The Usual Bank Failures

Warren Buffet wrote, “It’s only when the tide goes out that you learn who’s been swimming naked.”  Sure enough, the recent pace of interest rate increases by the Federal Reserve has exposed a few wet noodles among the banks and real estate companies.  The way things are heading, we soon may have enough for a pasta salad.

Officials assure the world American banks are sound.  They have every incentive to assure us because depositor confidence is the bulwark of banking.  If depositors flee, banks fail.  If banks fail, it’ll be the regulators and officials exposed in the ebbing tide.

We’re not so sanguine, but we don’t believe panic is in order.  First, banks are inherently fragile and always have been.  Their financial structure sets them up to fail in weakening economic times.  Banks “borrow” short-term funds (i.e., deposits) using the funds to make longer-term loans or purchase bonds.  See the bank run scene from It’s a Wonderful Life for a dramatic explanation.

The banks’ loans and bond purchases can have substantial risks.  The loans can fail, the market value of the loans and bonds can drop, and they might be impossible to sell quickly.  The depositors, on the other hand, can demand their money back at any time and they expect 100% of it to be returned with interest.  This incongruity creates opportunities for the usual bank failures.

Nonetheless, at this stage, taxpayers appear to have more reason to worry than depositors.  Rescuing banks is very expensive for the government.  Regardless, investors should still consider alternatives.  For example, those with more than $250,000 per person at a bank should think of splitting it up between banks, despite the precedent of the FDIC bailing out larger depositors.

If having cash in government guaranteed deposits is important, then shop around for high yield savings accounts and CDs. is a good resource for finding the latest high yield bargains.  Read the fine print, though.  There can be gotchas, such as high interest only on a portion of your deposits or onerous fees.  Furthermore, the yields may be teasers, thus requiring regular movement of your money to capture the greatest yield.

Another alternative, money market funds, are uninsured investments but are historically very stable.  They often invest in very short-term bonds or other safe securities, often issued by the US Treasury or federal agencies.  Despite the lack of insurance, the investments held by the funds are completely transparent to investors and the risk profile is a far better match for short-term investment needs compared to banks.  Only in extremely rare cases have any of these funds failed to return at least 100% of the investment to the investor.

One money market fund is Vanguard’s Federal Money Market (VMFXX) with an SEC yield of 5.02% as of this writing.  In my experience this fund has consistently provided yields as high or higher than just about any bank.  Be sure to read the prospectus.


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