September 24, 2008

FDIC Insurance Myths & Sound Personal Banking Practices

Posted in finance tagged , , at 3:08 pm by mj

The economy is in the crapper. Banks are failing. The “full faith and credit of the United States government” is all people believe in. Which is scary, if you think about it.

Anyway.

Everybody’s concerned about FDIC insurance coverage, and graphs like this (via the WSJ via Paul Kedrosky) are sending people into fits:

From Paul:

The U.S. has a $6.881-trillion on deposit with banks, but only $4.241-trillion is insured. In the case of IndyMac something like $1-billion deposits was uninsured.

It seems this is one of those cases where subtleties are nearly impossible to communicate, because summaries of FDIC regulations are incomplete.

Hence why I’m writing this, hoping to do my part to help spread accurate information and reduce fear in my tiny part of the world.

First, let’s get this out of the way:

NEVER put all your money in a single bank.

The examples below are extreme cases. In addition to the possibility of bank failures or robberies, you also have to deal with compromised account numbers, being held at gun point, and so on.

A rule we like is a minimum three banks, and a minimum of two accounts that require going to the physical bank to access (e.g., CDs).

OK. So the rule everybody hears is “The FDIC insures you up to $100,000.” What they leave out is the multiple “ownership categories.”

The best source of information is the FDIC’s own introduction to FDIC insurance.

To quote:

Deposits maintained in different categories of legal ownership at the same bank can be separately insured. Therefore, it is possible to have deposits of more than $100,000 at one insured bank and still be fully insured.

Read that carefully. Then read the following pages that describe the eight ownership categories.

For example, use the FDIC Deposit Insurance Estimator to calculate your coverage under the following scenario at a single banking institution:

  • Bob & Alice have a joint savings account with $200,000 balance;
  • Bob has a single savings account with $100,000 balance; and
  • Alice has a single savings account with $100,000 balance

The result? Bob and Alice have $400,000 covered under the FDIC program.

How does that work?

Under FDIC rules, a combined savings account is split equally among all owners of the account, each of whom can be covered up to $100,000 in the “joint ownership” category.

And the “join ownership” category is independent from any coverage in the “single ownership” category.

This has other advantages, as well. If Alice were to get held at gun point, she could not, alone, wipe out their savings, because she does not have access to her husband’s money.

Similarly, if Bob were to get hit by a bus, Alice would immediately have access to 1/4 of their savings–even if there were some hold placed on the joint account (say, if Alice were being investigated because her best friend was driving the bus).

Also, if Bob and Alice were to get a divorce, they’d both be able to get by for a while–and amicably–even if there were a dispute about their shared property. And if they love each other now, it only makes sense they’d want to protect their partner in the event that things turn sour.

This is actually less than what’s possible. Add in a couple of IRAs ($250,000 each) and requited “payable-on-death” accounts, and it balloons to $1,100,000. Beyond that, and I believe you’re past typical personal banking needs. (Unfortunately, the EDIE tool doesn’t allow deep linking to the final reports.)

Given this, how is it that so much of the nation’s deposits are not insured? Too many single people? Too many rich idiots? Or are those graphs wrong and simply based on assuming any amount over $100,000 is uninsured?

My take-away is that the FDIC’s rules–which may seem a little troubling (why only $100,000?)–reinforce sound personal banking practices.

But more troubling for me is the possibility that the FDIC may not actually be financially prepared for what’s coming. From this article:

The total amount of losses to be covered is estimated to be as high as $8 billion. According to the FDIC 2007 Annual Report, the FDIC has only $53 billion to cover losses of this nature. If all the banks on the FDIC watch list were to fail, how much would it cost the FDIC? Does the FDIC have estimates calculated for this?

Of course the FDIC has calculated the estimates.

And, as with almost all institutions, they don’t have enough money.

So of course if all the banks on the list failed, they’d be in trouble, and so would we all.

But Bob and Alice have each other.

And they have their gold bullion investments.

And that secret stash of diamonds buried in their basement.

And that’s all that matters when all the world economies fail. Love. And diamonds.

What’s that you say? They should have buried gasoline instead? Dang. I guess they’ll just suffer, then. Poor Bob and Alice.