Terry Coxon: "FDIC-insured bank deposits may be a better bet than T-bills"

[WildAboutHarry]

I did some digging into Why the Best-Laid Plans...  Harry really didn't like FDIC-insured accounts.  He found the structure, the insurance reserve, etc. troublesome.  However, he also noted that some Treasury-only money market funds hold repurchase agreements and that these were undesirable.  I still find FDIC-insured deposits only a notch or two lower than Treasury securities, but caveat emptor.

For cash, this means direct ownership of treasury bills.  Treasury backed money market funds are a close second.  IMO short term treasury ETFs like SHV or SHY are a distant third, but probably ahead of FDIC insured bank accounts (or CDs).

No one directly owns treasury bills anymore, as Harry pointed out in Inflation-Proofing Your Investments (page 240).  He also aptly described the counterparty risk involved with broker-purchased Treasury securities and commented that the likelihood of fraud on the part of a broker

...would be greatest at the very time you were relying most on the safety of your T-bills -- during a banking crisis.  In desperation, some of them "borrow" investments...  Only when the firm's problems become unmanageable do the customers learn that they've been robbed.

I suppose that T-Bills purchased through Treasury Direct is as close as one can come to "direct" ownership.

Investing according to Browne's principles means, first, allocating your assets 25% each cash, gold, long term treasuries, and stocks - and, second, within each asset class getting as close as you possibly can to direct ownership.

I agree completely.  How close you can get to the ideal HBPP is complicated by individual circumstances (i.e. taxable vs. tax-deferred accounts), the changing legal environment (bye-bye to Swiss bank accounts), and investment product availability and innovation (no more bearer bonds, the development of ETFs, etc.).

[Gumby]

No one directly owns treasury bills anymore, as Harry pointed out in Inflation-Proofing Your Investments (page 240).  He also aptly described the counterparty risk involved with broker-purchased Treasury securities and commented that the likelihood of fraud on the part of a broker

...would be greatest at the very time you were relying most on the safety of your T-bills -- during a banking crisis.  In desperation, some of them "borrow" investments...  Only when the firm's problems become unmanageable do the customers learn that they've been robbed.

Harry was right. This actually just happened the other day with MF Global. $630 Million is missing, stolen right from client accounts.

http://www.forbes.com/sites/robertlenzn ... 0-million/

The scary thing is that MF Global was a Primary Dealer! (A 'Primary Dealer' helps create a liquid market for Treasury Bond transactions).

MF Global is a stomach churning story. Some MF Global clients tried to remove their money early when the initial rumors of bankruptcy started, about 10 days ago. Instead of wiring those clients the money, the firm cut rubber checks and sent them in the mail. By the time the checks arrived, the firm had already filed for Bankruptcy and the checks had bounced.

http://blogs.reuters.com/unstructuredfi ... ber-check/

I'd actually be shocked if MF Global wasn't the only institution to steal client assets.

I suppose that T-Bills purchased through Treasury Direct is as close as one can come to "direct" ownership.

That must be why they call it TreasuryDirect.

[AdamA]

Harry was right. This actually just happened the other day with MF Global. $630 Million is missing, stolen right from client accounts.

So does this mean that no matter how conservative my investments were (i.e., T-bills), when I asked for my check from the brokerage it bounced?

It's hard for me to believe that the government would allow a brokerage to stiff someone on short term treasury debt like this (then again, just because it's hard for me to believe doesn't mean it's not true), and if they did, I think this would be a much bigger story, causing a much bigger panic.

[craigr]

Someone looking to do the portfolio but decides they don't have a good cash option insteads keeps it in some wonky cash money market sweep fund at their brokerage is making a mistake. They should probably put the money in a bank CD under FDIC limits if they don't have a Treasury MMF to put it into. This is a better option than what they are currently doing. It's all about making better choices and FDIC is better than an uninsured MMF.

Craig, in what order of risk would you consider the following? (We have already established that a treasury only MMF is lowest risk.)

1. FDIC insured account / Bank Deposit Program
2. SHY
3. SHV

Currently, I have a scottrade account...they are doing something to incorporate FDIC into cash holdings called Bank Deposit Program (http://research.scottrade.com/public/kn ... 84265a0291)

This is a hard call. On one had FDIC has a track record of following through on paying back customers during bank closures. Whereas we've never seen a massive failure of an ETF yet to know what would happen and how SIPC insurance would handle it. But on the other hand banks do very risky things with customer assets at times which an ETF that is holding primarily short term notes from the Treasury is unlikely to do due to the stated prospectus and SEC compliance.

All investments have risks. The best would probably be your own managed ladder of T-Bills. But this can be cumbersome for many people if it is not automatic. Further, unless you have the notes sitting in your own safe, the brokerage still controls them under their street name for you. So there is still counter party risk.

I suppose my answer is that we just diversify the best we can and hope it doesn't all come crashing down at once. Also, be mindful of SIPC limits and split your assets up between brokerages. There isn't much more you can do. Consider a portfolio that was:

Stocks - Vanguard Total Stock Market
Bonds - Direct bond ownership through another brokerage.
Cash - iShares SHV or FDIC CD across multiple banks.
Gold - Physical control with some stored overseas at another bank.

In this case you have your money split across Vanguard, another broker for the bonds, perhaps a bank for the FDIC CD or Barclay's for the iShares. Then you have gold stored locally and some overseas.

In that scenario you'd have to have a lot of things blow up for you to be completely wiped out. Things would be so bad that it's probably time to get out the proverbial AK-47 and canned beans.

Or consider an all ETF/Mutual Fund portfolio if that's all you can do:

Stocks - Vanguard Total Stock Market ETF (VTI)
Bonds - iShares Treasury Long Term (TLT)
Cash - Fidelity Spartan Short Term Treasury Bond Fund (FSBIX)
Gold - Zurich Gold ETF (ZGLD) or Swiss Gold ETF (SGOL)

That puts your money across four different institutions with some mild form of geographic diversification that can be setup quickly and easily by just about anyone. Split the assets 50/50 between two brokerages even. That gives you two brokerages controlling 50% of your assets split across four different companies.

The above would be very unlikely to fail all at once. It could happen, but again the problem in the financial system would have to be truly catastrophic.

[Gumby]

Harry was right. This actually just happened the other day with MF Global. $630 Million is missing, stolen right from client accounts.

So does this mean that no matter how conservative my investments were (i.e., T-bills), when I asked for my check from the brokerage it bounced?

Yes. That's exactly what it means. MF Global co-mingled their accounts — mixing client money with company money. It's a felony offense.

It's hard for me to believe that the government would allow a brokerage to stiff someone on short term treasury debt like this (then again, just because it's hard for me to believe doesn't mean it's not true), and if they did, I think this would be a much bigger story, causing a much bigger panic.

It's a huge story. I'm surprised you haven't heard about it. Jon Corzine, the former Senator, ex-Governor of New Jersey, who recently resigned as the CEO of MF Global just hired Andrew J. Levander, a leading white-collar criminal defense lawyer. This is a very big deal. If someone doesn't go to jail for this, then the justice system is truly broken. Currently, neither Mr. Corzine nor MF Global have been accused of any wrongdoing

http://dealbook.nytimes.com/2011/11/04/ ... -attorney/

[AdamA]

It's a huge story. I'm surprised you haven't heard about it. Jon Corzine, the former Senator, ex-Governor of New Jersey, who recently resigned as the CEO of MF Global just hired Andrew J. Levander, a leading white-collar criminal defense lawyer. This is a very big deal. If someone doesn't go to jail for this, then the justice system is truly broken.

I have absolutely heard about it, but if short term US treasury debt vanished within a brokerage account, that is a bigger deal than is being acknowledged by the media.  

That is the kind of thing that starts a panic (i.e., makes me want to hold all of my cash under my mattress).  You can bet if it's happening at one brokerage, it's happening at a lot of them.

To clarify:  You are saying that there are in fact customers at MF Global who bought Treasury Bills at the fixed income desk there who were unable to receive their money?

Or, that there were customers who held treasury only money market fund shares who could not collect?

That is much bigger than a someone's-going-to-jail story.

[Gumby]

Nobody knows the exact details, but the headlines suggest that "cash" was stolen...

Forbes: Client Cash Reportedly Missing At MF Global; Debacle May Underline Case For Volcker Rule

I have a hard time believing that there weren't any Treasury Bills in the missing $630 Million in cash. Why wouldn't they have stolen T-Bills?? There's no reason to believe that they only stole risky assets. Entire accounts are missing!

MF Global was over-leveraged and they needed client cash to cover losses.

The company headed by Corzine disclosed $41 billion in assets versus $39 billion in debt and an equity value of $500 million plus $325 million of investment grade debt, according to Forbes’ Robert Lenzner.  That’s 82 times asset to capital ratio; Lehman was levered up 30.7 times. (Read Lenzner’s piece, Corzine Had MF Global Leveraged 80 To 1).
Source: Forbes: Client Cash Reportedly Missing At MF Global; Debacle May Underline Case For Volcker Rule

[Gumby]

Honestly, I'm not sure what it's so hard to believe. This is exactly what Harry Browne warned about... Here's the repost of the HB quote that WildAboutHarry posted, above, when he said that the likelihood of fraud on the part of a broker:

...would be greatest at the very time you were relying most on the safety of your T-bills -- during a banking crisis.  In desperation, some of them "borrow" investments...  Only when the firm's problems become unmanageable do the customers learn that they've been robbed.

That's the situation that MF Global found themselves in. When a brokerage house is leveraged 80-1, they need to "borrow" your cash, your investments, (and your T-Bills) to cover their losses until the house of cards comes tumbling down. Just like HB said.

[AdamA]

And I have a hard time believing that there weren't any Treasury Bills in the missing $630 Million. Why wouldn't they have stolen T-Bills?? There's no reason to believe that they only stole risky assets. Entire accounts are missing!

MF Global was over-leveraged and they needed client cash to cover losses.

I guess that's a good point.  It's not like there was a credit default...they basically just stole the money, so I guess the type of account they ripped off doesn't really matter.

But doesn't this basically mean that there is no safe way to hold T-bills?  You have to have a broker or a bank involved when you sell now, even if you buy direct.  

Maybe the best idea is to buy one year T-bills from Treasury Direct (or shorter and sign up for the automatic rollover) once a year, and then to cross your fingers when you sell and hope your bank or brokerage doesn't jip you?

[AdamA]

Honestly, I'm not sure what it's so hard to believe. This is exactly what Harry Browne warned about... Here's the repost of the HB quote that WildAboutHarry posted, above, when he said that the likelihood of fraud on the part of a broker:

...would be greatest at the very time you were relying most on the safety of your T-bills -- during a banking crisis.  In desperation, some of them "borrow" investments...  Only when the firm's problems become unmanageable do the customers learn that they've been robbed.

That's the situation that MF Global found themselves in. When a brokerage house is leveraged 80-1, they need to "borrow" your cash, your investments, (and your T-Bills) to cover their losses until the house of cards comes tumbling down. Just like HB said.

That is true, but he also recommended using treasury only money market funds.  He said to avoid the one's that use repos. 

But I agree with you.  The bottom line is that it doesn't matter if they use repos or not if they're just going to loot the supposedly safe accounts when they need money.

[craigr]

But I agree with you.  The bottom line is that it doesn't matter if they use repos or not if they're just going to loot the supposedly safe accounts when they need money.

There's the rub. When you have anything at a broker it's not really in your name. It's in a street name of the broker:

http://www.sec.gov/answers/street.htm

So even if you have your cash in a money market account that is all Treasuries you still have counter-party risk. But at some point the logistics of managing all this requires that some kind of broker be involved. Whether it is for a T-Bill ladder, MMF, stock fund, etc. If they are stealing then there isn't much you can do about it but spread your money across several brokerages to limit the damage.

HB was of course right, but he also advocated storing money at a couple different brokerages just in case stuff like MF happens which is what I also recommend.

[AdamA]

But at some point the logistics of managing all this requires that some kind of broker be involved. Whether it is for a T-Bill ladder, MMF, stock fund, etc. 

It seems like it might be worth the extra bit of hassle to simply keep your cash with Treasury Direct.  Someone recommended in another thread just buying one year T-bills once a year.  It eliminates counter party risk, until you need the money, at which point you can have whatever amount you need deposited into your bank account. 

I realize this isn't always possible (some 401k's, TSP, etc), but where it is possible, seems like it makes sense.  Plus it's cheaper with the expense ratios of some of these funds being what they are.

[moda0306]

Does treasury direct have ira options??  Somehow I doubt it.

[WildAboutHarry]

Does treasury direct have ira options??  Somehow I doubt it.

Your doubt is correct.  No IRA option with Treasury Direct.

For those of us in high-state-income-tax states, though, Treasury Direct (and Treasury Bills, Notes, and Bonds in general) are a kind of semi-IRA, since the income from treasuries is not subject to state income tax.  In California that can be up to an almost 10% haircut.

[AdamA]

Does treasury direct have ira options??  Somehow I doubt it.

Right, but if you have some cash outside of a retirement account, it seems like a good option.

[Lone Wolf]

It seems like it might be worth the extra bit of hassle to simply keep your cash with Treasury Direct.  Someone recommended in another thread just buying one year T-bills once a year.  It eliminates counter party risk, until you need the money, at which point you can have whatever amount you need deposited into your bank account. 

I realize this isn't always possible (some 401k's, TSP, etc), but where it is possible, seems like it makes sense.  Plus it's cheaper with the expense ratios of some of these funds being what they are.

This has been a great discussion, particularly Gumby's observation of how it relates to the debacle at MF Global.

We'll have to see what kind of details come out on that in the end, but I will be extremely interested if we learn that they "borrowed" someone's personal T-bills.  That'd really be stunning.  It would certainly imply that Treasury Money Market funds would also be in danger of the same sort of abuse.  If anyone finds out whether or not something like this happened, I'd definitely be interested in hearing more.

As for TreasuryDirect, I've been hesitant to build out an entire ladder there.  The reason is that I have some concerns about how "liquid" such "cash" would really be.  From what I understand, in order to sell any of these securities, you'd need to transfer them to a brokerage, which appears to involve (at the very least) filling out a "government form" of unknown complexity and then mailing it in.  Then, once said transfer is complete, you'd be able to sell these securities on the secondary market via your brokerage.  This doesn't sound like a very simple or enjoyable process to me.  Does anyone have experience with going through this?

I think that before I started rigging up my T-ladder in TreasuryDirect, I'd want to have sent at least one T-bill through this entire process as the "canary in the coalmine".  If I'm in need of cash in any kind of hurry, the last thing I want to find myself doing is filling out some government form and sending it through the mail.

[Gumby]

We'll have to see what kind of details come out on that in the end, but I will be extremely interested if we learn that they "borrowed" someone's personal T-bills.

I think craigr hit the nail on the head about the "street name" of one's investments at a brokerage. There is no such thing as "personal T-bills" when they are owned through a brokerage. The assets are often registered in the street name.

I am posting the relevant quote from the SEC's Q&A page that craigr referenced:

Street Name

When you buy securities through a brokerage firm, most firms will automatically put your securities into "street name." This means your brokerage firm will hold your securities in its name or another nominee and not in your name, but your firm will keep records showing you as the real or "beneficial owner." You will not get a certificate, but will receive an account statement from your broker on at least a quarterly and annual basis showing your holdings.

To learn more about the different ways you can have your securities held or registered, please read "Holding Your Securities - Get the Facts."

Source: http://www.sec.gov/answers/street.htm

I suspect that even if you called your brokerage, they wouldn't give you a straight answer about this. So, why should we be surprised that MF Global stole "personal T-Bills" when they were likely registered in MF Global's street name in the first place? It's not like these T-Bills ever have the name or social security number of the the real owner (or "beneficial owner") on them.

[moda0306]

I was under the impression that the assets you own through a brokerage, through the nature of the accounting and regulatory treatment of those assets, are truly yours, and if your brokerage crumbled around them they'd still be your securities.

Not that there wouldn't be an unfortunate waiting period to get the assets dished out, but I thought there were built in legal identity fail-safes that preventa  brokerage collapse from truly effecting the assets you own through them.

I have no link or anything... but I'm sure I've had this conversation with someone and I'm disappointed to hear that there's less of a roof over my assets than I previously thought.

All these discussions lately about our cash and bond holdings are great, you guys.  I'm really rethinking my TLT and FDIC cash holdings at this point.

[Gumby]

I have no link or anything...

http://www.sec.gov/investor/pubs/holdsec.htm

[Gumby]

When you're done reading that link, you'll wonder why you'd ever allow your investments to be held in "street name". However, most retail investment houses will then explain the advantages of "street name" registrations.

From Vanguard Brokerage Services:

All the services you’d expect

Investors’ securities are held in “street name,”? which means that they’re held in a broker or clearing agent’s name rather than the brokerage customer’s name. Securities held in street name can easily be transferred at the time of a sale, and you don’t have to worry about the loss of the certificates or their costly replacement.

At Vanguard Brokerage Services, a division of Vanguard Marketing Corporation, your securities are held in street name by us. We’re also a member of the Financial Industry Regulatory Authority (FINRA), as well as the SIPC.

In addition, you’ll receive the following account services at no charge...
Source: http://www.vanguard.com/pdf/s235.pdf?2210040890

So, there you have it. Registering your assets in "street name" benefits the clients in terms of transaction ease, improved services, and lowering costs. When your assets are registered in "street name," the brokerage house acts as a custodian for you. From what I can tell, if the custodian goes bankrupt, you can transfer the assets to another custodian. But, I believe your assets would first be subject to the control of a bankruptcy trustee. Once your assets are verified by the trustee, they become transferrable from the bankruptcy estate to another.

It seems that "street name" registrations also allows for easier securities lending. Vanguard released a white paper about this, outlining their own approach vs. other brokerages:

Vanguard: Securities lending: Still no free lunch

[moda0306]

Nice work Gumby.

I think all of this, including LW's observation about the simple time it would take to turn anything, no matter how pure & reliable, from 1's and 0's into cash, indicates to me (reiterating here) that cold, hard cash, in some amount, is a good idea.

Much like you actually decide to hold some gold coins vs ETF, it just seems that in the absence of something tangible, you're relying on too many interconnected institutions to get cash quickly.

Maybe it's not that important to be able to access 100% of your cash portion at a moments notice, and simply that it BE THERE holding nominal value for  the few days/weeks while the markets sort themselves out, but cash, being the "weakest" PP asset, should really be something that at least a decent amount of you can rely on quick usage.

Especially in low-rate environments like today, I think there's nothing quite like green money.  The trick is putting it somewhere safe enough where the risk of it being stolen, destroyed or lost is lower than the risk of it being tomfooleried out of your hands by Wall Street.  I think, much like gold, a mix of safety deposit box and physical in a safe (or other safe location in-home) are probably the best way to "diversify your physicals."  This way, you don't need there to be quick turnaround on your treasury direct account getting you a check in the mail.

[moda0306]

Another thing... weren't we a while back solar flares and their potential ability to knock out our electronic systems?

I'm not going to venture to guess exactly how much $$'s would be valued in that world, but I'd imagine that people would have faith in eventual government recovery since it was merely an electronic event, not a political one, and would value cash VERY highly.

I think we need to accept that holding too much in terms of 1's and 0's (earning .1% interest no less) is probably a dangerous under-diversification of some sort.

[Lone Wolf]

So, why should we be surprised that MF Global stole "personal T-Bills" when they were likely registered in MF Global's street name in the first place? It's not like these T-Bills ever have the name or social security number of the the real owner (or "beneficial owner") on them.

I'd still be very surprised.

What's special here is that my personal T-bills have a known CUSIP that I maintain a record of (along with an extensive paper trail.)  If a bad actor starts absconding with individual securities like this, it seems like it would be almost impossible to hide.

This would require not only brazenness but a large volume of very, very deliberate fraud.  The system would have to be built in such a way that a security listed in my account (complete with CUSIP) would have actually been sold to another individual.  This is complex, difficult, extremely risky, and reasonably obvious to your victims.  Not an easy thing to obfuscate a la Madoff.  That's why I'd find it shocking to learn that this went on at MF Global.  Conspiracies with that many moving parts are usually unmaintainable.

I don't yet see an A to Z process by which MF Global could abscond with individually-marked securities in customer's accounts without quickly making it very obvious that they are a criminal enterprise.  How would something like that work?

I think all of this, including LW's observation about the simple time it would take to turn anything, no matter how pure & reliable, from 1's and 0's into cash, indicates to me (reiterating here) that cold, hard cash, in some amount, is a good idea.

I think you're exactly right here.  With interest rates this low, keeping real, live Federal Reserve Notes available to you is a fantastic idea (IMO.)

[Gumby]

What's special here is that my personal T-bills have a known CUSIP that I maintain a record of (along with an extensive paper trail.)  If a bad actor starts absconding with individual securities like this, it seems like it would be almost impossible to hide.

I'm not sure how the CUSIP number would help you. The CUSIP numbers aren't unique to your account.

For instance, every single 01/15/2012 US Treasury Note (@ 01.12500%) has the same CUSIP number. The CUSIP number is 912828KB5. It's just a number for computers to identify the type of investment you are trading.

http://fixedincome.fidelity.com/fi/FIBo ... =912828KB5

If you own $100,000 of CUSIP 912828KB5, and it's registered in the "street name" of your brokerage, there is no personally identifiable information attached to that investment.

[Lone Wolf]

What's special here is that my personal T-bills have a known CUSIP that I maintain a record of (along with an extensive paper trail.)  If a bad actor starts absconding with individual securities like this, it seems like it would be almost impossible to hide.

I'm not sure how the CUSIP number would help you. The CUSIP numbers aren't unique to your account.

For instance, every single 01/15/2012 US Treasury Note (@ 01.12500%) has the same CUSIP number. The CUSIP number is 912828KB5. It's just a number for computers to identify the type of investment you are trading.

Right, it doesn't uniquely tie the security to me, but does uniquely identify the security by type, issuer, and date of issue.  (And by extension, as you pointed out, by interest rate.)

So if I understand the scenario you think took place at MF Global, it went down like this.  You believe that MF Global (allegedly) maintained a pool of T-bills with this same CUSIP number that is (allegedly) too small to account for all the outstanding such T-bills in customer's accounts.  (Allegedly.)  That would mean that the books for this individual security type were cooked, right?  That means making fake interest payments on time for securities that do not exist.

Do you think this is what they did?  Or is there some other mechanism that I haven't considered?

I certainly don't disagree that it's possible this happened.  It'd be amazing to me, though.  You wouldn't be shocked by that level of malfeasance?

All in all, this is making me feel better and better about having my portfolio spread across so many different institutions.  This was borne of laziness rather than brilliance... but by God I give myself full credit anyway!  Thanks for bringing up such an interesting topic.