Never Mind the Fiscal Cliff
“Investors Now Fear Fiscal Cliff More Than Weak Economy,” read a headline on USAToday this week.
According to the article, even though stocks are getting pumped up to their highest level in nearly five years… surveys conducted by people who care about this kind of thing say investors fear the “potential growth-crimping one-two punch of rising taxes and government spending cuts set to kick in Jan. 1” will impact their portfolios more than the lack of new jobs being created in the economy.
Next week, they’ll probably be hyped up about Iran again or something.
The good thing about being a cynic is you don’t get caught up in these fuzzy-thinking debates. We even had to look up the term “fiscal cliff” to find out its DNA. It’s a term Democrats apparently wield to scare voters into thinking they’d be better off with higher taxes.
Today, we open with a look at a story that could have much more far-reaching implications for your wallet and your portfolio than the “fiscal cliff” might ever have.
“You probably don’t realize this,” our Laissez Faire editor Doug French writes, “but your finances are standing behind more than a trillion dollars of the bank deposits of large corporations and municipalities housed at America’s largest banks.
“It all began in 2008,” Mr. French goes on, “as it usually does.
“During the crash, the FDIC instituted the TAG (Transaction Account Guarantee) program. TAG provides unlimited coverage for noninterest-bearing transaction accounts. These are typically checking and payroll accounts for corporations and government entities and possibly large personal accounts.
“Taxpayers are backing the equivalent of the federal deficit in TAG deposits alone,” Doug explains. “The vast majority of these deposits are held by the top five banks.”
“With the Fed stomping down interest rates to zero, banks are paying but a few basis points in interest-bearing accounts,” Mr. French writes. “Depositors are permitted to forgo that puny bit of interest in exchange for complete FDIC insurance protection. That’s a trade-off worth embracing.
“How has this changed the money market?” Doug asks, letting Jim Grant explain: “Zero-percent interest rates and blanket FDIC guarantees of bank deposits reconfigured what used to be a market in short-dated IOUs of the private sector,” writes Grant in his latest Grant’s Interest Rate Observer. “Today’s money market is increasingly a market of short-dated IOUs of the public sector.”
“Corporate cash, then,” Doug writes, “has been redirected from productive uses in the private economy toward lying fallow in large bank balance sheets.”
“When a given claim yields nothing,” Grant continues, “the prudent investor will roll Treasury bills or — functionally the same thing — lay up deposits at a too-big-to-fail bank.”
According to American Banker, the percentage of corporate cash in bank accounts in May stood at 51%. Comparing that to 42% last year, and 23% in 2006, we think something might be brewing here…
“According to the FDIC,” Doug continues, “noninterest-bearing deposits for the top five banks have swelled by over 100% since 2008, when the FDIC put TAG in place. You can get an idea of the shift by looking at the demand deposits at commercial banks generally.
“This is a direct result of Ben Bernanke’s policy of zero interest plus the FDIC/congressional policy of unlimited deposit guarantees,” Doug points out. “Corporations are trading interest for safety, or at least the illusion of safety.”
The big picture: The FDIC Deposit Insurance Fund (DIF) is now $22.7 billion, but it represents only a tiny fraction of the $7.1 trillion in total deposits it backstops. Heh. The Problem Bank List website sums it up thus. The DIF:
“is equivalent to trying to protect yourself with an umbrella in the middle of a Category 3 hurricane. The collapse of one of the ‘too big to fail’ banks would immediately require the FDIC to seek financial assistance from the U.S. Treasury. During the height of the financial crisis, the FDIC was granted a line of credit with the U.S. Treasury for up to $500 billion.”
“TAG,” Doug explains, “the umbrella in the metaphor, is scheduled to expire at the end of this year. Like so many other government intrusions, it was a temporary fix.
“Two years later and bankers are addicted and don’t want to give it up.”
“The Fed’s zero interest rate policy already has banks under margin pressure,” Doug continues. “A flood of funding encouraged by the FDIC’s emergency TAG insurance for noninterest-bearing deposits causes bank managements to take on even more risk for more yield. That turns into something all-too-familiar: zombie banks doing stupid things.
“Are the politicians worried? Nope. TAG has plenty of supporters on Capitol Hill.
“Far from supporting economic growth, as supporters of TAG suggest, the FDIC insurance for TAG-eligible deposits actually spurs unsafe and unsound banking practices. In the case of JPM, the result of the nearly 10% increase in total assets caused by the ‘flight to quality’ encouraged by TAG was a significant increase in risk taking.
“Banking lobbyists may cry for an extension of the TAG program to stimulate economic growth or jobs. In reality, TAG is simply another act of government intervention to benefit the big banks at the expense of small banks and customers.”
On Jan. 1, 1934, deposit insurance went nationwide with deposits up to $2,500 covered (roughly $41,000 today). “Now,” Mr. French writes, “not quite 80 years later, U.S. deposit insurance coverage has gone from an inflation-adjusted $41,000 to unlimited.
“What backs up this whole system? Not capital. Not wealth. It’s just paper, paper printed by government. With unlimited deposit insurance, that financial nuclear explosion can happen any minute,” Doug concludes. “And you will be left to pick up the pieces.”
Ah, yes. At least the bailouts were successful.