Tuesday, February 2, 2010

Jimmy Stewart Cared, But Why Should You?

I have a confession: I've made it this far in my life without ever seeing It's a Wonderful Life.  I consider this an accomplishment for someone who studied economics.  You cannot imagine how many lecturers reference a single scene of an old film.  All I know is that Jimmy Stewart has the teller window slammed on him at the bank.  He apparently didn't like that.

Most people reading this wouldn't particularly care if their bank failed.  Your deposits fall below FDIC insurance limits, so you won't lose anything.  I know several people who have experienced failure in their primary banking relationships, and they barely noticed.  Most bank failures since FDIC, luckily, have not hurt any depositors.

Bank failures more likely strike blows at companies. Imagine some very large deposits. Microsoft's cash to make payroll on January 31st, for example.  At some point, it must sit in a reasonably small number of places.  Not in $250,000 slices.  Microsoft has no interest in taking risk with their payroll, for even an instant, when someone else, (shareholders of a bank) reap the rewards.  Or, maybe they do break it magically into $250,000 slices.  That has a cost.  Microsoft shouldn't have to bear that cost, or the risk.

So, why should we care about bank failures?  Because FDIC has the backing of the Federal government's ability to tax us.  This promise of insurance protection primarily benefits the shareholders of banks, not the depositors at banks.  As I've probably said before: the existence of insurance changes risk taking behavior, rarely for the better.  As long as FDIC insurance exists, bankers and borrowers reap the benefits more than the taxpaying depositors.

Endless discussions of late examine the Volcker Rule, whatever this rule may be.  As best I can understand, it means something like "bankers cannot engage in any risky activity that does not benefit their clients."  Here's some news:  You, the bank customer who relies on banks to store your cash and service your transaction essentially reap no benefits at all from any risky behavior by banks!

All the political discussion seems to forget banks have two sets of customers.  These two sets of customers have completely conflicting interests.

So, you ask, what do I do?  I separate cash management and risk taking as best I can.  I also maximize my potential value from FDIC, as best I can.  What does that mean?  I have precious little cash in a bank that provides great cash management and transaction processing.  I mean like two weeks worth of cash.  Really.

Then, I hold a liquidity cushion in the riskiest, most likely to blow up bank in the country at any given time.  Check here for the guy at the top of the list.  Why?  Because I don't care, it's not my risk!  I have FDIC protection!  Then, I take lots of risks with my investment portfolio.

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