How to Avoid Losing Your Money in a Bank Collapse

Unless you've been hiding under a rock or off on a deserted island somewhere, you've probably heard about the IndyMac Bank failure in the news recently. Maybe you haven't been giving much thought to your personal finances and think that your have nothing to worry about. Well here's a suggestion for you...WAKE UP, and pay attention!

Most of us have probably never seen or even heard of a "run on the bank." Perhaps you don't even know what the term means. A run on the bank means that the depositors who placed their money at a particular bank (e.g. in the form of savings accounts or checking accounts) start withdrawing their funds all at once. Since a bank only has a small fraction of cash available as compared to the amount of deposit obligations, no bank can pay all of its customers if they want to withdraw their deposits at the same time. And if the bank can't meet its obligations, it fails. Obviously, this doesn't happen very often. And for many of the people reading this, this has never happened (at least to the degree that they have experienced it personally). For instance, the only time I've ever experienced a run on the bank was when I watched the movie It's a Wonderful Life. Remember the scene? George and Mary are about to go off on their honeymoon when they notice a whole bunch of people standing around the locked entrance of the Bailey Building and Loan. That was a run on the bank.

During the early days of the Great Depression there were many banks that went under because of this situation. And when it happened, most of the people who had their savings in banks ended up with nothing...or at the most, a few cents on the dollar. So in the 1930's the Federal Deposit Insurance Corporation (FDIC) was created by the U.S. government. The idea was to create an organization that would insure the deposits made by bank customers in order to foster confidence in the banking system. Not a bad idea really...and it worked. People gained confidence in banks again and were putting their hard earned money into savings accounts and other deposits again.

So what happens when a bank fails? Basically, the FDIC rides in to the rescue...they will take over the bank and pay back the bank's customers or find another bank to run the failed bank's business (this is a very simplistic description of what happens). In any case, the insured depositors get their money back. But there a catch...deposits are insured up to $100K only. Each customer can only have $100K of insured deposits at any given bank. Any more than that...and it's too bad for the customer, they are not guaranteed that money. For example, stories are now surfacing about some of the customers at IndyMac Bank who are getting pennies on the dollar, if they're lucky.

Ok, so if you make sure to spread around your money so that you have less than $100K in any given bank, then you should be ok right? Well, that's definitely a start. My guess is that most people don't even think about doing something that simple, only because they've never experienced a bank failure. I mean, how many bank failures can you remember prior to this year? Sure there were the Savings and Loan failures back in the 80's, but even that was a long time ago. People have just gotten complacent. I heard a guy on the radio yesterday talking about how he had $250K at IndyMac and will probably lose a big chunk of it. So if you remember only one thing from this article, remember this...DON'T keep more than $100K deposited at any one bank!

But back to the question of whether you are "safe" if you spread around your money as to have less than $100K in any given bank. The real question is, how much does the FDIC have in its reserves to cover bank collapses? Surely they can cover everyone's deposits, right? Well, let's take a look. As of the end of 2007, the FDIC had 1.22% of the amount of insured deposits in its reserve fund. That means that for every dollar that is sitting in an insured deposit somewhere, the FDIC has 1.22 CENTS in reserves to cover a potential loss.

I don't know about you, but that doesn't make me feel very confident. Sure 1.22% reserve might be fine when the banking system is chugging along healthy. But what about in times like these, when we are seeing massive drops in property value and the highest foreclosure rates ever? What if several banks fail at the same time? Some experts are actually saying that a number of bank failures will occur in the next few months. I would assume that if a catastrophic banking system collapse were to happen, something would be done in Congress to make sure the FDIC can fulfill its obligations. But guess who would end up paying for that? The money's got to come from somewhere, and we all know the government has a knack for raising money...through taxes!

I'm not trying to be a "glass is half empty" kind of person. Frankly, I don't believe we'll get to the point where the FDIC is in trouble. But I do think people need to wake up and take care of what needs to be taken care of. You can't think that just because your money is in a savings account at a bank that it's safe. Heck, you shouldn't be putting your money in bank savings accounts anyway...but that's a topic for another article.