By Dr. Jim Dahle, WCI Founder
Here's a question.
“I was shocked to see bank runs in March 2023. I thought those went away after regulatory changes [from] the Great Depression. What takeaway should there be from the troubles that Silicon Valley Bank (SVB) and other banks had during March 2023?”
In March 2023, depositors of SVB engaged in a classic “bank run” that resulted in the Federal Deposit Insurance Corporation (FDIC) stepping in and putting the bank into receivership. There were a number of factors that made SVB particularly susceptible to this problem, but all banks are susceptible to a bank run. The reason is because the money you lend to a bank does not stay at the bank. The bank lends it out to others. Our banking system is also a “fractional banking” system, meaning that the bank can and does lend out even more money than it receives in deposits.
This all works just fine—unless all the depositors want all their money back at once. Obviously, the more a bank lends out, the more money it can make in the good times, but the higher risk of a bank run. Regulations have been put in place over the years that limit how much a bank can lend out and what kinds of assets and how much of them it must keep to pay the demands of depositors.
In the case of SVB and many other banks, the assets the bank holds are relatively safe Treasury bonds (Treasuries). However, while Treasuries are guaranteed by the US government, a holder of a Treasury must hold it until maturity to be guaranteed to receive their entire principal back. If they sell it prior to maturity, it will be sold for a gain if interest rates have fallen and for a loss if interest rates have risen. Since interest rates went up dramatically in 2022, Treasuries that must be sold early, especially long-term Treasuries, will be sold at a severe loss. This made it even more difficult for SVB to raise funds to meet depositor demands during a bank run.
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Lessons Learned from SVB
There are a number of lessons to learn from this situation. The first is to avoid buying long-term assets with short-term debt. Since they can be called at any time, bank deposits are the ultimate in short-term debt. A bank has to do this to a certain extent, of course, but in your personal life, it should be avoided. Homeowners doing this en masse with adjustable-rate mortgages contributed to the Financial Crisis of 2008. If SVB had not “reached for yield” by buying long-term Treasuries and had stuck with short-term Treasuries instead, it would not have been in such a mess.
The second lesson is to understand and take advantage of FDIC (and National Credit Union Administration (NCUA), the credit union equivalent) limits. Essentially, the federal government insures bank deposits up to $250,000 per depositor per bank. If you have more than $250,000 in cash, it would be wise to split it up between different banks so it is all insured. While this is not always possible, it is generally a good practice.
The third lesson is that the government will often do more than it is required to do. The FDIC was only required to back up $250,000 of depositor money, but it essentially stepped in and insured all SVB deposits to prevent systemic risk to the financial system. While concerned about the moral hazard of “bailing out” businesses, the government felt that letting the bank—and its investors—fail without hurting depositors was the proper place to draw the line in these circumstances.
The government has done similarly unexpected things in the past, such as the recent student loan holiday that has lasted more than three years. While you cannot count on these sorts of interventions, you can take advantage of them when they do occur. This particular action should make you a little more comfortable to keep more than FDIC limits in a single bank. It would not be surprising to see future Congressional bills and regulatory action directed at raising FDIC limits, either with or without requiring an insurance premium to be paid by the depositor.
The fourth lesson is that even successful businesses need backup banking plans. The problem with the SVB crisis that required the government to step in was that it was about to affect the lives of everyday people. Their employers banking at SVB were profitable businesses with plenty of cash. However, through no fault of their own, they could not access that cash to make payroll, and they were facing a possible loss of that cash. If they had some of their money elsewhere, even at a second bank, this would not have been nearly as much of a problem.
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Cautious with Cash
The fifth lesson is that banks are not great places for you to invest large amounts of cash. While there have been times in the last few years when a high-yield savings account paid more than money market funds, that is no longer the case. As of this writing (in May 2023), the best money market funds are paying over 4.8% while many high-yield savings accounts are only paying around 4.2% and the average savings account yield is closer to 0.35%.
If you have a need to hold large amounts of cash for any length of time longer than a few days, you are far better off linking your bank account to a high-quality money market fund at one of the big mutual fund companies and moving money back and forth as needed. Not only will you earn a higher yield, but there is no risk of a bank run on a money market fund (money market funds do not engage in fractional banking).
Banking is an important part of all our financial lives. However, just like our currency, the fractional banking system requires a certain amount of trust. When that trust is eroded, severe economic disruption can occur for society as a whole. To minimize risk, be careful how you and your businesses interact with that banking system.
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How much does the FDIC limit influence where you put your money or whether you split it up between different banks? Has the SVB meltdown made you rethink your plans? Are there other reasons to be wary of putting too much money in banks? Comment below!
[Editor's Note: This article was originally published at ACEPNow.]
I’m not sure about your claim at the end “but there is no risk of a bank run on a money market fund”. I seem to remember reading that that was a big issue in the 2008 financial crisis. MMFs aren’t FDIC insured. I’d rather get 4.2% or whatever on my Ally savings account that’s FDIC insured than 4.8% uninsured in an MMF.
The issue in 2008 was that MMFs might have had to “break the dollar” and investors would only get 98 or 99 cents on the dollar. That’s a far cry from a bank run where you lose everything.
That’s your right to take 4.2% insured over 4.8% uninsured, but I certainly think 0.6% is more than adequate compensation for that tiny risk given the structure of a MMF. I’d feel differently about an amount over the FDIC limit at a bank.
A few questions…. What are the tax consequences of moving back and forth from a money market fund? Will this generate a 1099-INT statement at year end similar to a HYSA? Would you recommend a Municipal Bond Fund for parking money short term instead of a MMF or HYSA?
None. It’s no big deal. Yes, you get some sort of statement. At Vanguard it’s a 1099-DIV, but just for being in it, not for moving around.
No, bonds aren’t for short term money.
Can you please give examples of high-quality money market fund at one of the big mutual fund companies
Vanguard Federal Money Market Fund.
Many people (myself included at one point) don’t realize that this FDIC limit of $250K insurance per depositor, means that a joint account is insured to $500K. I suggest calling that out explicitly.
Great suggestion. Done elsewhere of course in a 12 year old post: https://www.whitecoatinvestor.com/maximizing-fdic-insurance/
FDIC limits can often be extended beyond $500K if the account(s) are set up properly. There are some limits and there will be changes April 1,2024. (edie.fdic.gov) There is also NCUA (MyCreditUnion.gov/estimator), SIPC and DIF Banks that can protect above the $250K limits.
Now lots of banks and bank like options are offering an option where they send out your money to 6 or 8 banks every night so you get $250K at each bank.
You’ve got me on my back heels, Dahle. But the pain is coming – reversal very soon. Then we test new, new lows.
The SVB run was planned and the Fed is there to bail them out, that’s the point of a central bank. Showing us that they still just pick winners and losers, according to … oh yeah, politics. Crypto in this case, lol
The lesson that was very clear to me from SVB (or First Republic or Signature Bank) meltdown was that henceforth, no National bank will be allowed to dissolve and lose depositors funds irrespective of the deposit amount. The Fed will swoop in, justify the need to make exceptions and clean up the mess. The 2008 PTSD is a never-again event.
So, one can keep $1 million in any of the 30 or 40 National banks (assets over 100 billion) and there is a 100% certainty that the entirety of the deposit will be covered by the Fed. It is evident that if the Fed lets JP Morgan, Wells Fargo, Citi or PNC or alike disappear, the Fed is also done. The US market = The National banks.
However, if you are banking with a Regional bank (small asset bank), stick with the $250K rule as no one will be coming in to rescue you. These outfits die off unceremoniously not infrequently.