FDIC exposure

Discussion of the Cash portion of the Permanent Portfolio

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Lone Wolf
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FDIC exposure

Post by Lone Wolf » Mon Nov 29, 2010 8:23 am

Harry Browne recommended holding cash in treasury bills or a money market fund that only owned treasury bills.  I think it's furthermore safe to say that he would probably have been comfortable with a person putting a portion of their cash into other "full faith and credit" instruments such as I-series savings bonds.

However, one thing he was unambiguous about is that simply sticking cash in a bank account is not the same thing as holding treasuries.  With the FDIC insurance fund holding approximately 1% of what it needs to cover obligations, there's little evidence that it could withstand a bank run that reached "stampede" levels.

I have consciously "bent" this rule in my own holdings.  I have an HSA on which I can earn 5% interest.  I also have maintained my old CD ladder that I've kept up since well before I started the Permanent Portfolio.  These represent, in total, about 25% of my cash holdings.  I'd always thought that this was more or less a minor peccadillo and didn't really matter so long as I kept the percentage under control.  But then I caught this from MediumTex and reconsidered:
MediumTex wrote: The common theme with all PP tinkering is that we will make a small tweak to the approach with the intention of making it safer, when the actual result is often just the opposite.

People want to swap gold for TIPS.
...
People want to put their cash into municipal bonds, CDs and agency debt.
Ouch!  I consider swapping TIPS for gold to be an enormous error, one so bad that it would likely wreck the PP's performance.  (In fact, looking at past performance, it is clear that it would have.)  Seeing CDs mentioned in the same breath made me wonder whether I am a yield-chasing psycho simply asking for trouble.

So how do others see it?  What % of FDIC exposure in CDs and HSAs do you generally consider "okay" for your own Permanent Portfolios (if any)?  I'm quite fond of my old CD ladder but if I'm taking more risk (and getting less reward) than I thought, it'd be good to realize that.
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Re: FDIC exposure

Post by MediumTex » Mon Nov 29, 2010 9:44 am

I would just say to make sure you fully understand the risks of FDIC-insured accounts.

The basic problem is that banks in a fractional reserve banking system simply don't have anywhere enough money to pay all of their depositors, and do not have the ability to print money.

The U.S. government is in exactly the same position as the banks, but it CAN print money.

This was HB's argument in a nutshell.

Of the tinkering points I made, I think that using FDIC insured accounts is probably a minor offense, especially if it is a small part of the cash holdings, and several banks are used. 
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Re: FDIC exposure

Post by Lone Wolf » Mon Nov 29, 2010 11:24 am

MediumTex wrote: The basic problem is that banks in a fractional reserve banking system simply don't have anywhere enough money to pay all of their depositors, and do not have the ability to print money.
Yeah, that about covers it.  Fractional reserve banking is such an odd idea when you really think it through (or at least it is to me.)  It strikes me as a concept that is right on the borderline of fraudulence.

I also liked how Harry Browne put the problem with the FDIC.  Banks are "borrowing short and lending long".  Alice thinks that she can withdraw her money any time that she likes.  But the bank has lent it out to Bob on a 30-year mortgage.  God help us all when the Alices of the world decide they want to convert their bank accounts into Federal Reserve Notes.
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Re: FDIC exposure

Post by foglifter » Mon Nov 29, 2010 12:42 pm

Lone Wolf, I'm doing a similar thing with my cash: high-yield HSA (5%), high-yield savings account in a credit union, short-term bond fund in 401(k). I do understand the risks of holding cash in non-Treasury instruments, but I see it the way MT described it. If US government can print money to pay their bond interest they will have no problem printing money to meet FDIC obligations.
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Re: FDIC exposure

Post by Lone Wolf » Mon Nov 29, 2010 1:13 pm

foglifter wrote: If US government can print money to pay their bond interest they will have no problem printing money to meet FDIC obligations.
This is how I always viewed it as well (and pretty much still do.)  However, I'm making an effort to question any investment assumptions that I formulated before really studying the PP.  I believe much more strongly now than I did a few years back that the world can be a very uncertain place.

I believe that the government would print up whatever was needed to cover the FDIC shortfall.  However, Harry Browne's point (ultimately a correct one) is that we know failure to roll over short-term treasuries is fiscally the end of the line for a government.  If failure to pay represents an existential threat to the guy with the printing press, you can be pretty sure said printing press will be cranked up if it has to be.
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Re: FDIC exposure

Post by Austen Heller » Mon Nov 29, 2010 2:07 pm

Consider that the yields on treasuries are often not much lower than comparable term CDs, especially when you realize that the treasuries are NOT subject to state taxes.  As of today, the 5-year treasury yields 1.5%, and many banks are offering 5-year CDs in the 2-2.5% range.  So my point is that the additional yield of 0.5-1% is not worth the risks of losing your money in a FDIC collapse.

This is a great time to be considering your cash strategy, since it feels like it could be a lull before the storm, just like it felt in '07 and early '08.  Who can predict a bank run? - might never happen, or it might be next month.  I knew people who were over the FDIC cap when WaMu failed, and it was scary to see them running around trying to collect their cash at the height of crisis.
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Re: FDIC exposure

Post by Jan Van » Mon Nov 29, 2010 3:35 pm

Austen Heller wrote:This is a great time to be considering your cash strategy, since it feels like it could be a lull before the storm, just like it felt in '07 and early '08.
Isn't it ever!?!
Yesterday at Borders I was browsing the business/investing section, and there are quite a few books about "the coming hyperinflation" and/or "the fall of the dollar". When I returned home, sad and depressed, I was wondering what to do with my cash. Considering I have more than the requisite 25% in cash/SHY right now. Don't think holding a part in Euros is a good move either...
Related, should I just finance the new car I'm planning to buy instead of paying cash? It will be easy to pay off that debt in hyper-inflated dollars after all...
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Re: FDIC exposure

Post by foglifter » Mon Nov 29, 2010 3:50 pm

jmourik wrote:
Austen Heller wrote:This is a great time to be considering your cash strategy, since it feels like it could be a lull before the storm, just like it felt in '07 and early '08.
Isn't it ever!?!
Yesterday at Borders I was browsing the business/investing section, and there are quite a few books about "the coming hyperinflation" and/or "the fall of the dollar". When I returned home, sad and depressed, I was wondering what to do with my cash. Considering I have more than the requisite 25% in cash/SHY right now. Don't think holding a part in Euros is a good move either...
Related, should I just finance the new car I'm planning to buy instead of paying cash? It will be easy to pay off that debt in hyper-inflated dollars after all...
If you can get a low rate in the environment where banks are hesitant to loan to anybody it makes sense. I just got 3.49% for 5 years and I'm not going to pay it off early. But be prepared to furnish lots of documentation - these days car loan application process is like if you are getting a mortgage. No matter how good your credit score is.
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Re: FDIC exposure

Post by moda0306 » Mon Nov 29, 2010 4:01 pm

Jmourik,

Going into debt to buy consumer goods is probably the most fun but least effective way of hedging for currency collapse.  If our currency collapses, you'll be MUCH better off with more emergency goods or even just gold/silver bullion than any new car.  The destabilizing blow to our economy will not just make everything more expensive at the same rate, but make unnecessary luxuries (new cars, McMansions, plasma TV's) much less valuable in relation to much more useful, necessary items (canned food, guns, generator, basic shelter).

I have mixed feelings on FDIC insured dollars, but I do strongly believe in a solid "inventory" of things that will probably fair well in any kind of panic, whether it's a deflationary meltdown or hyperinflation currency collapse, both of which are pretty devastating.  This would include a useful vehicle (wagon, SUV, truck), decent amount of gas you rotate through (old gas is bad), plenty of canned food, rice & other foods that last a while, gold/silver bullion, a few guns and plenty of ammo, etc.

Think of any zombie movie or Tremors or something... what would you want?  A new car?  No.  Even if only for bartaring purposes, you'll want the basics.  On top of the PP, having this stuff can actually be kind of fun, since you'll use a lot of it anyway if you properly rotate inventory, can get bulk pricing, and hedge a little bit for non-destabilizing inflation, as you have $xxx worth of inventory on hand, instead of dollars in a bank account.

Maybe you won't need much of this, or need it for long, but if stuff starts to hit the fan and your paper assets are starting to look pretty useless, you can take the approach that: 1) everything will turn around and I can bartar this stuff and make a fortune, or 2) keep it and ride this b***h out... or, as I would, some combination of the two.

I even try to keep my gas tanks in my cars at least half full, always have at least $40 on me, and maybe $200-500 in a safe next to my gold/silver.  Little things can help small emergencies/inconveniences from turning into giant problems.
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Re: FDIC exposure

Post by Jan Van » Mon Nov 29, 2010 4:18 pm

To clarify, it's not so much that I WANT to buy a new car, more that I NEED a new dependable car. Since I need to spend the money anyway, I'm just wondering whether to pay cash or take out a loan. In other words, am I better off keeping the cash in an FDIC insured account?  ;D
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Re: FDIC exposure

Post by craigr » Mon Nov 29, 2010 5:39 pm

jmourik wrote: To clarify, it's not so much that I WANT to buy a new car, more that I NEED a new dependable car. Since I need to spend the money anyway, I'm just wondering whether to pay cash or take out a loan. In other words, am I better off keeping the cash in an FDIC insured account?  ;D
I'm a no debt fan personally. If you can pay cash then I'd do it.
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Re: FDIC exposure

Post by foglifter » Mon Nov 29, 2010 7:23 pm

jmourik wrote: To clarify, it's not so much that I WANT to buy a new car, more that I NEED a new dependable car. Since I need to spend the money anyway, I'm just wondering whether to pay cash or take out a loan. In other words, am I better off keeping the cash in an FDIC insured account?  ;D
If your FDIC-insured account pays after-tax at least the same or more than your loan interest - why not? I max out my HSA which pays 5% tax-free. I'm also DCA-ing into PRPFX in a taxable account - I know, I know, this is not exactly cash and no FDIC insurance, but I can live with it. I like the tax-efficiency of PRPFX - this is one of very few conservative options suitable for taxable accounts.
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