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

[moda0306]

If somebody doesn't want to hassle with buying ST bonds right now, is the CoI sufficiently safe?  Obviously we still have our concerns about Treasury Direct, but if you can't sell your 1 month or 1 year or whatever treasury bond when you want to, maybe, until rates rise, the CoI is a better option.

Lastly, can you request a paper check from TD for your CoI balance (as opposed to simply a transfer to your bank)?

[WildAboutHarry]

have you done this? is it all online? how long does it take?

You have to fill out a form, I don't recall if you need a Medallion signature guarantee or not.  Since you can buy Treasury bonds for no or very low cost at Fidelity/Vanguard, I would use them to buy (and sell) LT bonds.

If I were going to use TD for something other than I-Bonds I would limit it to bills and short notes -- roll your own Treasury money market fund.  It has been a while since I've done anything along those lines, but TD did have automatic rollovers of bills, so you really could do a set and forget, cheap to run, pure Treasury cash position fairly easily.

[Greg]

I was just looking at this old thread regarding FDIC-insured accounts vs. owning T-Bills. I realize there is a spread of interest between them and this is what the market feels is the necessary difference in the risk.

The question I was wondering is "is there a collective reasoning as to how the spread between these two is chosen at all? Or just supply and demand".

I was wondering if there is a way to determine quantitative the chance that all banks will fail or at least enough banks will fail that FDIC insurance will be exhausted. Kinda like how they have a 1 in hypothetically 10 million chance of getting struck by lightning.

Could you look at all the countries around the world and see how often they default on their banks if they have some sort of government insurance on their holdings? Not sure how many other countries however work like this so maybe it wouldn't be an apple to apples comparison.

[WildAboutHarry]

Remember that US Treasury instruments appeal to a wider (i.e. international) audience with very, very deep pockets.  FDIC accounts are for the "little guy" with only $250,000 to deposit.  That, alone, creates greater demand for Treasury bonds than FDIC-insured accounts and drives the rates of the former lower.

From a practical standpoint, if the FDIC (i.e. the federal government) isn't covering its obligations I suspect that Treasury bonds would be experiencing problems as well.

I don't know this for sure (i.e. I haven't Googled it), but as far as I know no one has lost money in an FDIC-insured account because of bank failure.

[Greg]

Remember that US Treasury instruments appeal to a wider (i.e. international) audience with very, very deep pockets.  FDIC accounts are for the "little guy" with only $250,000 to deposit.  That, alone, creates greater demand for Treasury bonds than FDIC-insured accounts and drives the rates of the former lower.

From a practical standpoint, if the FDIC (i.e. the federal government) isn't covering its obligations I suspect that Treasury bonds would be experiencing problems as well.

I don't know this for sure (i.e. I haven't Googled it), but as far as I know no one has lost money in an FDIC-insured account because of bank failure.

I'll have to look into this too. As of now, I have just started my PP and have about half of my cash portion in I/EE bonds and about half in an ING savings account. I'll be purchasing more and more I bonds as a cash instrument and get into a bit of short term treasuries as well but I have a hard time rationalizing the risk of FDIC vs. treasury. To me at least the loss in interest does not make up for the safety. They could be much safer but perhaps I'm just a risk taker 

[Gumby]

FDIC accounts aren't really "money" in the way we like to think of as money. The bank holds a shared pool of real money in their reserve accounts at the Fed, and your FDIC bank account is just a line on a statement promising you some access to that money when you need it. But, the system isn't designed to work if everyone demands their money simultaneously. Most people feel comfortable with these paper-statement promises to access reserves, but HB wanted the PP to have cash as a buffer during "extreme situations." Well, "extreme situations" are when the fractional reserve system gets put the kinds of under enormous pressure that it wasn't designed to sustain.

Congress has promised to back the FDIC, only in spirit, but not with any legislation.

[moda0306]

Gumby... perfect concise analysis... but what's your conclusion?  Do you see there really being risks associated with FDIC accounts that T-Bills don't have?

I simply can't see the gov't getting away with guaranteeing Chinese T-Bills while Grandma's bank account dries up... the political pressure would be SO huge that I tend to see FDIC insured accounts as a solid substitute.

That said, I see both T-Bills and FDIC insured accounts as having "electronic" risk in that if for some reason our whole electronic payment system broke down, I'd want greenbacks to do the walking for me.

[Gumby]

The big difference I see between T-Bills and FDIC is the warm fuzzy feeling you get about not having to wait for lawyers and lawmakers to sort out the fallout of a bank run. I agree that grandma might eventually see 90¢ on her dollar, or 100¢ on the dollar if all goes well, after a bank run. But, those holding T-Bills get to sleep in on the day that their savings bank (or hundreds of savings banks) go under. Your neighbor and everyone else with FDIC will be sweating bullets for a few weeks while the details are sorted out. And under an extreme situation, you have to imagine that the details of an FDIC implosion might take more than a few hours to get sorted out. It could even take weeks, for all we know.

FDIC accounts are a form of private credit. Private credit has risks.

[moda0306]

Gumby,

But Bank deposits ARE legal tender... T-Bills are not... if bank deposits are failing like crazy, I wonder if we'll actually be swallowing our "bonds are money" words, when we have all these T-bills that mature at the end of the month and we need money NOW.

If actual cash-money is in that high of demand (the exposure to bank deposits is so huge I can't imagine there not being HUGE demand for base money) I wonder if that will actually negatively impact anything other than pure legal tender.

Thoughts?

If my savings account (FDIC insured) is at 1%, and T-Bills are at .3%, I wonder if taking 30% of my cash portion in physical form (between a safe, another super-secret spot, and a safety-deposit box... kind of like gold), and still getting .7% (as opposed to .3%) on all of my cash by keeping the rest under the FDIC would be worth it...

Or perhaps a mix of all three.

My biggest thing is that the balances in checking, savings & even CD's are actually legal tender, while T-Bills are not.  What, praytell, is the impact of that distinction.

[hoost]

I'm not sure what the answer is here but I think it's an interesting discussion.  I'll add some thoughts that hopefully someone can use to make sense of this and give us a good answer.

I'm not sure that bank deposits are necessarily legal tender.  I believe legal tender would only be the reserves that the bank holds.  I'll elaborate a bit with an example, because I'm not sure I have it right.

Let's say, Moda and I both have a bank account at Citi (is that still a bank?) and Gumby has an account at Chase.

Citi Reserves:  100
  Moda's acct:  100
  Hoost's acct:  100

Chase's Reserves:  100
  Gumby's acct:  100

If I give Moda 50, then we get this:

Citi Reserves:  100
  Moda's acct:  150
  Hoost's acct:  50

Chase's Reserves:  100
  Gumby's acct:  100

The transaction happens within Citi, so no reserves are transferred. 

Now if I give Gumby 25, and Gumby gives Moda 50, we get this:

Citi Reserves:  125
  Moda's acct:  200
  Hoost's acct:  25

Chase's Reserves:  75
  Gumby's acct:  75

Chase has to transfer 25 in reserves to Citi, because the balance of payments b/w the banks (50-25) was 25.

Now if Moda gives Gumby 50, and Gumby gives me 50 on the same day, we get this:

Citi Reserves:  125
  Moda's acct:  150
  Hoost's acct:  75

Chase's Reserves:  75
  Gumby's acct:  75

The reserves don't change because the balance of payments between the two banks (50-50) is zero.

I think when transacting with the govt, the govt is like a separate bank, so reserves must be transferred, because only reserves are legal tender.

---

Banks have a current reserve requirement of somewhere between 0 and 10% depending on the total amount of deposits they hold.  I think the 10% requirement kicks in at 6 million in deposits.

This means that in our example, both Citi and Chase could have 1000 in deposits with only 100 in reserves (I actually think it can be higher through various manipulations).  So if people came to claim 1000 in deposits in cash, and the bank only had 100 in reserves (very little of which is kept in the bank's vault) available, that might be problematic.  If this happened with one or two smaller banks, the govt may just let them collapse, and then refund some of the depositors' money through FDIC.  I would imagine this being a long and drawn out process...I'm sure there are examples of it in the last 20-30 years.

If it the situation wasn't limited to one or two smaller banks, but was occurring with multiple big banks, it would be more dire.  In that scenario, I would expect to see a bank holiday.  So that certainly speaks to keeping some cash on hand.

If that situation persisted, I would expect that banks would have to redeem savings at a reduced rate, depending on whatever the FDIC (via Congress) decided to fund them at. 

Before it got to that point, the Fed would likely try to increase the amount of reserves available by purchasing treasury bonds, either on the open market (which would go straight to the banks) or directly from the treasury, which I would see as less likely because it would be the banks needing the reserves.  This would essentially circumvent Congress, but the challenge would be that there may not be enough Treasury bonds outstanding that people are willing to sell.  In that case, it would come back to the Treasury to spend money and create new bonds for the Fed to buy to add reserves.

If that train of logic makes sense, then I think it does make sense to hold Treasuries vs. bank savings.  The treasuries depend on the solvency of the entire monetary system; whereas a savings account depends on the solvency of one bank.

That's as far as my brain will take me right now.  Maybe someone can find more implications than just that.

[craigr]

If the govt. stiffs holders of t-bills to make good on FDIC the implications would be catastrophic for the dollar. Grandma may get her money, but it wouldn't buy much. Any situation with t-bills not being paid is going to be horrible for FDIC. I don't see any other way for it to work out.

[WildAboutHarry]

If the govt. stiffs holders of t-bills to make good on FDIC the implications would be catastrophic for the dollar. Grandma may get her money, but it wouldn't buy much. Any situation with t-bills not being paid is going to be horrible for FDIC. I don't see any other way for it to work out.

A more likely situation is that the government pays both treasuries and makes good on FDIC deposits of insolvent banks in the same way -- printing press.  This is one of the main HBPP arguments for holding treasury bonds in the first place.  The fed can't default because it can print.  They just let the presses run a bit longer to take care of insolvent banks.

[Gumby]

Gumby,

But Bank deposits ARE legal tender... T-Bills are not... if bank deposits are failing like crazy, I wonder if we'll actually be swallowing our "bonds are money" words, when we have all these T-bills that mature at the end of the month and we need money NOW.

As long as Primary Dealers are doing their job (i.e. making a market for Treasuries, with support from the Fed) then we won't have a problem converting our Treasuries into Cash.

If actual cash-money is in that high of demand (the exposure to bank deposits is so huge I can't imagine there not being HUGE demand for base money) I wonder if that will actually negatively impact anything other than pure legal tender.

Thoughts?

The only risk-free legal tender is cash in your hand. A Savings Account is not legal tender, since you must convert it into a legal tender account (i.e. checking). The money in a Savings Account is typically lent out, since it doesn't have to be counted towards a bank's reserve requirement.

But, in terms of liquidity, it's the Fed's job to work through its Primary Dealers so that everyone who wants to convert their Treasuries into cash can do so. But, let's not forget that during a bank crisis, everyone would be clamoring for Treasuries. So, you would have no problem selling your Treasuries since everyone would be rushing to buy them.

Furthermore, banks drain their excess reserves into Treasuries. So, if Treasuries fail, then all excess reserves would fail as well. And if Treasuries and excess reserves fail, then the entire monetary system fails — since we have a debt-based currency.

If my savings account (FDIC insured) is at 1%, and T-Bills are at .3%, I wonder if taking 30% of my cash portion in physical form (between a safe, another super-secret spot, and a safety-deposit box... kind of like gold), and still getting .7% (as opposed to .3%) on all of my cash by keeping the rest under the FDIC would be worth it...

Or perhaps a mix of all three.

My biggest thing is that the balances in checking, savings & even CD's are actually legal tender, while T-Bills are not.  What, praytell, is the impact of that distinction.

Again, the only legal tender in a bank is a checking account. Savings and CDs are not legal tender. You can't pay a debt with the money in a CD or a Savings Account. The money from those accounts must be converted into legal tender form (i.e. checking).

I get the feeling that you want savings accounts and CDs to be legal tender so that you can get a better return. But, as Harry Browne pointed out... the reason why the yield is higher is because the risk is higher. Risk and yield go hand and hand. You don't get a higher yield and lower risk. It doesn't work that way.

Just foliow Harry Browne's advice and you'll be fine... Keep a few week's supply of cash on hand for an emergency. And keep the rest in Treasuries. When banks are failing left and right, you'll feel good knowing your T-Bills will survive the turmoil (even if you can't easily touch them during the turmoil). And use your emergency cash during the actual emergency.

I'll also point out that Treasury Direct used to have a policy of sending checks to people when electronic deposits weren't set up. And I believe they still send a check when electronic deposits can't be completed. I see no reason why they wouldn't send out your T-Bill payments as a check if your bank wasn't able to receive the settlement. The Treasury has to pay you, or it's considered a major world-ending credit event.

[MediumTex]

Although the analogy isn't a perfect fit, you might think of FDIC-insured bank deposits like shares of an unallocated gold pool, while treasuries are more like segregated gold bullion.

[moda0306]

Gumby (and others),

Good points about checking/savings... though I'd say that banks guarantee (don't they) that the only thing preventing us from converting our savings/CD's to checking are possible penalties... either way, aren't situations where "banks are failing left and right" also potentially, if not likely, ones where primary dealers (banks... maybe the same ones failing) are also failing in their role as primary dealers?  It seems to me that these situations might be quite similar.  Now at this point I agree with most here that 1) the fed would fund the treasury directly, and 2) the federal government would back the FDIC... theoretically, #1 would have to happen before #2, but to me it seems like we're missing the point that the very banks that are primary dealers stabilizing the treasury market could also be the ones failing unless the fed does something unprecedented... thereby immediately giving the treasury the ability to do the same and back the FDIC.

I wonder if yield reflects risk on FDIC accounts any more than yield reflects risk of I-Bonds... FDIC limits on only certain types of accounts create a limited supply, same as I-Bonds.  So I don't tend to equate those increased yields with the risks.

I don't know how to build a Failure Flow Chart out of this, but I'm loving how this thread picks back up every several months after we (think we) have learned more about macro.

[Gumby]

Good points about checking/savings... though I'd say that banks guarantee (don't they) that the only thing preventing us from converting our savings/CD's to checking are possible penalties...

Huh? If your bank has failed, you won't be able to convert your CDs and Savings Accounts into checking. Your bank will be closed, and you'll be outside on the sidewalk with a cardboard sign asking people for money.

either way, aren't situations where "banks are failing left and right" also potentially, if not likely, ones where primary dealers (banks... maybe the same ones failing) are also failing in their role as primary dealers?  It seems to me that these situations might be quite similar. Now at this point I agree with most here that 1) the fed would fund the treasury directly

The Fed can't just fund the Treasury directly. It's illegal. It would take an act of Congress to allow that. Besides, the Treasury has a few tricks up its sleeve if it needs to stay "funded" (seignorage, drawing on other accounts, allowing emergency Treasury spending first and delaying the bonds until a later date, etc).

, and 2) the federal government would back the FDIC... theoretically, #1 would have to happen before #2,

Again, it would take an act of Congress to back the FDIC. Not a risk worth taking in my opinion — particularly since Congress might be gridlocked when the bill needed to pass. And as HB pointed out, getting a bill to pass might require FDIC holders only getting 90¢ on the dollar, or 80¢ on the dollar.

but to me it seems like we're missing the point that the very banks that are primary dealers stabilizing the treasury market could also be the ones failing unless the fed does something unprecedented... thereby immediately giving the treasury the ability to do the same and back the FDIC.

Unprecedented? You mean like in 2008, when the Fed loaned Primary Dealers all the money in the world that they needed to stay afloat and complete Treasury transactions?

http://www.federalreserve.gov/monetaryp ... rimary.htm

Moda, Primary Dealers have access to unlimited amounts of liquidity and loans from the Fed when they need it. They get special treatment. That's why they call them Primary Dealers. And no, that doesn't mean that a savings account held at a Primary Dealer's bank is 100% risk free (see MF Global, which stopped being a Primary Dealer on Oct 31, 2011). It just means that Primary Dealers, worldwide, will be given the loans they need to make a market for Treasuries.

[moda0306]

Gumby,

My point about my savings and cd was that in normal times I have the right to convert them to legal tender on demand.  With treasuries I depend on a market price to do that

The unprecedented act i was talking about WAS the fed funding the treasury directly.

How much can we rely on those treasury "tricks" to be smooth?

My point isnt so much that bank accounts should be risk free so much that if banks are failing left and right, the treasury is having difficulties too, and, most importantly, in a dash for cash, the distinction between legal tender and tbills becomes hauntingly clear.

[WildAboutHarry]

Although the analogy isn't a perfect fit, you might think of FDIC-insured bank deposits like shares of an unallocated gold pool, while treasuries are more like segregated gold bullion.

It is a pretty good analogy, and the method can be extended to all four HBPP assets:

Gold: Physical gold > allocated gold > unallocated gold > GTU > GLD > .......... > coin shop storage...

Bonds: Bearer Bonds (extinct) > Treasury Direct > Brokerage (your name) > Brokerage (streetname) > TLT...

Cash: Silver Certificates (extinct) > Federal Reserve Notes > Treasury Direct > FDIC > Brokerage (your name) > Brokerage (street name) > SHY...

Stocks: Low cost 500 Index/Total Market > high cost 500 Index/Total Market > Actively managed fund > .......... > Munder Net Net Fund...

[Gumby]

My point about my savings and cd was that in normal times I have the right to convert them to legal tender on demand.  With treasuries I depend on a market price to do that

What's your point? Treasuries are as good as cash during "normal" times. Many Treasury Money Market Funds even have check writing capabilities.

The unprecedented act i was talking about WAS the fed funding the treasury directly.

How much can we rely on those treasury "tricks" to be smooth?

Well, they have to be smooth. Otherwise the entire monetary system grinds to a halt. If the Treasury market is frozen, then banks won't be able to convert savings (held as excess reserves) and CDs into legal tender (i.e. checking). Most of the monetary system would be frozen until the Treasury market started running again. So, this idea that CDs and Savings Accounts are somehow more liquid than Treasuries is false, since CDs and Savings Accounts depend on the Treasury market functioning properly. Furthermore, Savings Accounts and CDs have a right to delay withdrawals, to prevent bank runs. So, Savings Accounts and CDs are just as illiquid as Treasuries are.

I'm not really sure I understand your logic, Moda. If the Treasury market stops functioning, the banking system freezes up. If the banking system and Treasury market freezes up, the credit market freezes up and CDs become worthless pieces of paper. Though, in reality, the credit market is likely to freeze up before the Treasury market freezes up — making CDs and Money Market Funds the first casualties — likely triggering bank runs.

Also, Harry Browne recommended keeping physical cash on hand so that you wouldn't need to go through the impossible task of withdrawing illiquid savings during a credit event. Once the credit event ended, your T-Bill would be safe — right where you left them. What exactly is the problem with that approach?