Another True Cliff: The End Of FDIC Insurance For Big Bank Deposits

by: Russ Winter

"Politics is the entertainment branch of the Military-Industrial Complex."
- Frank Zappa

Among the many cliffs out there that soon need to be dealt with is FDIC insurance on bank deposits over $250k. Called the Transaction Account Guarantee Program, or TAG. This insures all non-interest-bearing transaction account deposits above the standard $250,000 coverage limit. About 51% of these deposits are held in corporate or business accounts. TAG comes to an end on December 31.

Deposits covered by TAG are estimated to total about $1.6 trillion, or approximately 13% of total bank liabilities. Three-quarter of those deposits are held in banks with assets greater than $100 billion. Less than 4% of this amount was held in small community banks with assets of less than $1 billion.

The expiration of TAG means deposits will again be unsecured bank risk rather than government secured credit risk.

There is speculation that the expiration of TAG will lead to negative interest rates in the Treasury bill market. It is entirely unclear how Treasury money markets can absorb the costs of accepting this money, let alone profit from it. It could cause dislocations within the banking system and increase bank funding costs. I submit that if conditions are dicey or black-swan like on other fronts as we approach January, depositors will simply stuff currency and cash into corporate vaults rather than accept negative Treasury and money market rates.

If depositors take their cash and run when TAG expires, "the banks seeing a net outflow of deposits may respond by replacing the lost funding by issuing non-deposit liabilities, by reducing its cash holdings, or by shrinking its securities portfolio," Bank of America analysts Misra and Smedley suggest.

Their point is an important one. Banks have been a growing source of demand for longer-term fixed-income securities as deposits have surged. BofA says 66 percent of banks' current holdings mature over three years from now. If they become sellers of those securities, interest rates could rise and banks would then be faced with higher costs for long-term funding.

Indeed, this may explain the true cause of the Fed's MBS program. The funds from the Fed purchases will rotate to the Too Big To Fail Banks. The banks receiving these funds will rotate the money immediately into short-term treasury securities that will be priced at negative interest rates. Those negative rates or zero T-Bill rates versus holding funds in unsecured bank deposits will create a real dilemma for Corporate Treasurers that can't avail longer-term CD offerings.

The end of TAG may be the true cliff. At minimum, it may serve to put money into motion, including distorting the U.S. Treasury market even further and right in the face of potential U.S. credit downgrades. At maximum, the scramble may trigger a major bank run by large depositors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.