Money safety update - American banks

"I warn you, Sir! The discourtesy of this bank is beyond all limits. One word more and I—I withdraw my overdraft." (Punch, June 27, 1917)

I recently looked at the security of deposits in British banks, but what about the USA? As with my earlier post this morning, we find concise information included in a different argument, in this case about the American liquidity crisis.

In the USA, it seems that up to $100,000 in checking and savings accounts (per depositor per "member bank") is covered by the Federal Deposit Insurance Corporation. There were two separate funds - one for banking, the other for savings (following the $150 billion losses in the savings & loan crisis a generation ago) - but they have been merged as from the end of March 2006.

There are three compensation methods used. One is direct payment to the investor, termed a "straight deposit payoff". The other two involve transfer of business to a healthy bank, with some financing from FDIC: these are known as "purchase and assumption" (P&A) and "insured deposit transfer" - full details here and here. (N.B. although FDIC prefers not to make a straight deposit payoff, as it is the most expensive solution for them, it remains an option - Sutton and Hagmahani's brief account skates over this point.)

The $100k upper limit for depositor protection is more generous than in the UK - and it seems to be 100% insured, unlike for the poor British saver. But, the authors warn, FDIC "only works when bank failures are isolated events, and will not work in a systemic crisis...or for that matter one really big bank failure."

Taking a more general view, the article explains that the subprime mess has reduced liquidity in the system, causing it to work inefficiently, which is why the Federal Reserve has pumped in more cash - accepting "toxic waste" collateral in return, and offering a discount on its loan rate to banks.

The authors have two objections to this assistance:

• it rewards bad behaviour and encourages a repetition ("moral hazard")
• accepting unrealizable obligations as collateral is inflationary, since it turns nothingness into money

Their prediction: a fall in the value of the dollar, and if the banks disguise their problems and fail to clean house, at worst a collapse of the financial system. The Fed has bought some time, but that time has to be used for urgent reform.