Bank failures and deposit insurance

If you think your local deposit insurance scheme like the FDIC will protect you, you’re not ready for the next bank failure. And there are oh-so many reasons why the next bank failure is coming.

Dateline: Langkawi, Malaysia

I remember being ten years old when we got our first Internet connection. It was Prodigy, a dial-up service that – much like AOL – promised access to a lot of proprietary content.

As you may recall, companies like Prodigy ran their own news services, movie listings, and everything else. Access to the wide open world wide web was something that was almost considered high risk for the average American.

However, it didn’t take long for that world wide web to blossom, and an entire round of entrepreneurs to look at ways to use the internet to market their products.

I ran a few small business websites back then, and I remember advertising for a product called NextCard.

The idea behind NextCard was simple: some genius who was CFO of a big credit card issuer quit to offer his own credit card line, available exclusively online. They were the first bank to offer instant online approvals.

He and his wife figured that they could undercut established competitors by not sending out those old mail offers that used to clog up everyone’s mailbox.

They also assumed that internet consumers would be far better credit risks because, back in the day, internet users were a far more sparse demographic and tended to be rather affluent.

Of course, it is such assumptions that often lead to people and companies being wiped out, and that is exactly what happened with NextCard.

It only took a few years for the company, which was among the largest purchaser of high-priced banner ads all over the internet, to go under and leave behind a huge mess.

Turns out that affluent internet users didn’t really need another credit card from some upstart bank, but plenty of at-work internet users in dire straights were happy to get a NextCard as their last resort.

The fact that NextCard charged single-digit interest rates in an era when savings accounts actually offered a decent return is another story.

After the company went bust, the deposit insurance guys at the FDIC stepped in to clean up the mess.

When the FDIC takes over a bank, they try to sell off whatever assets they can. In some cases, they’ll easily find another bank to take over customer deposits and act as if the original bank failure never happened.

On the other hand, there are plenty of times when that doesn’t happen and the FDIC is left to pick up the pieces.

NextCard as one of those. A small amount of the company’s accounts were purchased on the cheap by a vulture outfit, while the rest were simply shuttered at a cost to the FDIC of $450 million.

It is just one of hundreds of reminders that your best due diligence to protect yourself from bank failures is not deposit insurance or the FDIC (or whatever your local deposit protection scheme is), but finding the right bank.

Here at Nomad Capitalist, we talk about stronger, more stable offshore banks around the world in places like Hong Kong, Singapore, and even Switzerland.

Just one look at a list of the safest banks in the world and US banks barely make the list. Ditto for the UK.

Meanwhile, banks in Canada, Australia, Singapore, and even France repeatedly receive high marks.

The FDIC or any deposit insurance plan rely on only a handful of banks going under at one time in order to pay out.

It’s a simple equation: like any insurance policy, deposit insurance is based on the idea that a total economic catastrophe could NEVER happen, so it’s perfectly safe to keep a small amount of money on hand to cover any potential bank failures.

In the United States, that number currently stands at one penny for every $3 in deposits.

Last year, the FDIC crowed that “insured depositors are safe and their deposits are protected by a strong FDIC fund”.

What caused them to make such a proclamation?

All of $25 billion in the kitty.

The US government is up to its usual deceptive tricks when it comes to just how safe your bank deposits are. $25 billion may sound like a lot to the average US person, but it’s a drop in the bucket.

To put things in perspective, Bank of America is the only bank with more than $1 trillion in deposits and a nearly one-eighth share of the US banking market. Put the top ten US banks together and their deposits total nearly $4.7 TRILLION combined.

That’s entirely HALF of the money on deposit in US banks.

One wrong move on the part of any one of those top ten banks and mass chaos would erupt. It would be like trying to run into an explosion at a chemical factory with a cheap fire extinguisher you grabbed at Home Depot.

When you consider that those same banks have hundreds of trillions of dollars in derivatives liabilities on their books, the entire situations looks even worse.

You might as well get dropped into Iraq with a water pistol before you try and patch up just one large bank failure with the FDIC’s help.

As recently as a few years ago, the FDIC was basically declared broke. Bankrupt. Insolvent.

It doesn’t help that, years after the economic collapse and the US propaganda machine declared banks to be safe once again, fourteen banks in the United States have failed this year alone. The FDIC will tell you that themselves.

(For comparison, Singapore has never had a bank failure. Austria hasn’t had one since World War II.)

But those bank failures are childs’ play compared to the exposure the big banks have. And, just like NextCard back in the 1990s, the biggest banks are making some highly speculative bets.

For example, after the financial bubble burst and the banks had to be bailed out, everyone swore off NINJA loans and other real estate lending for those with bad credit. They learned their lesson, they claimed… at least until they started bringing back no down payment and no credit check loans just a few years later.

However, one asset class banks couldn’t wait to get their hands on was the subprime auto loan category.

Heck, if subprime borrowers can’t pay their mortgage, why not loan them money to buy a beat up car?

Banks made some wild assumption that a bunch of deadbeats would NEVER default on their car loans. I can imagine some overpaid bankers standing in a conference room pitching the merits of handing out car money to serial delinquents like candy.

Oh, the money to be made.

Now, the subprime auto loan bubble is among the latest to reach ready-to-burst status and car repossessions are up 70% as US car owners are having trouble making monthly payments.

No one at the government is saying anything, because it is such subprime lending that allowed the US auto industry to make its much ballyhooed come back a few years back.

This is all part of the unholy alliance we talk about here: the government needs skewed data to convince everyone that the economy is back on track so all of the crooked politicians can stay in power and continue their looting unabated.

Meanwhile, corporate America needs a boost from government in the form of bail-outs and other wealth grabs to even keep the lights on.

I hope you’re noticing a trend here: any alleged economic growth in the United States and much of western Europe is merely thanks to distorted economic factors that produce short-term results, not solid long-term gains.

The government and big business can only run their shell game for so long.

And that brings us back to the banks. It’s only a matter of time before one of the fault lines in the undercapitalized US banking system causes a massive disaster.

You can’t have a bunch of ill-informed greedy banks taking a flyer on every hair-brained idea that comes down the pike without eventually having a massive financial disaster.

Any of us reading this could have predicted that making subprime auto loans would be just the latest ill-advised boondoggle US banks would get themselves into.

Heck, when I was seeking out investments to park some of my radio money in several years ago, I looked into the idea of “buy here, pay here” car lots. After all, who wouldn’t love to make 30% interest on a secured asset?

It turns out, a lot of smart people, including some guys in the business. It didn’t me long to hear all of the sob stories from real operators getting burned by their customers. If only the world’s largest banks with trillions of dollars of YOUR money on deposit would have stepped onto an actual car lot, they too could have avoided wasting a lot of money.

But the banks that have your money don’t have to worry because they pay hush money to the guys at the FDIC to tell their customers that they are “protected” by a deposit insurance fund that is worse than a kid’s piggy bank with a nickel rattling around in the bottom.

Banks that have made similarly poor decisions have caused big problems before. You’re already well aware of what happened in Cyprus, where depositors lost millions in many cases, but you may also remember the US savings and loan debacle that saw the industry’s entire “deposit insurance” scheme wiped out.

Of course, you could argue that depositors of failed banks might be made whole by the government, but the trend is frightening in that regard. Bail-ins, where depositors bail-out the bank rather than the government, are already in place in a number of western countries.

If things go bad, the politicians will be running for cover and sticking you with the bill.

Western governments can’t turn the dial on the printing presses any higher to pump out the kind of money a real bank failure would cost.

Of course, it only takes one.

That micro-finance bank in Cambodia that lends $100 at a time to rice farmers secured by land looks pretty good by comparison. At least they pay 10%.

Andrew Henderson

Andrew Henderson

Andrew has been internationalizing since 2008, and has learned what works and what doesn't work when it comes to reducing taxes, increasing personal freedom, and creating wealth. Click here to work with him personally.
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