A research in bank runs

The first bank-like (In this case, thrift institution that deals with deposits and mortgages instead of pure deposits) institution has failed and I get to see the first physical bank run in my life where people line up to withdraw their money. IndyMac paves the way for images of what’s to come… other bank failures. I still can’t believe that my semi joking advice to my colleague of having $2000 in cash might actually be the best advice I’ve given in my life. I, on the other hand, am not following my own advice.

The reasoning is simple. I am relying on the government backed insurance that ensures $100,000 of my deposits will be guaranteed. Since I have not reached that limit, I know that all my money is safe… or is it? A simple question requires a simple answer. I need to know what will cause the worst case scenario where all of them are wiped out? The conclusion is this. It will take the bankruptcy of my banking institution as well as the dry out of the insurance fund to wipe everything to zero. Since we are in Canada and trails the US by 6 months, I decided to take a look at the entities in US to get an idea of what’s to come.

For those of you unaware. FDIC is the entity. Currently they have $53 billion in the insurance fund which goes into taking over the failed banks. For IndyMac, it wiped out $8 billion of the fund. Which makes you ask this question. How many more bank failures can the FDIC take and what happens when the fund runs out? For a rough estimation, assuming each bank failure wipes out the same amount (which is an exagerration since IndyMac is really big and the most extreme, subsequent banks that fails might be smaller), it will take 6 more bank runs to wipe out FDIC funds.

So the next question is. What happens then? Research shows that the FDIC is then not obligated to pay your deposit if it doesn’t have anything in its fund. Even though the entity is created by the congress, it is however created as an independent agency. Meaning that the government has no obligation to back it up. It is up to the whim of those politicians you are paying to decide to rescue it, just like Bear Sterns. Fannie Mae and Freddie Mac (minus the countless others that they allowed to fail).

The moment the 6th bank fail. Social unrest will happen as the rest of the population will start seeing their whole life savings wiped out. Government intervention will come too late as the avalanche effect will see to it that it happens too fast for any entity to react. Or if it is even possible to react, too big for anything to affect the momentum that’s already in place.