(The roles of the CEO and CFO: a collaborative opportunity)
Yesterday, Treasury Secretary Janet Yellen said that the Federal Deposit Insurance Corporation (FDIC) was not considering providing “blanket insurance” for banking deposits. The comments were made at a hearing of a Senate appropriations subcommittee, where lawmakers posed questions about the administration’s efforts to protect depositors and prevent bank runs. In a period of market nervousness, this sort of commentary is not reassuring, to say the least, yet it has legislative precedent. In this blog I will provide some historical context, and conclude presenting a solution how to manage the risk that your bank will fail, your deposits will not be readily accessible, and you will become a general unsecured creditor of the failed bank.
For purposes of the analysis, I looked back to the 2008 financial crisis. The crisis led to the collapse of several large banks and financial institutions such as Lehman Brothers, Bear Stearns, and Washington Mutual, which resulted in significant losses for investors and indeed, to uninsured depositors (for example, for depositors of IndyMac, the most expensive bank failure in the FDIC history). According to the FDIC, over 500 banks failed between 2008 and 2012. Washington Mutual (WaMu) collapsed in 2008. At the time of its failure, WaMu was the largest savings and loan association in the United States with over $300 billion in assets (https://www.fdic.gov/bank/historical/bank/bfb2008.html). Its collapse was caused by a combination of factors, including bad mortgage loans and the broader financial crisis that was unfolding at the time. When WaMu was seized by the federal government in September 2008, its deposits were sold to JPMorgan Chase. However, not all deposits were fully covered by the FDIC, which insures deposits up to a certain amount (currently $250,000). Nevertheless, JPMorgan Chase honored all WaMu accounts and continued to provide banking services for its customers. Prior to 2008, the previous “bailout” was Continental Illinois (1984) when the FDIC stepped in and covered not just the insured and uninsured depositors, but also some other creditors.
Two weeks ago, we watched in shock the bank run and collapse of Silicon Valley Bank (SVB), the second biggest bank to ever fail, after WaMu. At SVB, companies and individuals held significant amounts (in some cases hundreds of millions of dollars) in checking accounts. Importantly, SVB was rated investment grade by S&P and Moody’s and was considered the darling of Silicon Valley and where the “smart money” banked. Within a couple of days, the FDIC stepped in and announced ALL deposits will be protected. Why, you would ask? Well, according to Janet Yellen, it was a specific case, where the agency deemed it necessary due to the inherent contagion risk. That is, the FDIC invoked what is known as “The Systemic Risk” exception to cover ALL deposits. What Yellen was referring to dates back to 1991 when the FDIC became insolvent for the first time in its history. As a result, Congress passed the FDICIA Improvement Act, mandating the FDIC’s Deposit Insurance Fund maintains a set percentage of the amounts it insures. The legislation also included taking away the discretion the FDIC had to protect uninsured depositors. That being said, the “Least Cost Test” was added. It was to address the possibility that there may be cases, for example when another bank acquires the failed bank, that protecting small amounts of uninsured depositors would end up being less costly to the Fund than the alternative. Similarly, the FDICIA included the provision referred to as “the Systemic Risk Exception.” The first time this exception was used was 17 years later, in 2008, when certain banks were deemed too big to fail. In fact, things were so dire in 2008 that a “Temporary Liquidity Guarantee Program” was put in place where the FDIC, for the first time ever, agreed to guarantee not just the uninsured non-interest-bearing accounts, but also debt (bonds) banks have issued to the marketplace.
The collaborative roles of the CEO and CFO is to ensure that the financial health of the company is maintained and that the company’s assets are protected. One important aspect of this is the management of the company’s deposits, which are typically held in commercial banks. Depositors experience with past bank failures and statements made by the FDIC make it clear that it would be a mistake to assume that the FDIC will cover deposits in excess of the stated $250,000 limit in the case of future bank failures (note, the limit is per depositor, not per account).
One way that CFOs can protect their company’s deposits is by diversifying their banking relationships. This means spreading deposits across multiple banks, rather than holding all of the company’s deposits in a single one. Clearly far from an ideal solution, and in many cases not at all practical, assuming your company (or you personally) maintain large levels of cash at any given point in time. Even if you have a borrowing relationship with your bank that requires your company to maintain all your cash reserves with that bank, as a condition of the loan there is an alternative. In fact, one that has no upper limit: Short-term Government Obligations.
Short-term US Government obligations are sold through Treasury bills (T-bills). T-bills are short-term debt securities issued by the US government, with maturities ranging from a few days to one year. They are considered to be one of the safest investments available, as they are backed by the full faith and credit of the US government. And, they earn interest!To invest in T-bills, you can purchase them directly from the US Treasury through their online portal, TreasuryDirect. You can also purchase T-bills through a broker or a bank. When purchasing T-bills, you can choose the maturity date that best suits your investment needs, with options ranging from a few days to 52 weeks. Another option for investing in short-term US Treasuries is through exchange-traded funds (ETFs) that track short-term Treasury bonds. These funds invest in a portfolio of short-term Treasury bonds and offer investors exposure to the Treasury market. Some popular options include the iShares Short Treasury Bond ETF (SHV) and the Vanguard Short-Term Treasury ETF (VGSH) and for longer-term considerations, Treasury Inflation-Protected Securities (TIPS).
It’s important to note that while short-term US Treasuries are generally considered to be safe investments, they do come with some risks. For example, the value of T-bills and Treasury bond ETFs can fluctuate based on changes in interest rates and the overall economic environment. The shorter the duration of the bill, the less the risk of fluctuation. Moreover, the valuation risk is effectively mitigated if the securities are held to maturity.
About Joe Alouf
Joe is a turnaround and restructuring expert. He typically serves as an interim CFO or special advisor to companies going through transformation. Earlier in his career, Joe specialized in advising banks that were in distress and taken over by the FDIC.