The FDIC’s Transaction Account Guarantee (TAG) is scheduled to expire at the end of the year. Where will the money go?

The FDIC’s Transaction Account Guarantee (TAG) is scheduled to expire at the end of the year. Will it go out with a bang or a whimper?

According to a Sept. 4 Goldman Sachs research report, $1.4 trillion of non-interest bearing bank deposits will change from being FDIC insured to uninsured. The remaining $0.9 trillion in non-interest bearing bank deposits will be covered when the insurance cap reverts to $250,000. Will there be an exodus from the banks and, if so, where will the money go?

There are 4 paths the cash could take:

  1. The money will stay put. A lot of the cash consists of transactional balances that are necessary for businesses to operate and shifting to a more operationally intensive account is hard.
  2. The cash will migrate to more credit worthy institutions. For those who have high balances and have relied on the FDIC insurance wrap, they may think twice about leaving the cash with a bank they have think more about. Small banks could be hurt.
  3. The cash could go to money funds. With the money funds under attack by regulators who see the $1 share price as economic fiction, investors may give pause to jumping in. But in the short term, its probably the path of least resistance.
  4. The cash could go into the shorter-term gov’t. securities or repo markets. This would come the closest to replicating the risk of a FDIC insurance guaranteed account. Some have speculated that this might push T-bill rates (and repo) into negative territory.

We can understand why there was a push to extend the FDIC policy. Should some crisis befall the economy, a government wrap of deposits would, a priori, stall bank runs. Safe assets have been scarce enough without a mad dash caused by frazzled money looking for a new home. Eventually economics won’t be the deciding factor — it will come down to being a political decision whether to extend the program or not.

Recently the Blog zerohedge quoted a BofA report which said, “…Because many depositors are highly risk averse, we expect that a portion of the US$1.6tn in fully insured deposits in accounts with more than US$250,000 in balances will leave banks for the relative safety of money market funds and direct holdings of Treasury and agency securities. This could result in negative bill yields and wider 2y swap spreads, in our view. However, deposits of the banking system as a whole will likely not decline when this provision expires, though there may be dislocations for individual banks…” This report was in the context of QE3, which would pump deposits back into the banking system, albeit this time anything above $250,000 won’t be insured. This seems a bit extreme to us, but stranger things have happened.

At the end of the day, there will be some dislocations but, barring a financial crisis of the Lehman variety and a lack of many better options, we think the death of TAG will be more of a whimper than a bang.

A link to the Goldman Sachs report is here.

A link to the zerohedge post is here.

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