Is My Bank Safe?

The question of the day has been coming fast and furious from friends, relatives and colleagues — Is my bank safe?

Today’s news was not good, if you are a shareholder with Bank of America or Citicorp — Citi was off 36% and closed at $2.  B of A was right behind at $3.  The stock market is telling us that these banks are insolvent.  In spite of the billions of dollars of TARP money, the bailout has not succeeded for these banks.   This is not a good sign for depositors in these banks and while they might get bailed out again, it is a good time to be prudent and watch out for your money.

Let’s start with a little legal background and history to give you a flavor for the history of bank failures.  Under U.S. laws dating back almost 200 years, depositors are creditors to the bank.  You give them your money, they give you an IOU — the bank is borrowing your money.  In the past (before the depression-era laws guaranteeing deposits via the Federal Depository Insurance Corporation – FDIC,null,null,null),  when your bank failed, you were a creditor and you lost your money along with the other creditors of the bank.   When a bank fails, you lose your money and there’s nothing legally you can do about it.

Banks operate by paying depositors interest for using their money, then lending out the money and collecting a higher interest.  The difference between the interest charged borrowers and that paid to depositors is a profit to the bank.  For many years, a joke in the banking business was it was a 3-6-3 business because they paid depositors 3%, lent money out at 6% and left work to play golf every day at 3PM.  Not anymore.  Now they must be biting their fingernails every time the President or Treasury Secretary go on TV.

The more of its deposits a bank lends out, the more profits they make.  However, there is a catch, and that is that you need enough money sitting around at the bank to pay the depositors their money back, upon demand, to keep their confidence up and hope they don’t demand all of their money back, which would lead to a run on the bank and ultimately, its failure.  Bank failures were fairly commonplace throughout the history of the U.S, in fact, in 2008 twenty-five banks failed.    The FDIC’s “problem list” of banks they watch carefully grew to 252 institutions, the largest number since 1995.  

FDIC Press Release Here:

” rel=”nofollow” target=”_new”>www.fdic.gov/news/news/press/2009/pr09027.html

Everything works well with this system, until there are excess losses from bad loans, money the bank has lent out that will never come back to the bank due to business failure, fraud, personal bankruptcy and a variety of other reasons including toxic derivatives.  When depositors get wind of these problems, they all want their money back immediately, there isn’t enough cash on hand to pay everyone, and that is the crux of a bank run.  In the old days when banks were strictly local, depositors would know exactly how well the factory down the street was doing and that they had borrowed money from the bank in town.  Banks would keep gold on deposit and issue “banknotes” that could be redeemed for that gold.  But gold and silver are an issue for another post.

Once a bank had a run, lines of people would impatiently wait outside, hoping to get their money back.  It was important to be early in line — you stood a better chance than the fellow at the end of the line who might get to the teller’s window to only be told they were out of money and the bank was closed for good, sorry.  Banks were a confidence game in the sense that the owners had to show depositors that they would be paid back and once the crowd saw that people were being paid back, they would return their money to the bank for safe keeping.  That would end the run.

Other times, things did not end so well.  Banks would run out of money and be declared insolvent.  The bank owner’s personal possessions would be auctioned off to pay depositors and other creditors pennies on the dollar and that was the end of that.  Once a bank started to fail, depositors would flee the failing banks and put their money in banks that were better capitalized.  This in itself made the weak banks fail and the strong banks get stronger by attracting more deposits — a good thing for the economy, but not for depositors who didn’t have the foresight to flee the weak bank in time.  During the first Great Depression, thousands of banks failed and that was one of the main reasons we have FDIC insurance at most every bank today, to provide protection for depositors.  

Exactly how much protection is there really for depositors today?  Not much, it turns out.  The government claims to cover accounts up to $250,000 (through 2009, when the maximum reverts to $100,000,null,null,null), but this is not the whole story.  Today, FDIC has about $19 billion in assets, less than they paid out in claims for failed banks in 2008 — and none of those banks was the size of Bank of America or Citicorp.  The fund reserve ratio at the end of 2008 was at an all time low of 0.40% of deposits covered (it usually stands at around 1.25% of deposits).   There is a good chance that if either B of A or Citi failed, they would exhaust the fund.   While the U.S. Treasury can “print” the money to make the insurance good, this can take time, including executive orders, acts of Congress, etc.  Meanwhile, you don’t have access to your money.

As an example, during the late 1980′s when banks in Texas were in the midst of the Savings and Loan crisis, even banks that were insured took several months to pay out.  Those whose deposits exceeded the $100,000 limit lost everything over that amount, so spread your money among a number of banks if you have more than that on deposit.

Today, the banking system faces far larger, more systemic difficulties.  The subprime mess was roughly $1 trillion in scope.  The Option-ARM and Alt-A mortgages that will reset with higher interest rates and set off the next wave of defaults is set to hit in late 2009 and it will also be another $1 trillion.  Add to this personal credit card and other consumer debt of about $2.5 trillion, a good part of which went back and forth with home equity loans and will surely default and you can see the trouble the banks are in.  However, there is even worse news to come; the toxic derivatives in the form of Credit Default Swaps (CDS) a form of insurance against default and Interest Rate Swaps (IRS) among other forms of securities floating out in the marketplace.  Banks in Europe have according to a news report in the Telegraph (UK) $24 trillion worth of this bad paper — this exceeds the total GDP for all of Europe for a year.  Worldwide, the total notional value of toxic derivatives is $600 trillion, more than ten times the world’s GDP.  This is clearly a problem that will break the bank because no one knows how this will all play out — you just have to assume that some of it will end badly.

For this reason, I recommend keeping several months worth of your personal cash requirements at home “in the mattress”.   If you don’t have this much money around your home, you should go to your bank immediately and make the withdrawal.  If you don’t have a safe, you should think of some good hiding places that you won’t forget and where the money won’t be at risk from calamity such as fire (don’t put it in the oven, for example).  Cash kept at home is not insured, so don’t bring all your money home.  You will also want to consider keeping some gold and silver coins at home, as well, and we’ll talk about this in another post.

Which brings us to the point of this post — you’ll still need a bank to conduct your personal business.   Are there any good banks that didn’t make stupid loans, purchase brokerage houses or bankrupt mortgage lenders?  It turns out there are still old-fashioned banks that didn’t go crazy with sub-prime loans and derivatives, but you have to search them out.  They are typically smaller, family run operations with high ethical standards, pillars of the community, etc.  TheStreet.com has a bank rating list you can research in your public library, which contains data about types of loans (commercial vs. consumer,null,null,null), rates of bad loans, reserve ratios, liquidity and so on.  Here is a very abbreviated list I excerpted from several states for our readers, follow the link below to TheStreet.com Bank and Thrift Screener (Safari Mac browser not supported, but others work fine):

California

A+ First Security Thrift Co., Orange

A California First National Bank, Irvine

A Farmer’s and Merchant’s Bank, Long Beach

A California Pacific Bank, San Francisco

A Silicon Valley Bank, Santa Clara

A Bank of Willits, Willits

A- First Commercial Bank USA, Alhambra

A- Los Angeles National Bank, Buena Park

A- First National Bank of Marin, Marin County

A- Summit Bank, Oakland

A- Bank of Stockton

A- Savings Bank of Mendocino County, Ukiah

Connecticut

A Citizen’s National Bank, Putnam

A- Essex Savings Bank

A- Liberty Bank, Middletown

A- First National Bank of Suffield

Georgia

A Merchant’s and Farmer’s Bank, Comer

A Southeastern Bank, Darien

A Global Commerce Bank, Doraville

A Century Bank and Trust, Milledgeville

Illinois

A+ First National Bank of Dwight

A Albany Bank and Trust Company NA, Chicago

A State Bank of Lincoln

Nevada

 

A First National Bank of Ely

A- Eaglemark Savings Bank, Carson City

A- Credit One Bank NA, Las Vegas

A- Heritage Bank of Nevada, Reno

 

New Jersey

A+ Sumitomo Trust and Banking Company USA, Hoboken

A First Investor’s Trust, Edison

A Brunswick Bank and Trust Company, New Brunswick

A Custodial Trust Company, Princeton

New York

 

A+ Sumitomo Trading and Banking Company USA, Hoboken, NJ

A National Bank of Coxsakie

A First National Bank of Groton

A Brooklyn Federal Savings Bank, New York

A Asia Bank, NA, New York

A Delta National Bank and Trust Company, New York

A National Bank of New York City

Virginia

A+ Virginia Bank and Trust Company, Danville

A Burke and Herbert Bank and Trust Company, Alexandria

A Bank of Southside Virginia, Carson

A Highlands Community Bank, Covington

A American National Bank and Trust, Danville

A Grundy National Bank

A Bank of Charlotte County, Phenix

Washington (State)

A South Sound Bank, Olympia

A Washington Federal Savings and Loan Association, Seattle

A- Skagit State Bank, Burlington

A- Valley Bank, Puyallup