bank regulators
  • not sudden, but ongoing disregard for the most basic bank risk rules
  • overly concentrated types of customer bank deposits
  • blatant, massive disregard for FDIC insurance coverage (over hundreds of millions of dollars by some depositors**)
  • among other factors.

There is no grey area regarding the rules that were broken, which is the most upsetting factor! California-based Silicon Valley Bank (SVB) and Silvergate Bank, along with New York City-based Signature Bank were all overtly overly exposed to either cryptocurrency, high technology, or both in terms of depositors and levels of deposits. This led to a series of “dominoes falling” events culminating in not having enough deposits on hand to satisfy depositor withdrawals. Bank failure. Plain and simple.

This edition of TGIF 2 Minutes could end here, but please read on to briefly understand several of the basics involving deposits at your bank, credit union or online financial institution. These rules ONLY apply to institutions covered by FDIC insurance.

  • The FDIC explicitly insures up to $250,000 per bank customer. If your bank or credit union is covered under the FDIC, then the coverage applies. (Usually there is literally a sticker on the window of the physical bank building, or the FDIC logo is contained somewhere in the small print or footnote in your bank’s website.) Or you can ask your financial adviser.
  • Deposits over these levels are not explicitly FDIC-insured. Again, note that numerous depositors at SVB were clearly massively over the $250,000 limit, with over $100,000,000 or more on deposit.
  • The FDIC rule extends to specific account types (IRA, Joint accounts, Trust accounts, etc.) enabling a customer to have multiple account types each insured for up to $250,000 including interest.
  • Custodians of brokerage accounts often have a “banking arm” that allows these types of institutions to offer FDIC insurance on cash deposits up to the applicable $250,000 limits. This type of cash is often called “Bank Sweep” and currently pays tiny amounts of interest.
  • Most (but not all) Money Market funds are *NOT* FDIC insured. Money Market funds collect a management fee and currently pay much, much higher rates of interest than Bank Sweep cash.
  • There are Money Markets that are covered by FDIC insurance due to the structure of the underlying banks paying the interest to the money market holder. Minimums in these types of money market funds are typically much higher ($1,000,000+).
  • Money Markets are issued in $1 increments, or shares, and MAY lose their $1 value. This fact MUST be disclosed by the provider, financial adviser or banker offering the Money Market. “Breaking the buck” or dropping below the $1 value is typically highly unusual, but it can happen. Your financial adviser can discuss your particular money market.

Enough for one week. Time will tell if the current, still-high 6% inflationary environment can withstand more pressure. Higher interest rates from the US Federal Reserve may (sadly, for the best) continue to reveal more “naked swimmers”.

*James B. Stewart, The New York Times. March 10, 2020.
**Andrew R. Chow, March 10, 2023.

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