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In Part III of my Synthetic Financial Disasters series, I’m going to focus on the implicit trust we all seem to have in our financial institutions and whether that trust is truly warranted and what potential disasters loom in our near future.

Over the past few years I’ve frequently opened bank accounts (checking, savings, Certificate of Deposits, Money Markets, etc) and I’ve always made sure to select banks that had decent rating from Bankrate.com and were FDIC insured. But I’ve recently begun in investigate what exactly it is that I’m getting with “FDIC insurance.”

What is FDIC?

FDIC is a government agency charged with making sure banks don’t go insolvent. FDIC does this by requiring banks to maintain certain level of cash reserves for their depositors. The rules generally breakdown something like this:

“In order to receive this benefit member banks must follow certain liquidity and reserve requirements. Banks are classified in 5 groups according to their risk-based capital ratio:
• Well capitalized: 10% or higher
• Adequately capitalized: 8% or higher
• Undercapitalized: less than 8%
• Significantly undercapitalized: less than 6%
• Critically undercapitalized: less than 2%
When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent.”


 Now the critical component here is “when the number drops below 6% the FDIC can change management….take other corrective action.” The obvious questions to ask: What happens when MANY banks can’t meet this capitalization requirement? Does the FDIC take over EVERY bank? What exactly is corrective action?

Prior to 1980, FDIC only insured deposits up to $40,000 and in 1980; the limit was raised to $100,000 USD per depositor. Oddly enough, the insured amount hasn’t been raised since 1980 despite high growth of inflation of the past 26 years. In today’s inflation adjusted dollars (3% over the past 26 years on average), FDIC insurance should cover $217,935. No interest has been expressed in raising the limits. Why? Does the government expect people to be able to live off of $100,000 for the rest of their lives during a time of financial crisis?

FDIC was created to quell concerns about the stability of banks arisen after the 1933 Great Depression. Bank solvency issues arose again during the Savings & Loan crisis in 1980s where over 1000 institutions failed. The cost was about 150 billion to the US government.

We now appear to be headed into a “perfect storm” of bank failures. The US real estate market has been financed with risky ARM loans, consumers are up to their eyeballs in credit card debt and the American savings rate is now in negative territory. To make a bad situation worse, banks have instituted smaller and smaller fractional reserve requirements so they don’t actually hold on to their depositors money; they simply lend it out again as credit card debt, home equity lines, etc. It is also mind boggling that most of the wealth/debt in this country is nothing more than entries on a computer screen. There is approximately 500 billion USD in printed currency floating around the world but there is outstanding debt in the trillions of dollars!

The SIPC is in a similar situation but it concerns itself with brokerage account deposits.

“Though created by the Securities Investor Protection Act (15 U.S.C. §78aaa et seq., as amended), SIPC is neither a government agency nor a regulatory authority. It is a nonprofit, membership corporation, funded by its member securities broker-dealers.”
“ ‘Insurance’ for investment fraud does not exist in the U.S. The Federal Trade Commission, Federal Bureau of Investigation, state securities regulators and other experts have estimated that investment fraud in the U.S. ranges from $10-$40 billion a year.
With a reserve of slightly more than $1 billion, SIPC could not keep its doors open for long if its purpose was to compensate all victims in the event of loss due to investment fraud.”

“What is SIPC?” Did you read that last statement “With a reserve of slightly more than 1 billion?” SIPC has one measly billion dollars? One billion dollars / 300 million people = $3.33 per person. This is so ridiculous it’s hilariously funny. And note that this doesn’t cover “fraud” so if someone hijacks your brokerage account it’s gone!

How do you prepare for FDIC and SIPC failures?

I do not know other than converting your “digital/virtual/ethereal” money in your bank and brokerage into tangible assets such as jewelry, gold, diamonds, real estate that can generate income (commercial, rental, and investment property) or other tangible assets or perhaps your own small business.