“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would a revolution before tomorrow morning.”
- Henry Ford
We’ve all heard the expression, “It's like money in the bank!” What could be safer or more reliable than one of our long-standing financial institutions?
Ironically, in recent years, it's becoming clear that banks aren't the safe havens for our dollars that we imagine.
FDIC Insurance and the Illusion of Protection
When the value of houses and stocks went into freefall in 2008, a few people began to become concerned about their bank savings. The FDIC, which insures bank accounts, was quick to give extra assurances. FDIC insurance limits on savings accounts were increased from $100k to $250k and Suze Orman was hired as a spokesperson for public service announcements. The public breathed a little easier, and banking went on as before.
In 2009, the FDIC also put out a pamphlet called, somewhat grandiosely, “No Safer Place in the World For Your Money.” The brochure bragged that, if necessary, they could access a $100 billion line of credit from directly from the US Treasury that “under federal law, can be expanded to $500 billion.”
Very impressive indeed, until you consider that the total deposits in US banks is about $5.37 trillion. This pencils out to a guarantee of about two cents on every dollar deposited, unless they raided the Treasury coffers. (And re-appropriating the defense fund budget or the social security trust fund would hardly be a solution.) Other analysts have estimated the reserves to be even less than 2% of deposits.
This highlights a common misconception about FDIC insurance, and banking in general, that your money is somehow "backed" be real-world assets. That is simply not the case. To understand how this really works, let’s take a look at the concept of Fractional Reserve Banking.
Fractional banking is a system where only a small percentage of bank deposits are covered by cash-on-hand. The actual reserve requirement for banks is only 3 – 10%. This means that a bank can loan out 10 to 33 times what its customers have deposited. When a loan or credit card is issued, the applicant’s qualifications give the bank permission to extend credit, and in this way, money is manufactured out of thin air!
Today, dollars (which are literally "banknotes" representing a promise to pay) are not backed by gold, printed money, or anything stored in a vault. The value of this conceptual cash is determined by the worth that people agree to assign to it in combination with whatever confidence society has in the banking institutions and the government.
The truth is that FDIC insurance would be nearly useless in a real economic crisis in which there was a run on banks of any size. Your cash would still be worth more than Monopoly money, but not much.
Even spokesperson Suze Orman confessed her own moment of panic. In a candid US News Money interview in which she discussed taping an Oprah show during the height of the financial crisis, Orman revealed, “I knew it was possible that by the time we came off that show that the entire United States economy could have collapsed. Our credit had frozen — I wasn’t sure we were going to be able to get money out of our A.T.M.’s."
Suze knows as well as anyone, people can't keep spending money that doesn't exist, whether it's from credit cards or a fractional reserve banking Ponzi scheme. Like Bernie Madoff, banks are betting that they'll never have to pay too many people back at once.
What you don’t know will hurt you. There are safer places to put your money. Next time we will look at a few places that are safer than banks. Until then, buyer be aware!