First, Colonial received a major investment from a now bankrupt business, Taylor, Bean, and Whitaker.  This company funded and facilitated a huge number of mortgages, particularly in the southeast region.  But that’s old news.

Second, Colonial’s failure was leaked prior to its actually being shut down and placed into receivorship.  This is a huge issue.  There are two schools of thought on this.  The first is the most simple: somebody leaked the information at BB&T, Colonial, or the FDIC out of pure stupidity.  There’s a good reason that the public isn’t notified when a bank is going to close.  It saves that bank, usually, from having a run and costing the FDIC even more money.  The second reason is a little more complex and underhanded.  Somebody might have purposely leaked the news that the extremely strong BB&T was going to buy the deposits of the very weak Colonial, because Colonial was already seeing a run on deposits.  The first instance is extremely problematic; the second, extremely smart.  We’ll have to wait and see what really happened.

Third, Colonial bank received TARP money after getting a similarly large amount of private investment.  It received $550 million tax payer dollars, to be exact.  Recently, the TARP inspector general (aka TARP czar) raided offices of the bank alleging fraud that probably would have kept the bank from receiving funds.  As an FYI, a number of bankers and investment professionals that I have spoken with agreed with me when I was astounded and angered that Colonial received funds in the first place.  They’ve been failing for quite some time.  There goes $550 million down the tubes that was only supposed to be invested in the strongest and/or most systemically important financial institutions.  There’s a scandal brewing here, just wait.

Finally, and this is the biggest future news of all, the FDIC is going to run out of its self-funded reserve for losses.  This means that it’s likely that it will tap its line of credit at the Treasury.  This isn’t the first time this has happened, and you shouldn’t panic, but it’s one more bit of shocking fall out from the financial disaster that we’re desperately trying to get behind us.  Let me repeat, the FDIC is about to run out of its own money and start relying on taxpayers.  Can the government handle it? Absolutely.  Does this highlight how bad our situation was and continues to be? Absolutely.  Most importantly- Are your deposits still safe? Absolutely.

Let me explain myself.

There are two groups of bankers paying high rates right now.  One camp pays them because they have to do it.  They’re on the verge of going out of business and have to pay high rates in order for you to leave your money there.  As long as you’re FDIC insured, you should take advantage of these poor souls. 

The group that I want to deal with in this post is the banker who pays high rates because he wants to do so, not because he is desperate to keep your money. 

This group is exceedingly smart, forward thinking, and low-risk taking.  He’s paying rates on short term CD’s at current market rates.  That is, for CD’s with around 30-days to 2 year maturities, he’s paying somewhere between .5% to a little less than 2%, respectively.  That’s not how he’s being smart though. 

What the smart banker is doing is locking in long term CD money now in anticipation of substantially higher rates coming in the future.  He’s paying around 4% (which by the way isn’t really all that high of a rate compared to rates over the last 20+ years) on 5 year CD’s.  Right now, that CD is losing him money, but over time, he’ll make a killing on it. 

Here’s why:

With the Federal Reserve and the Federal Government already having promised, guaranteed, or directly put 11 trillion dollars into the economy, there is going to be inflation.  You cannot put that amount of money into our economy without devaluing our currency, i.e. causing substantial inflation. 

(Read Fed. Charman Bernanke’s latest comments on inflation here)

If words like inflation, devaluation, the mirage of the Federal Reserve, etc., don’t mean much to you, let’s put it in terms of something everybody understands: gas.

Everyone needs it, everyone wants it, and you have to use it almost every day.  Now, let’s say everyone had to drive as much as they do now with the car that they have right now, BUT there was only enough gas on earth for everyone to have three gallons per month.  The price of gas would be unbelievably high, right?  Gas would be VERY valuable. 

 Alright, now take that same scenario and let the oil countries produce so much for everyone to have one thousand gallons a month.  The price would be extremely low right?  It wouldn’t be nearly as valuable.   That second scenario is what is going to happen to the value of our dollar over time because there are just so many dollars available right now. 

When inflation hits, and it will, interest rates will naturally go up in line with how bad that inflation gets.  This means that bankers will have to pay you higher rates on your CD’s.  So right now, the smart banker is using his forsight and knowledge to pretend to be paying people a “high” interest rate on 5 year CD’s, all the while knowing that you’re being a fool for falling for his little trap. 

My point is: Before you just go after the highest rate, look at the longer term implications.  If something seems too good to be true, it probably is.  Bankers paying high rates on short term money are probably going out of business soon.  Those paying “higher” rates on long term money that locks you into a very long holding period are probably taking advantage of your ignorance about inflation. 

Remember, inflation runs somewhere between 2% and 3% per year in good years.  We’re about to enter a period of high inflation (think something similar to the late 1970′s and the Nixon/Carter years).  Do you really think that 4% on a 5 year CD is a great rate in light of the fact that just 12 months ago you were getting 5.35% on 1 and 2 year CD’s?  Do you really think that if prices at the grocery store are rising at 5-10% per year that you’ll be happy about basically losing money on your CD?  If you’re fine with all that, then by all means, get that 4% CD.  If that scenario scares you, put your money in something much shorter term and settle for the lower rates in anticipation of being able to get a much higher, inflation-adjusted rate in the fairly near future. 

If you don’t believe me when I say 4% is a historically very low interest rate, check out what rates on 6-month CD’s have done over time here.  Keep in mind these CD’s have terms 4.5 years shorter than what you’re locking in if you take that 4%, 5 year CD.

(For all you who care about political correctness, insert “she” in the smart banker references wherever you deem appropriate.)

In October of last year, President Bush increased insurance coverage per individual from $100,000 to $250,000. This was done, essentially, to prevent a sweeping run on all banks. It was a brilliant move to build confidence that really cost taxpayers nothing (so far).

On May 20th, 2009 President Obama signed into law a continuation of the enormous increase in FDIC coverage. This additional coverage was set to expire on December 31 of this year. The new law extends the coverage through the end of 2013.

Here at my bank, we had already fielded several calls from concerned CD customers about this potential loss of coverage. One man went so far as to request something in writing from me stating that he would be allowed to pull his money if the coverage reversed back to $100,000, and we had done nothing to otherwise insure his funds. We were already developing a game plan to combat a run on our tiny little bank if the coverage had reverted. Depositors would have taken money out in droves to accommodate for the reversal of insurance. This could have been very bad not only for us, but for the system in general. We might have had a situation similar to the one I’ve discussed in a related blog post below.

So this is your good news headline of the day: “President Obama Averts Potential Run on the American Banking System, Seven Months in Advance”

Kudos Obama.

For more information on the extension, please see the following website:

http://www.fdic.gov/deposit/deposits/changes.html

I thought this would be the perfect platform to briefly describe the most likely scenarios for a bank shutting down, what you can and can’t do following your bank failing, and where to find important information.

Here are the three most common (though not all-inclusive) scenarios.

1. Your bank fails and the FDIC takes it over without finding another bank to buy it.
2. Your bank fails and the FDIC finds a buyer of the deposits.
3. Your bank fails and the FDIC finds a buyer of the whole bank.

Scenario 1

Your bank is known to all regulators and bankers as the ugly, fat, annoying girl. Not only does it have a huge amount of problems on the surface, but it’s made up of such useless deposits and loans that nobody- not even the drunkest guy at the bar- will take her home.

If you have your deposits at this bank and they’re under the FDIC insurance limit, you’ll probably be sent a check for the balance of your account on the Monday following the Friday that the bank closes. If any part of your deposits is over the FDIC limit, you lose that amount of money (ONLY the amount that exceeds the limit). Over the weekend, the FDIC will contract with a big bank like Bank of America or SunTrust to allow transactions on the accounts to post as they normally would. You’ll have to open up another account at another bank immediately.

If you have a loan at this bank, you keep paying your loan, but might have to change where you send your payments. You will be strongly encouraged or flat out told to find another bank to take over your loan. If the loan is unsecured, you might be required to pay it immediately or find another bank to take it over. This is a bad scenario for people with loans, because the FDIC simply doesn’t have the right staff to service the accounts. It will get rid of them as fast as possible or sell them to another bank/private company. This doesn’t always turn out badly for loan customers, but it’s the worst scenario for you.

Scenario 2

To use a similar analogy, bankers and regulators think of you as a really attractive person but you have an STD. You’re hot, but they wouldn’t touch your assets even if you paid them.

If you have a deposit account with this bank, you’re perfectly fine. You won’t have to do anything but get used to a new bank’s name on your checks, debit cards, statements, etc. You’ll probably even get to work with the same staff with which you’re used to working. You’ll see the same smiling faces and hopefully get the same great service. Your accounts will also continue to be fully insured and you’ll have the peace of mind that comes with a stronger bank.

The only downside in this scenario is that the rate you’re currently paid on things with variable rates (money markets, savings accounts, checking with interest, etc) might be changed to a much lower rate. CD rates should be honored until maturity, but you will probably not be paid nearly as well when they renew.

If you have a loan with this bank, you’re in the same boat as Scenario 1 customers. The FDIC wants to get rid of you, and it doesn’t particularly care how it does it. See Scenario 1 for the breakdown.

Scenario 3

Keeping with the theme, your bank is as hot as Miss America (or Brad Pitt, for the ladies), has a great personality, and unfortunately was dumb enough to swallow a gallon e coli bacteria. With the proper penicillin, this will once again be an awesome bank.

If you have a deposit account with this bank, just like in Scenario 2, you’re perfectly fine. Go ahead and go on that weekend trip and don’t worry about your debit card working. Again, your accounts are fully FDIC insured immediately.

If you have a loan with this bank, you’re in luck. The new bank wants you and values you. They might give some customers a hard time, but they want to keep the vast majority of them. If you’re a bad loan customer (Don’t act like you don’t know you are), you’ll probably be harassed until you go away, get foreclosed on, or agree to some kind of painful workout. If you’re a good customer, just write the new bank name on your loan payments and keep rolling along merrily.

Important Information:

If your bank fails (or you think it might have failed), it is absolutely critical that you go to the following website:

www.fdic.gov

In the upper left hand corner, you will see something that says “Bank Closing Information – (Day the bank Closed)” and underneath, it will list the closed banks for that week. Click on your bank name and read EVERYTHING on each page. This will tell you exactly what you need to know regarding your accounts and what changes to expect, if any. It will also give you some interesting information detailing the transaction that took place and the loss to the FDIC fund.

The FDIC will also post information on every door and drive through window of every branch immediately upon closing the bank. This will basically detail the same information that you can find on the website.

Finally, always remember that your accounts, no matter how ugly or attractive your bank is, are fully insured up to the FDIC limit if they have a sign that says “FDIC Insured” posted in the lobby. There is absolutely no reason to worry about your money if you keep it under this limit. You will ALWAYS be paid that money…unless of course, the FDIC and US Government fall… but let’s not get into that just yet.

Him: “You know, if the government just keeps handing money over to banks that do nothing but hoarde it and lose more money, we’re never going to get out of this…”

Me: “Well, believe it or not, banks are making a ton of loans still, and the bailout was necessary because of the huge amount of money that it would have taken for the FDIC to make good on its insurance promise.”

Him: “It wouldn’t have cost nearly as much for the FDIC to just shut down all the bad ones and let the good ones survive!”

Me: “Well, let’s just pretend that this bank went out of business, ok? You have a few CD’s with us that total about $50,000… and you’re fully FDIC insured. Sound right so far?

Him: “Yep”

Me: “Alright, so we have about 6,000 customers who are in a similar position as you…and we’re a very small bank, Agreed?”

Him: “Yep”

Me: “If we went out of business today, the FDIC would lose anywhere from 50 to 100 million dollars because of just us going out of business.”

Him: “That’s a lot of money!”

Me: “Right. Now if you think about a Bank of America or Citibank, they do business with something like 100 million people just like you… and are each about 100 times as big as we are. Can you imagine what the loss would be if they went under?”

Him: “Holy hell!”

Me: “And if they went out of business, do you think people would think their money was safe ANYwhere?”

Him: “No, I’d probably pull my money out and hide it under my mattress…”

Me: “That’s exactly why they had to bailout the system. To make sure you, and 100 million other people, didn’t do that exact thing.”

Him: “Oh… well i guess that makes a lot of sense.”

There is something very well known, but not fully appreciated about the basic concept of banking. Here’s what happens: you put your money in a bank, and that evil banker goes out and invests your money, pretending it’s his own, to make a profit. In exchange for your money the banker either pays you some interest rate or at least supposedly gives you safe and continuous access to your funds, so that you don’t have to have a personal safe and your own monetary system. The key to all of this is the belief that your money is actually safe and accessible. But banking is all one big hoax; David Copperfield has nothing on your average banker. Your money isn’t actually there. It’s invested somewhere else, which the banker may or may not be able to get quickly in the event that you actually do want all of your money at once.

For the most part, this is rarely a problem. You fully believe that your money is not only there today, but will also be there tomorrow and 30 years from now. The banker keeps plenty of cash on hand to supply what he thinks will be enough to make customers happy and to ensure that your Starbucks purchase isn’t declined. The issue comes when you no longer believe that your money is safe.

This confidence problem caused economic disasters throughout the history of the world. The Great Depression is the most glaring example in modern history, but there were “panics” (in America) starting in 1785 and happening every 15-20 years or so up until 1929. These are what I refer to as true “panics.” People started to look up under Copperfield’s stage and realize that maybe he didn’t actually make the elephant levitate – and it scared them to death. They pulled money out of banks in droves and on most occasions, caused the entire economy to completely fail.

In the 1930′s, though, the government decided that something absolutely had to be done in order to stop panics, and consequently Depressions, from happening. For this reason, they not only set up a strong regulatory frame work to oversee banks, but they more importantly set up the Federal Deposit Insurance Corporation. In doing so, they decided that to make people feel more safe, they would essentially guarantee most citizens’ deposits in banks. If your bank goes out of business, no big deal! Uncle Sam will write you a check for your funds. The importance of this “invention” is enormous. For 70+ years, there were no true financial panics, and many thought there never would be one again. This allowed the economy to grow at an unbelievable rate over time without being interrupted and thrown back 30 years because of a stampede of irrational human fear. Loans and capital flooded into the economy thanks in large part to the simple belief money in banks was and would continue to be backed by the full faith and credit of the U.S. government, which hadn’t been questioned since the early 1800′s.

That brief walk through history brings me to the modern crisis. To put it mildly, the Great Depression would have had nothing on what would have happened had the American government and subsequently nearly every other major world government not stepped in to stem the effects of the atomic bomb that was the U.S. Housing Market Collapse. The FDIC is the key to the argument, and because politicians and regulators are scared to death to tell you the real reason for the bailout, I’ll go ahead and show you Copperfield’s trick.

The U.S. Government would have bankrupted if there had not been a bailout. This would have caused every other major economic world player to also collapse, since everyone holds owns some of our debt. Great Britain would have yearned for the days of the Battle of Britain in lieu of 30-50% unemployment. China would have reverted back to a 3rd world country. The U.S. would no longer be a superpower. There would be an enormous world-wide power grab and populist movement, not unlike the situation that led to the rise of Hitler. We would be in a nuclear winter without ever having dropped a real bomb.

The reason that the government would have bankrupted is simple. Citigroup would have played a large role in this and is just one of many institutions that would have led to this enormous problem. The company, at one time, had nearly 3 trillion dollars in assets. That’s a loose term for where bankers “invest” the money that people give them. A substantial portion of the money people trusted to Citigroup were FDIC guaranteed. The FDIC only had about 50 billion dollars in funds at the time, and Citigroup was well on its way to becoming insolvent. There is simply no way that the FDIC could have covered the cost of its guarantee. To be sure, they have an open line of credit with the Treasury, but once Citibank goes… then the real panic sets in. That’s when Regions, Fifth/Third, Bank of America, and any number of other major players also start to see deposits leaving in droves. At that point the loss to the FDIC becomes so large that the government has to issue trillions more in debt just to fund the FDIC’s lifeline. We’re running at a huge deficit already, but can you imagine what it would be like if the FDIC essentially had to write a check for every insured dollar in the country? While some banks would surely have survived, as has been the case in past panics, the government simply would not have been able to sell enough debt at cheap enough levels to sustain the FDIC guarantee. Without that, there is no banking system. There are no loans. There are no debit card or check purchases. The economy is thrown back to the 1800′s for 20-30 years provided that the government somehow manages to keep the country together and maintain power.

Because that situation was not only plausible but highly likely, Uncle Sam had to do some extraordinary things to ensure that he didn’t have to make good on the FDIC promise to the entire country. The 750 billion dollars in hard bailout money is just a drop in the bucket of what the total economic cost of a collapse would have been. The government had to maintain the illusion that your guarantee is still good without having to actually prove it in a large way. I’m generally very against anything resembling a government hand out, but this exception simply had to be made. Sometimes in war, you have to make very hard decisions, and that’s what this is- a war. You got drafted back in September 2008 without ever being properly notified. We have all made a huge sacrifice today so that our children and grandchildren can (hopefully) enjoy peace and a standard of living in excess of our own. It’s true that we’ve also burdened them with even more debt, but to summarize Warren Buffett, sometimes it’s better to have to pay for a lunch later than to have no lunch at all.