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The · Psychohistorian

Handling illiquidity

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As I mentioned yesterday, Citigroup's agreement to purchase Wachovia's banking assets on Monday was an illustration of how the present system can work, without new forms of government intervention. Wachovia, you may recall, experienced liquidity problems as a result of a "silent run" last week with depositors withdrawing enough from their accounts to get them under the FDIC insurance limit. More fundamentally, Wachovia had made some bad mortgages, particularly "pick your payment" pay option mortgages, which allowed borrowers to choose a payment below the amount of interest, increasing rather than decreasing the principal amount. As best I can tell, Citigroup accepted those mortgages and responsibility for the first $42 Billion of losses on them, amounting to somewhere between 10% and 20% of the principal, with the FDIC picking up the tab if the losses amounted to more than that.

Today brings news about how the present system can work even better given a bit of time. Wells Fargo, which has been in talks to acquire Wachovia for some months, wasn't able to finalize their offer in time for opening of business Monday morning. They kept working on it, though, and today announced they had reached a competing agreement. Their agreement is much sweeter than Citigroup's - they buy all of Wachovia, not just the banking assets, assume all liabilities, so the FDIC doesn't have to guarantee anything, and pay more to Wachovia's stockholders. They can do this because they've stuck to making the good, conservative mortgages, and avoiding the high risk ones. The advantage to Wells Fargo is that they get to expand to the east coast, diffusing risk by diversifying their mortgage and loan base.

This is the way the system should work - and the way it does work when the government relies on well thought out institutions, like the FDIC, instead of on having wannabe cavalrymen taking precipitate action.

One good article on Wells-Wachovia deal:
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On October 3rd, 2008 05:14 pm (UTC), enugent commented:
One statistic I've wondered about and haven't seen mentioned anywhere - do you know what percentage of deposits in the US are above the FDIC limit? It seems like it shouldn't be very high - most people don't have that much savings in the first place, and those who do are more likely to be savvy about things like FDIC limits. We make a point of transferring money to another bank every time our regular account starts bumping against $100k (although I think we may be entitled to $200k for joint accounts, but I haven't looked that part up). I thought it was crazy that one of the proposals in the bailout was to raise the FDIC limit, because it seemed that it would affect so few people.
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On October 3rd, 2008 06:32 pm (UTC), psychohist replied:
For Wachovia, it was 21%, which was slightly above the national average of 20%. That's much more than the amount of free cash banks can reasonably keep around, which is probably in the couple of percent range. I think a lot of people prefer the convenience of keeping fewer accounts or banking with just one bank.

I'm not sure there's a need for a cap at all - except maybe for very large accounts where it's worth while for the owner to take the trouble to move the money around to take advantage of tiny - say, tenth of a percent - interest rate differences.
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On October 3rd, 2008 06:42 pm (UTC), psychohist replied:
Oh, and:

most people don't have that much savings in the first place

If you're bumping up against the $100k limit a decade after truly entering the work force, you should be well over $300k when you retire, no? I don't know how much you make, but someone making less than a third what you might well still be over the limit by retirement.
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On October 3rd, 2008 07:00 pm (UTC), enugent replied:
Even so, as a percentage of funds, rather than accounts, I would have thought the number would be quite small - I'm very surprised by 20%. We only have that much because we don't have it tied up in home equity right now, since we're still renting (and don't we feel smart about that at the moment!) - much of it is the profit from the sale of the house in Boston. Isn't it more typical to have wealth in one's home or in other investment accounts, rather than in liquid bank accounts?
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On October 3rd, 2008 09:42 pm (UTC), psychohist replied:
Some people are conservative and like to keep their money in insured accounts. It's possible that more of these people tend to be the retirees that hold most of the money right now. I know my mom tends to keep a lot of her money - outside of real estate equity - in FDIC insured NFCU certificates of deposit and such.

Also keep in mind that corporate accounts, which have the same insurance limits, may have a very different profile. Even very small companies - say, half a dozen full time employees or so - can easily exceed $100,000 in working capital.
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On October 3rd, 2008 07:02 pm (UTC), enugent replied:
I did find one cite that of the top 10% of Americans for wealth, the median amount in accounts which could be FDIC insured was $58,000 - nowhere near the limit. I have trouble reconciling that with 20% of funds being above the limit, unless there are a few people out there keeping millions in their checking accounts.
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