Why isn't cash held in savings accounts?

[Kriegsspiel]

I haven't seen an explanation for why cash isn't held in a regular savings account in the PP, but is instead held in the short term treasuries or money market accounts.  Why is that?

[craigr]

There is no FDIC insurance to worry about if you hold tbills or short term treasuries. As long as the US govt. remains, they will be paid no matter what is going on in the banking sector that could be impacting FDIC.

With that said, people do use bank accounts for some cash and this is understood for convenience. Just keep it under FDIC limits and understand that in a serious bank crisis the money is more at risk. Also I strongly advise not chasing yield with your cash.

[smurff]

In a serious bank crisis the FDIC may not be able to pay all the claims that come before it, at least not within a reasonable amount of time.  

Sort of like with MF Global--it's been nearly a year and the powers that be are still "in discussions" with Jon Corzine over the affair, including the trustee responsible for gathering together the assets and paying people.  They're still seriously discussing the notion that customer assets can be used to pay off MF Global's debts!  Imagine what would happen in a serious banking crisis to someone with $500,000 in their PP, all of it in accounts held at the bank Uncle Joey works at. Not only might they lose $250,000 (the current FDIC limit), but may have no access to the other money either.

With ST treasuries, the government will pay you when they mature, even if they have to print-on-demand the money in a government parking lot.

[Pointedstick]

I've been thinking about this a lot lately; how worried are we that Congress would let account holders crash and burn in the event of a major banking crisis that stained the FDIC? I mean, in theory, they could raise the FDIC limit to whatever they wanted, and whatever the limit is, the money is always going to be there unless Congress reneges on the FDIC commitment. This is possible of course--just like anything's possible--but I kind of doubt that Congress would allow millions of Americans to lose the money in their savings and checking accounts that they thought were safe. It would be political suicide for every congresscritter who voted against shoring up the FDIC. Yes, you'd be relying on Congress not to do something stupid, but it strikes me that we're all doing just that right now by hoping that Congress doesn't try to start balancing the budget, thereby reducing the supply of treasuries for us to save with. In no case are we immune to Congressional idiocy.

[MediumTex]

I've been thinking about this a lot lately; how worried are we that Congress would let account holders crash and burn in the event of a major banking crisis that stained the FDIC? I mean, in theory, they could raise the FDIC limit to whatever they wanted, and whatever the limit is, the money is always going to be there unless Congress reneges on the FDIC commitment. This is possible of course--just like anything's possible--but I kind of doubt that Congress would allow millions of Americans to lose the money in their savings and checking accounts that they thought were safe. It would be political suicide for every congresscritter who voted against shoring up the FDIC. Yes, you'd be relying on Congress not to do something stupid, but it strikes me that we're all doing just that right now by hoping that Congress doesn't try to start balancing the budget, thereby reducing the supply of treasuries for us to save with. In no case are we immune to Congressional idiocy.

To me, the biggest risk with the FDIC is potentially having to wait a while to get paid.  In a crisis, that is often the time that you can't afford to wait to access your money.

[Gumby]

FDIC accounts are not appropriate for the PP. Government Bonds are obligations of the government and the US Treasury. FDIC accounts are not. Congress has only supported the FDIC in spirit (with a non-binding resolution).

As Wikipedia says:

In light of apparent systemic risks facing the banking system, the adequacy of FDIC's financial backing has come into question. Beyond the funds in the Deposit Insurance Fund above and the FDIC's power to charge insurance premia, FDIC insurance is additionally assured by the Federal government. According to the FDIC.gov website (as of January 2009), "FDIC deposit insurance is backed by the full faith and credit of the United States government". This means that the resources of the United States government stand behind FDIC-insured depositors."[35] The statutory basis for this claim is less than clear. Congress, in 1987, passed a non-binding "Sense of Congress" to that effect,[36] but there appear to be no laws strictly binding the government to make good on any insurance liabilities unmet by the FDIC.
Source: Wikipedia : FDIC

In other words, Congress has only passed a non-binding resolution to stand behind FDIC.

Browne also discusses this in the following episode of his radio show:

https://web.archive.org/web/20160324133 ... -04-17.mp3

Answer starts at 13:05 of the show.

Here is a transcript of that answer...

HARRY BROWNE: In my suggested portfolio, 25% is in cash. And I have suggested that the cash portion should be either in Treasury Bills or in a money market fund that invests only in Treasury Bills. And the reason for that you don't want to be concerned about credit risk. Same thing with the bond portion, it should be in Long Term Treasury Bonds, because despite the terrible way the Treasury handles its money. And its not really the Treasury so much as [the way] Congress, and the President handle money and create all of these fiscal crises and the deficits and so forth. Despite all that, the fact is that the Treasury can always tax us or even print the money as necessary to repay the principal and interest. Now doing that, of course, creates bad problems. But it creates bad problems not just for Treasury securities, but for all types of debts. CDs, the Bonds of other companies, and Commercial Paper and all of these things are affected by it. And what you know is that there is no credit risk with any kind of Treasury securities, even though there may be an investment risk. But there is credit risk with the others. If we had sudden Deflation in this country, it may well be that banks would not have the money to repay all of the CDs that they have issued. Now, we like to think that the Federal Deposit Insurance Corporation would back up the banks. But, the Federal Deposit Insurance Corporation keeps only about 1% to 2% in a reserve fund. 1% to 2% of all the liabilities it has. So, it's in a position, the Federal Deposit Insurance Corporation to bail out a single bank when it fails, or another bank when it fails, or another bank over here when it fails. But, if we had a run on the banks in this country, and all banks were under siege from depositors who are afraid and wanting to get their money out of [them], there's no way in the world the Federal Deposit Insurance Corporation would back them up. Now Congress could appropriate money out of the General Fund for the FDIC, but I suspect that the Budget itself would be in horrendous shape at a time like that, and it wouldn't be likely that Congress would just vote to pay off all those liabilities of the banks 100¢ on the Dollar. Rather they would come up with some kind of plan that you got 50¢ on the Dollar, or only people who could show they were in need got it. Or in some other way it would renege on the promises, but attempt to pay off part of it. But, the Treasury Bills would be in a different position. They would be continually refinanced and taken care of. Now I'm talking about an extreme case here, and the situation that would exist. But, I believe that the Permanent Portfolio and the safety part of it should be set up not just for the risks that we can see in front of us, but for the unthinkable. For the things we just don't expect to happen. Like civil unrest in this country. Or other things of... A run on the banks or whatever it may be. Or hyperinflation of 20% or 30%. Whatever it might be that we don't see today as an imminent threat, the Permanent Portfolio should be able to cover all of those things so that you don't have to stay on top of it. So you don't have to keep reading the news and say, 'My gosh, are we going run into an unprecedented situation here now, and am I covered?' I want you to be covered no matter what happens...Now, the downside of the Treasury Bills is that they will not pay as much in interest as the CDs or any other short term kind of debt. And that's because Treasury Bills do have virtually zero credit risk, while the others have some measure of credit risk and that's what causes them to have a larger interest rate.

Harry Browne hits the nail on the head. If FDIC accounts were safer than T-Bills, the interest rate for T-Bills would be higher than CDs and FDIC accounts. You don't get higher interest rates with less risk. The market knows that T-Bills are safer, and the interest rates reflect that.

[k9]

What if the broker holding your treasuries goes bankrupt ? Can you get your cash back easily ? (cf MF Global, whose clients discovered their assets were actually not theirs anymore...)

Here in France, the situation is quite the opposite : you better keep your cash on special, government-backed saving account rather than buy short-term treasuries ; in the second case, you have to pay fees to your broker, forget about liquidity, pay a 45% tax on each coupon or benefit, and better hope your broker is not playing too much with your assets.

[Pointedstick]

Thanks for all that info Gumby, as usual! Know that this is a purely academic rumination here; I don't actually consider any of the money in my savings accounts to be part of my PP. I'd like to highlight this part of that Brown quote:

Now Congress could appropriate money out of the General Fund for the FDIC, but I suspect that the Budget itself would be in horrendous shape at a time like that, and it wouldn't be likely that Congress would just vote to pay off all those liabilities of the banks 100¢ on the Dollar. Rather they would come up with some kind of plan that you got 50¢ on the Dollar, or only people who could show they were in need got it. Or in some other way it would renege on the promises, but attempt to pay off part of it. But, the Treasury Bills would be in a different position. They would be continually refinanced and taken care of.

1. I really think voting not to shore up the FDIC in that situation would be political suicide. Can you imagine what would happen if all a lot of commercial banks collapsed and the American people faced the prospect of losing trillions of dollars held in checking and savings accounts? We're talking about voting, taxpaying poor and middle-class families losing large percentages of their net worth here. I think there would be rioting in the streets if Congress didn't protect that money somehow. Congressmen are stupid and venal, but if there's one trait they haven't lost, it's self-preservation.

2. Treasuries only work for the PP if there's a ready supply of them. If Congress misguidedly cuts the deficit, there are fewer treasuries. If they make a surplus (as happened only a decade ago), then the supply of treasuries goes negative. This is not an academic discussion; it happened under Clinton, thanks to a misguided Congress and President who were stuck with gold-standard thinking. What would we do if congress stopped issuing treasuries? Those of us using 30-day t-bill ladders, there goes your cash position! The funds using these instruments would begin to dry up too. Actually, was anyone here using a PP during the surpluses? What did people do when the treasury stopped selling new debt? Where did people store their cash?

Obviously both of these are remote possibilities. I don't think Congress is going to actually succeed at balancing the budget, and I don't think there's going to be a bank panic where nearly all the banks simultaneously collapse. It may even be that the latter is substantially more likely, but my point is that with Treasuries, you haven't actually eliminated the risk of Congress doing something stupid. It's just a different risk.

[Gumby]

What if the broker holding your treasuries goes bankrupt ? Can you get your cash back easily ? (cf MF Global, whose clients discovered their assets were actually not theirs anymore...)

When you purchase bonds through a brokerage, the bonds are typically held in the brokerage's "street name" registration.

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

In other words, the bonds are registered in the brokerage's name, and they act as a custodian for your bonds. You are the "beneficial owner" only in their internal records. Your brokerage house may "borrow" your bonds for their own lending purposes, and there is always a small amount of counterparty risk with this arrangement. That may be how a brokerage is able to offer "free" Treasury trades. You're basically buying assets for the brokerage's own use. You absolutely have a legal right to those bonds. But, you just need to understand that all brokers have small amounts of counterparty risk.

Harry Browne believed that during times of severe market stress is when counterparty risk was at its highest — when you needed your investments the most. If your brokerage were to declare bankruptcy — and followed the rule of law (and they didn't illegally steal your assets) — your ownership of your bonds would need to be verified by the bankruptcy trustee before they were released for transfer to another custodian.

As far as I know, TreasuryDirect appears to be the best way to have direct ownership of Treasuries. TreasuryDirect is excellent for holding bonds to maturity. However if you need to sell your bonds in TreasuryDircet before they reach maturity, you need to fill out a form to transfer them to a broker (such as Fidelity) for selling on the Secondary Market.

Here in France, the situation is quite the opposite : you better keep your cash on special, government-backed saving account rather than buy short-term treasuries ;

In a way, Savings Bonds and directly-held Treasuries are really just government-backed savings accounts. But, few people think of them that way, since they are called "debt". When was the last time you heard a politician or a pundit wish we had less government-backed savings accounts?

I can just picture the stump speech now... "We need to reduce the amount of government-backed savings in America!!" [crowd cheers]

[Gumby]

1. I really think voting not to shore up the FDIC in that situation would be political suicide.

Perhaps. Though, I can also picture politicians telling us that the government can't "afford" to bailout hundreds of banks. Maybe they would just wring their hands and debate and debate and debate and agree to give people 75¢ on the dollar or 85¢ on the dollar and people would be happy to get most of their money back. And I think there are probably politicians on the hill who actually believe that the government can't "afford" to bailout hundreds of banks in America.

Can you imagine what would happen if all a lot of commercial banks collapsed and the American people faced the prospect of losing trillions of dollars held in checking and savings accounts? We're talking about voting, taxpaying poor and middle-class families losing large percentages of their net worth here. I think there would be rioting in the streets if Congress didn't protect that money somehow. Congressmen are stupid and venal, but if there's one trait they haven't lost, it's self-preservation.

Yep. It would be bad. But, I'm fairly certain that there's a way to spin voting for anything into a win. You just say the whole thing was the other party's fault and it wasn't fair that every taxpayer in America should have to bailout those who made risky bets. If you were a Press Secretary and I asked you to write a speech explaining why a Senator voted against bailing out the FDIC, I bet you could do it. You'd just focus on all that was wrong with the bill and why the other side screwed up in writing it.

Keep in mind that Congress has always had the opportunity to fully "back" the FDIC and has never committed to it. You'd think it would be political suicide to kill a binding resolution to back the FDIC, but to date, such a bill has never been voted on. Perhaps HB is correct in that Congress might be in such gridlock that such a bill to back the FDIC never makes it to the floor.

2. Treasuries only work for the PP if there's a ready supply of them. If Congress misguidedly cuts the deficit, there are fewer treasuries. If they make a surplus (as happened only a decade ago), then the supply of treasuries goes negative. This is not an academic discussion; it happened under Clinton, thanks to a misguided Congress and President who were stuck with gold-standard thinking. What would we do if congress stopped issuing treasuries? Those of us using 30-day t-bill ladders, there goes your cash position! The funds using these instruments would begin to dry up too. Actually, was anyone here using a PP during the surpluses? What did people do when the treasury stopped selling new debt? Where did people store their cash?

You're absolutely right. It would be problematic. If you remember, the Treasury stopped issuing 30 year Treasuries when it started paying down the National debt. But, having no Treasuries wouldn't just be problematic for PP-holders. It would be very problematic for the entire private sector to lose access to dollar-denominated risk-free assets. Ideally, the government would just create risk-free government savings accounts where people could stash their money. (Warren Mosler has often suggested that the government just stop issuing long Treasuries and slowly replace them with government savings accounts as the remaining long bonds matured).

In fact, when the Clinton administration was paying down the debt, the government freaked out when they realized that there would be no risk-free assets for the private sector. Recently, a secret government report surfaced that showed how clueless they were about the ramifications of paying off the debt...

http://www.npr.org/blogs/money/2011/10/ ... ent-report

Read the Report: http://media.npr.org/assets/img/2011/10 ... erDebt.pdf

...One idea was to create a different kind of risk free asset. Kind of funny how they expected the debt to be paid down by 2012. Given what you know about MMR, you can see how impossible that would be in a debt-based monetary system.

If Congress did nothing to provide adequate risk-free assets to the private sector, it would just force people to ramp up private credit — which would eventually become unstable and then eventually require a private-sector bailout of risk-free assets.

Obviously both of these are remote possibilities. I don't think Congress is going to actually succeed at balancing the budget, and I don't think there's going to be a bank panic where nearly all the banks simultaneously collapse. It may even be that the latter is substantially more likely, but my point is that with Treasuries, you haven't actually eliminated the risk of Congress doing something stupid. It's just a different risk.

Right. Though, as HB pointed out, you don't need every bank in America to simultaneously collapse. All you need is a few Trillion dollars to go up in smoke and the FDIC would be in need of a bailout. We all agree that the bailout would likely pass, but you wouldn't sleep well if you were one of those people who needed a bailout. So, the whole point of the PP is just so that you can sleep well at night. It's the difference between being bullet resistant and bullet proof.

And if there were no Treasuries, I believe you would just find the least-risky assets you could find to replace Treasuries. (maybe AAA-rated bonds, if you had no other choice). Remember, the key to the PP is reducing credit risk and counter-party risk in all four assets. You just do the best you can.

[Pointedstick]

Gumby, that report is fascinating. I'm still reading through it, but I had a chuckle when I reached this point:

Investing in Private Fixed Income Securities

One vehicle for investment that might be appealing as an asset is the "Triple A" bond described above. Such a bond would be relatively risk free and be could be constructed in relative abundance. Mortgage backed securities are another option as well. The two largest Government Sponsored Enterprises, Freddie Mac and Fannie Mae together account for nearly half of all of the mortgages issued in the United States home mortgage market. Any private instrument we consider will carry some risk. The housing market is unique; by providing substantial liquidity to a fundamentally supply constrained market, the housing market could experience substantial increases in demand and price. Sweden embarked on a similar course of action in the past with mixed results. In the 1960's the Swedish government purchased debt holdings of government-owned mortgage corporations. This subsidized the housing market with positive consequences for both homeownership rates and household wealth. However, the financial system was very tightly regulated during this time. A subsequent deregulation led to a real estate price bubble that burst in the early 1990s. This fall in asset prices had a significant negative effect on the economy; bad loans were subsequently collected into a special public corporation as part of a government rescue package for the Swedish financial system in the 1990s.

Looks like we're not the only ones to have experienced a crash resulting from the government encouraging home ownership beyond what was seen in the market.

[WildAboutHarry]

Given the crappy rates on T-Bills, why not hold cash as, well, cash?

[dualstow]

The only reason I keep some cash in the bank is for a free safety deposit box -- never had one before I had a pp --  and for bill pay.

Given the crappy rates on T-Bills, why not hold cash as, well, cash?

Then you'd have to spray it occasionally for silverfish.

[WildAboutHarry]

Then you'd have to spray it occasionally for silverfish.

I'm sure the cocaine dust on most currency would repel silverfish.

Family rumor has it that my great-grandfather used to bury bills in a coffee can in the backyard (didn't trust banks).  My great grandmother would dutifully dig up the can and lightly launder and iron the bills prior to spending.

[Kriegsspiel]

Thanks everyone, it makes sense.

[Ad Orientem]

Thanks everyone, it makes sense.

Welcome to the forum. And I love the SN. I used to play the game when I was a kid.

[dualstow]

Family rumor has it that my great-grandfather used to bury bills in a coffee can in the backyard (didn't trust banks).  My great grandmother would dutifully dig up the can and lightly launder and iron the bills prior to spending.

Ha! When I was a kid, my grandfather used to iron $2 bills before giving them to me and my siblings as something of a collector's item.
I wonder where they are.

[WildAboutHarry]

Ha! When I was a kid, my grandfather used to iron $2 bills before giving them to me and my siblings as something of a collector's item.
I wonder where they are.

Were they $2 silver certificates or the regular $2 notes?  I'll bet ironing made them seem printing-press fresh!

[k9]

Here in France, the situation is quite the opposite : you better keep your cash on special, government-backed saving account rather than buy short-term treasuries ;

In a way, Savings Bonds and directly-held Treasuries are really just government-backed savings accounts. But, few people think of them that way, since they are called "debt". When was the last time you heard a politician or a pundit wish we had less government-backed savings accounts?

I can just picture the stump speech now... "We need to reduce the amount of government-backed savings in America!!" [crowd cheers]

Ha, funny you're saying that, because that's what I was saying to one of my relative recently. He told me "France should default and not pay back its debt ; that way, debt crisis problem solved !" ; I asked him if he was ready to lose all his savings, but he couldn't see the link between his savings managed by a public institution and public debt :/

[dualstow]

Ha! When I was a kid, my grandfather used to iron $2 bills before giving them to me and my siblings as something of a collector's item.
I wonder where they are.

Were they $2 silver certificates or the regular $2 notes?  I'll bet ironing made them seem printing-press fresh!

Oh, just the regular notes. I've never laid eyes on a silver certificate.

[Kriegsspiel]

Thanks everyone, it makes sense.

Welcome to the forum. And I love the SN. I used to play the game when I was a kid.

Damn, I didn't even realize Kriegsspiel was a board game, I had to google it.  It looks like fun.

[MachineGhost]

Harry Browne hits the nail on the head. If FDIC accounts were safer than T-Bills, the interest rate for T-Bills would be higher than CDs and FDIC accounts. You don't get higher interest rates with less risk. The market knows that T-Bills are safer, and the interest rates reflect that.

I'm coming around more and more that Harry Browne was an intellectual superstar.  He is no mere guru with his name attached to a proletarian portfolio.  Still, its hard to overcome the guru factor and the resulting suspicion.

[MediumTex]

Ha! When I was a kid, my grandfather used to iron $2 bills before giving them to me and my siblings as something of a collector's item.
I wonder where they are.

Were they $2 silver certificates or the regular $2 notes?  I'll bet ironing made them seem printing-press fresh!

Oh, just the regular notes. I've never laid eyes on a silver certificate.

You can fix that by looking at this comparison of a silver certificate to a regular dollar bill.



I have a few.  They're pretty neat.  Since they were defaulted on by the U.S. government on June 24, 1968 (they were supposed to be convertible into one ounce of silver), they're not that expensive in coin shops.  The coin shop will tell you that it's just another piece of worthless paper currency (though it will always be worth at least $1).

[WildAboutHarry]

Since they were defaulted on by the U.S. government on June 24, 1968 (they were supposed to be convertible into one ounce of silver), they're not that expensive in coin shops. 

I remember in the mid-1960s there was a "run" on the San Francisco mint to redeem Silver Certificates for actual silver.  I think you got a small baggie (no zip-loc!) with some silver drippings in it.

[stone]

I've been thinking about this a lot lately; how worried are we that Congress would let account holders crash and burn in the event of a major banking crisis that stained the FDIC? I mean, in theory, they could raise the FDIC limit to whatever they wanted, and whatever the limit is, the money is always going to be there unless Congress reneges on the FDIC commitment. This is possible of course--just like anything's possible--but I kind of doubt that Congress would allow millions of Americans to lose the money in their savings and checking accounts that they thought were safe. It would be political suicide for every congresscritter who voted against shoring up the FDIC. Yes, you'd be relying on Congress not to do something stupid, but it strikes me that we're all doing just that right now by hoping that Congress doesn't try to start balancing the budget, thereby reducing the supply of treasuries for us to save with. In no case are we immune to Congressional idiocy.

To me, the biggest risk with the FDIC is potentially having to wait a while to get paid.  In a crisis, that is often the time that you can't afford to wait to access your money.

The kind of thing to avoid is:
http://en.wikipedia.org/wiki/Icesave_dispute

The Icesave dispute is a diplomatic dispute that began in 2008 between Iceland on one hand and the United Kingdom and the Netherlands on the other. The dispute is centred on the retail creditors of the privately owned (since 2003) Icelandic bank Landsbanki, which offered online savings accounts under the "Icesave" brand. The bank was placed into receivership by the Icelandic Financial Supervisory Authority (FME) on 7 October 2008. As a result, more than 400,000 depositors with Icesave accounts in the UK and the Netherlands were unable to access their money for at least 6 to 8 weeks, while waiting for payout from the Deposit Guarantee Schemes in these countries. Much of the public controversy arose around the UK's use of the "anti-terrorism legislation" against Iceland.[1]