You probably don’t realize this, 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, 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. 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. 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? “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 Jim 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, has been redirected from productive uses in the private economy toward lying fallow in large bank balance sheets. “When a given claim yields nothing,” writes Grant, “the prudent investor will roll Treasury bills or — functionally the same thing — lay up deposits at a too-big-to-fail bank.”
American Banker confirms this shift:
“The percentage of corporate cash held in banks accounts stood at 51% in May, marking the highest level since the survey started seven years ago. This year’s percentage compares with 42% a year earlier and 23% in 2006. Seventy-seven percent of the companies surveyed value security the most, compared with just 2% that are insisting on yield.”
According to the FDIC, 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. Corporations are trading interest for safety, or at least the illusion of safety.
The big picture is that the FDIC Deposit Insurance Fund (DIF) is now $22.7 billion, but it only represents a tiny fraction (30 basis points) of the $7.1 trillion in total deposits it backstops. The Problem Bank List website points out the problem:
“This 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, the umbrella in the metaphor, is scheduled to expire at the end of this year. Like so many other government intrusions, it was put in place with the idea that it was temporary.
But back in 2010, the Dodd-Frank bill extended TAG for another two years until the end of this year. Then-FDIC head Sheila Bair said that the time,
“It’s necessary to extend the TAG program because the lingering effects of the financial crisis that emerged in 2008 in large systemically important banks have now spread to institutions of all sizes, particularly in regions suffering from ongoing economic weakness. Allowing the TAG program to expire in this environment could cause a number of community banks — already under stress — to experience deposit withdrawals from their large transaction accounts and would risk needless liquidity failures. This reflects the continuing legacy of too big to fail and the different liquidity pressures our community banks experience as a result.”
Now here we are two years later and bankers are addicted and don’t want to give it up.
Frank Keating, president and CEO of the American Bankers Association, claimed in The Wall Street Journal that taking away TAG “would increase uncertainty in an economy whose path is anything but certain.” The goal of the program, he says, was and is to maintain liquidity for financial institutions. TAG is necessary because, he says, depositors remain nervous because the economy has slowed, and because of the problems in Europe, the obvious fiscal cliff, the boogeyman, and who knows what all.
Jeffrey Gerhart, chairman of the Independent Community Bankers of America, says “TAG deposits anchor broader banking relationships and support local lending.”
Local lending? Fact: 40% of bank deposits are with the four largest banks and 78% of deposits are with the largest 1% of banks. Your local cupcake bakery isn’t seeing this money. In fact, banks aren’t really doing much lending at all. What they are doing is entering into derivatives transactions. And when it comes to derivatives exposure, the 1% of banks hold virtually 100% of derivatives, a total of almost $225 trillion at the end of the second quarter.
During his testimony before Congress, JP Morgan CEO Jamie Dimon noted that the bank’s deposits had swelled by $400 billion in recent years, putting pressure on the bank to seek higher returns.
Bank analyst Chris Whalen makes a salient point. The growth in JP Morgan’s TAG-backed noninterest-bearing deposits almost perfectly tracks the period when the bank increased its rogue speculative activity.
Whalen figures that TAG accounts for $200 billion of JPM’s deposit base, or about 10% of total assets, so that additional cash provided a big incentive for JPM management to add risk. The bank must keep asset and equity returns at least stable atop a much-larger balance sheet thanks to TAG supported deposits. Hence, JP Morgan must take on more risk.
Dimon told Congress that his bank was unable to deploy these increased deposits through lending. The liquidity instead has been invested in corporate bonds via the bank’s Chief Investment Office.
Whalen says insiders at JP Morgan confirm his suspicions that there was a connection between the increased trading activities of JP Morgan’s London office generally and the funding that was flooding into the huge bank through TAG deposits at the same time.
According to The New York Times, JPMorgan had just 30% of its portfolio investment in securities guaranteed by the federal government or its agencies this spring. This is a shift from the end of 2010, when those types of bonds amounted to 42%. By comparison, Bank of America had 87% of its bond portfolio invested in government or agency bonds in March.
The Times speculates: “While the bank made both bullish and bearish bets with these instruments, it appears the trading strategy started losing a lot of money when the market turned against corporate bonds toward the end of March.”
In banking, all things start with funding. Funding creates the need for earning assets. Banks must do something with the money.
The Fed’s zero interest rate policy already has banks under margin pressure. 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.
Senate Banking Committee Chairman Tim Johnson (D-South Dakota) wrote a letter supporting an extension of the TAG program, hardly a surprising position given that most of Citigroup’s banking operations are located in his state.
Johnson is carrying water for the too-big-to-fail banks. At the end of Q1 2012, more than 75% of the $1.3 trillion in TAG deposits was held by banks with assets greater than $100 billion. Less than 4% of this amount was held by small community banks with assets of less than $1 billion.
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.
Where does this idea of deposit insurance come from anyway? Your local sports store and fast-food joint enjoy no such protection against failure. It wasn’t until Jan. 1, 1934, that deposit insurance went nationwide with deposits up to $2,500 covered (about $41,000 in today’s dollars).
Even FDR was not initially a fan of deposit insurance. After all, eight states had bank deposit insurance programs just prior to the Great Depression and all eight funds failed.
Then FDR told a press conference:
“The general underlying thought behind the use of the word ‘guarantee’ with respect to bank deposits is that you guarantee bad banks as well as good banks, and the minute the government starts to do that, the government runs into probable loss.”
FDR presidential adviser Raymond Morley said at the time, “We knew how much of banking depended upon make-believe or, stated more conservatively, the vital part that public confidence had in assuring solvency.”
Now, not quite 80 years later, U.S. deposit insurance coverage has gone from an inflation-adjusted $41,000 to unlimited.
It’s no wonder that the financial system, while magnitudes larger, has grown many times more unstable. William Seidman, chairman of the FDIC during the S&L crisis, wrote, “A deposit insurance system is like a nuclear power plant. If you build it without safety precautions, you know it’s going to blow you off the face of the Earth. And even if you do, you can’t be sure it won’t.”
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. And you will left to pick up the pieces.