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Banking Failure 2.0 & Understanding FDIC Insurance
About a month ago we talked about the failure of Silicon Valley Bank as well as Signature Bank. Today, we will talk about another. First Republic was closed by the FDIC over the weekend. This banking failure is larger than the other two we spoke about and actually marks the second largest banking failure in history, but the good news is that it had a buyer. JP Morgan Chase has purchased all the deposits and most of the assets, so not a lot changed for most of the customers of the bank who came in on Monday morning. So why did this one fail? Like the other two we spoke about, First Republic had a run on its deposits – losing half of its deposits in a matter of a few days. According to the Wall Street Journal, 68% of its deposits were over the FDIC insured limit. That made those dollars vulnerable to movement when trouble started with some of its bank peers. First Republic’s strategy of catering to the wealthy came back to bite them as the wealthy began transferring those deposits elsewhere. Additionally, the bank had a large number of low yielding mortgages on its books at less than 3%. Doing some simple math, if you are earning 3% on your assets, but paying 4% on CD’s, you are losing money on those assets. If there are enough of those assets on the books, staying open is just not sustainable. In some ways, that scenario was a replay of the events that happened in the early 1980’s. Many banks did not have enough income coming in from their loans to cover the interest they were having to pay on their deposits, and many failed as a result. In light of that historical precedent, I still say this won’t be the last banking failure. When interest rates move at their fastest clip in 40 years, there are going to be side effects not just in the banking industry but in every industry. Now the banking industry as a whole is very sound, really as sound as it has ever been. There is more capital and the credit underwriting has been more conservative, but there will be certain players that will struggle because of decisions made in recent years.
Along those lines, a report came out from Vice-Chair of Supervision at the Fed, Michael Barr, on the failures of Silicon Valley and Signature Bank. In this report he identified a lack of awareness in risk management by the board and management. He also criticized the Fed in its supervisory approach as the bank grew in size and complexity stating that the Fed did not respond with appropriate supervision. There are sure to be regulatory changes for banks with over 100 billion in assets as a result.
How should this affect you? As a reminder, I shared some tips in one of our March podcast episodes to utilize various account type combinations to get your FDIC insured limit as high as you can. You can take your existing accounts and restructure them so that you are insured for more than $250,000. I’ll expand on that a bit here. FDIC insurance is not determined per person or per social security number but by category. There are 4 major categories when considering FDIC insurance coverage: individual accounts, joint accounts, IRA’s, and revocable trust accounts or POD accounts. You can be insured up to $250,000 in each of these account types and maybe more if you structure it appropriately. Let’s take a look at an example.
Let’s say Michael Jordan is married and has 4 kids and is trying to get as much FDIC insured in his local bank as possible. Michael and his wife could have individual accounts with up to $250,000 each. That’s $500,000 in coverage. Michael and his wife could then have a joint account with $500,000 in it or $250,000 of coverage each. That gets this couple up to $1,000,000 in fully insured deposits. We can keep going. Michael and his wife could also have an IRA with $250,000 each. That gets us up to $1.5 million using three different account categories. Lastly, Michael could create a POD, or Payable on Death, Account (which is a type of Revocable Trust, sometimes referred to as a Totten Trust). In this POD account, Michael could list his wife and each of the four kids as equal beneficiaries payable on his death at 20% each. Each beneficiary in a Revocable Trust account has $250,000 in coverage up to 5 beneficiaries, so that’s another $1,250,000 in available coverage. So we’ve taken a husband and wife with four kids and structured their accounts to include $2.75 million worth of FDIC coverage. Talk to your banker about the options you might have for your family. A little bit of thought of preparation can help you sleep a little bit better at night and still keep your funds at a single bank.
A second tip I shared in that March Podcast was to know your banker well. What kinds of risks is that bank taking? What is their philosophy on liquidity? What are their long-terms plans? These are all good questions and fair questions to ask your banker. In an age where we often do business with faceless entities, knowing the people on the other side of the transaction – particularly when it comes to banking – could be more and more important in the days ahead.
Moving on to the Fed, will they increase rates for the final time on Wednesday May 3rd? My best guess is that yes they will raise rates, but no, it is not the last time. I think a pause is likely – but the Fed may not be done if inflation does not settle down to their 2% target. Has inflation settled down a little bit? Absolutely. But costs are still rising in many categories in the 4% to 5% range. This is much higher than the Fed’s target of 2%. The Fed Funds Future’s market is actually forecasting rate cuts before the end of the year. That’s right, I said rate cuts – that the Fed will actually reduce rates in the back half of 2023. I don’t think this will happen unless there is a severe recession. Severe recessions can cause demand to collapse to such an extent that pricing power goes away and so does inflation. Although I think a recession is coming this year, my best guess is that it will be a moderate recession and not a severe one. If inflation remains elevated, the Fed may actually find itself raising interest rates again at the end of the year instead of cutting them like the market anticipates. And that could be happening perhaps in the face of a moderate recession. That would put them between a rock and a hard place, because they may be raising rates in the face of people hurting in the midst of a recession.
What may determine whether we face recession or not may have more to do with the money supply than anything. I have very much appreciated the work of Brian Wesbury, chief economist at First Trust. He is a disciple of Milton Friedman and has advocated that the money supply affects inflation more than anything. He calculates that the M2 supply of money, which includes all the money in currency, banks, and money market funds, grew by 40% during the first 2 years of Covid. That is massive! He also states that if we can trust the government’s numbers on M2 that the money supply is down 4.1% in the last eight months. That may not sound like much, but according to Wesbury, we’ve not seen that much contraction in the money supply since the Great Depression. He contends that recession is almost inevitable as a result.
We’ve been talking about preparing for recession on this podcast for months. What is the most significant thing you can do to prepare? Raise your reserves. Businesses are often not able to avoid recessions. You may see a contraction in your profits. You may even see losses that may be unavoidable, but you can be prepared to survive them. You can raise reserves in two ways – pay down debt or keep more money in your bank accounts. Reserves act as fuel to keep the business going if earnings dry up. Earnings are the lifeblood of a business, and if they dry up those reserves act as a blood infusion to the business. Think of the Joseph principle in the Bible. Joseph in the book of Genesis knew that famine was coming, so he stored up grain during the 7 years of plenty to get ready for 7 years of famine. And as it turned out, he was selling grain to the entire world because he prepared in advance. I don’t want you to think 7 years of famine are coming, but there are storm clouds on the horizon, so it would be wise to make sure your shelter is secure enough to withstand the downpour.
As a preview for our next podcast, we’re going to talk about Fed Now. This is an instant payment network that I have gotten several questions about what it is and how it works, so you can look forward to us unpacking that together in our next episode.
Did you know that MBC and Foundation Bank are locally owned and operated right here in West TN? We’re not a flashy bank, but we are a steady bank. We’ve been in business for almost 90 years, and although lots of things have changed, one thing we think hasn’t changed is the importance of relationships when it comes to finances. Start your conversation with us today by visiting your local branch or exploring our website to start your financial conversation and to learn more. If you’ve found this podcast helpful, we hope you’ll subscribe to it in your favorite podcast app and share it on social media. And until our next episode, God bless you.
-President Chad P. Wilson, CFP
Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on May 2, 2023. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.