When I saw bailouts and bail-ins in the mailbag, it piqued my curiosity…
Here what one of you had to say:
I’d love to see you cover the topic of “bail-ins” and how the banks can now bail-in our deposits during any financial crisis, to bail-out, once again the “BANKSTERs!”
What options do we have to safeguard our cash, other than to deposit in a bank?
Sure, own a little gold, bitcoin, etc.…. I don’t want to be bailed-in!
–Mike M.
Well, Mike, you’re correct. The government can bail depositors in. And it may be legal, but I personally think it’s a crime.
But – and it’s a big “but” – there are specific rules as to how a bail-in occurs.
So in this Morning Reckoning, I’m going to talk about the difference between bail-ins and bailouts. Then I’ll explain under what conditions a bail-in can occur. Finally, I’ll give you a couple of ways to make sure that never happens to you.
Let’s get to it.
What are bailouts?
First, let’s go over the easy part and get it out of the way.
A bank bailout is when the government provides financial assistance to a poorly managed bank to prevent its collapse and protect the depositors’ money.
Which depositors? We’ll answer that question further down…
Former U.S. Treasury Secretary Paul O’Neill once said of bankruptcy that it’s the “genius of capitalism.” By speaking that fundamental truth, O’Neill was relieved of his job.
Banks are companies and ought to be allowed to go bankrupt. I was against the bailouts in 2008 and my position has never wavered.
Once poor banks go under, the space is cleared for new banks – or new methods for saving – to spring up.
Sure, would bankruptcy hurt some depositors? Yes. But not those who have less than the maximum deposit insurance level. I’ll talk more about that later.
Now… how does the government execute a bailout?
This can be done by injecting capital into the bank, guaranteeing the bank’s debts or nationalizing the bank. Or, in the case of Bank of America and Merrill Lynch, the Federal Reserve Chairman can force an acquisition.
Bank bailouts are controversial for good reason. They usually involve taxpayers’ money to rescue financial institutions that are too big to fail.
But even worse is that the central bank may print money to cover the losses. From September 2008 to mid-November 2008, the Fed’s balance sheet doubled.
To quell public anger about bailouts, governments came up with a new method to save overextended banks: the bail-in.
What are bail-ins?
A bank bail-in is when a troubled bank’s creditors and depositors with large balances are forced to bear some of the losses instead of taxpayers.
This is done by converting a portion of their debt into equity or by seizing their deposits to recapitalize the bank and restore its financial stability.
A couple of things: creditors (bondholders) take this risk every day. It’s why fixed income traders are so miserable compared to equity traders. Equity traders ask, “How much money am I going to make today?” Fixed income traders ask, “How much am I going to lose today?”
Regarding depositors with large balances, this is the key to the whole conundrum.
It’s critical to remember the Federal Deposit Insurance Corporation (FDIC) in the United States insures your deposits up to $250,000 at each institution.
And that covers:
-Checking accounts
-Negotiable Order of Withdrawal (NOW) accounts
-Savings accounts
-Money market deposit accounts (MMDA)
-Time deposits such as certificates of deposit (CDs)
-Cashier’s checks, money orders, and other official items issued by a bank
What’s more is that each ownership category is covered. That is, if you have two or more accounts in two or more different ownership categories, you’re insured up to $250,000 on each.
Here are the different ownership categories:
-Single Accounts
-Certain Retirement Accounts
-Joint Accounts
-Revocable Trust Accounts
-Irrevocable Trust Accounts
-Employee Benefit Plan Accounts
-Corporation/Partnership/Unincorporated Association Accounts
-Government Accounts
So this begs the question: if the FDIC insures all this, how can you possibly get bailed in?
How can you get trapped in a bail-in?
Let’s say you only have one single account at one bank. You’ve got $300,000 in that single account. Your bank is about to go under, but the government has ordered a bail-in.
In a plain vanilla bail-in scenario, $250,000 of your deposit will be perfectly safe. The $50,000 you’ve got over the deposit insurance limit will be “bailed in.” That means the $50,000 will likely be exchanged for stock in the bank that’s worth nowhere near $50,000.
You’ll probably feel like you’ve lost $50,000, even if you didn’t lose the whole amount.
So how do you make sure this doesn’t happen?
What can you do to avoid getting bailed in?
There is no guaranteed way to avoid a bail-in, but depositors can take steps to reduce their risk:
–Don’t keep one large deposit at a single bank: Keep smaller deposits in multiple banks. That reduces the risk of losing a large amount in case of a bail-in. Also, ask your accountant to help you make sure separate amounts are in different ownership categories if you must, for some reason, stay at one bank.
–Spread your deposits across different banks: Keep amounts less than $250,000 at multiple banks within the U.S. That’s easy.
-Bonus tip: Since I’ve lived in a few countries, I never closed those foreign bank accounts and I use them as cash protection vehicles. If you’re American, keep in mind that you must declare your foreign bank accounts to the IRS (FBAR) with your tax returns if those accounts exceed $10,000 at any point in the year.
–Know the bank’s financial situation: Forgive me for being so obvious… but you definitely want to avoid banks that are in financial distress.
–Consider different investments: The easiest thing in the world to do is to buy US Treasury bills and bonds. They’re liquid cash substitutes the USG guarantees. And thanks to Chairman Pow, you even get a bit of yield nowadays.
Remember, these ideas only reduce the risk of a bail-in, they don’t guarantee that outcome. Ultimately, governments decide and they’re unpredictable.
Wrap Up
Not only do you now know how to reduce your chances of getting bailed in, but you also know why governments invented them.
Think about it. Only people with amounts over $250,000 would be affected by a bank going down.
So yes, your instinct was correct. In 2008, the government only bailed out their rich friends. It didn’t “save the world economy.”
And since the public figured this out pretty quickly, the Europeans invented the bail-in to require those rich folks to participate in the losses.
America later adopted bail-ins as a legal measure which will probably only be used for banks that aren’t too big to fail.
A big thank you to Mike M. for the stimulating question.
I try and read all the emails you all send me… it helps me get down to what really matters to the people I’m writing for.
If you have any feedback or topics you want covered, be sure to click here and drop me a line.
Otherwise, I hope you take measures to protect yourself if you haven’t already.
Once you do, stop worrying about it. There are far bigger fish to fry nowadays.
https://dailyreckoning.com/the-banksters-want-your-money/
