Dedicated to Deposits: Deals, Data, and Discussion

Brokered Deposits and Hot Money - Factors in Bank Failures?

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This New York Times article looks at how hot money is being considered as an important factor in accelerating the wave of bank failures. With 52 bank failures so far in 2009, the causes for these failures are being examined. Unfortunately, regulators seem to be focusing more on deposit rates than the real problem of risky loans.

The article focuses mostly on brokered deposits. Brokered deposits are typically CDs that are sold to customers by brokerage companies like Charles Schwab. The brokerage acts as an intermediary with the bank which actually holds the deposits. The article has a good description of why brokered deposits are blamed:
Rather than simply wooing local customers, they have turned to out-of-state brokers who deliver billions of dollars in bulk deposits, widely known as "hot money," from investors nationwide.
...
But the hot money also came with a high cost. To lure the money from brokers, banks typically had to offer unusually high rates. That, in turn, often led them to make ever riskier loans, leaving them vulnerable when the economy collapsed.

When a bank fails, brokered deposits make it more difficult for the FDIC to find a buyer for the bank. Even if the FDIC finds a buyer, they may still refuse to assume brokered deposits. Looking over my posts on this year's bank closures, I've counted 12 banks that didn't assume brokered deposits in their agreements to take over the failed banks.

For a bank who's taking over the deposits of a failed bank, the issue with brokered deposits is that they can be easily moved from one bank to another as brokers seek the highest rates. The only thing that keeps those deposits is the high interest rates. To me this sounds a little like internet savings accounts. With electronic transfers it's easy to move money from one account to another. Also, when accounts have little or no minimum balance requirements, you can move most of the money without the hassles of closing and opening accounts.

With the FDIC reviewing Ally Bank rates, it's apparent that the regulators have noticed internet accounts can be another source of hot money. It's likely that we'll see more regulations on internet accounts. The article ends with the following:
Ms. Bair said she planned to ask Congress for greater powers to limit the role of hot money in banking - be it brokered deposits, listing services or simply Internet sales by banks offering unusually high interest rates.

In my opinion, the focus of regulators should be on risky loans and not high deposit rates. The problem with focusing on deposit rates is that it may punish banks which are not depending on risky loans. A good example is a bank offering a high interest rate on a reward checking account. Without understanding reward checking, regulators may see a 4% rate on a checking account to be hot money. In reality, the bank is able to pay 4% for a number of reasons unique to reward checking accounts. It's not necessarily through the use of risky loans.

Thanks to the reader who mentioned this article in the comments.

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Comments
19 Comments.
Comment #1 by Anonymous posted on
Anonymous
Not sure I buy the brokered deposits story. I deal with two major brokers. They have consistently had lower rates (to the point that I've chastised them about it) than I can find on my own (using this (thank you!)and other sites. Perhaps the brokers are benefiting by some margin for each transaction but I am certainly not getting "the best rate/rates" available.

1
Comment #2 by Anonymous posted on
Anonymous
.

>> In my opinion, the focus of
>> regulators should be on risky
>> loans and not high deposit
>> rates.

No. The focus of of the regulators must be on curbing the unsustainable systemic risk. This might require them to take into account both a) risky loans and b) high deposit rates.



>> The problem with focusing on
>> deposit rates is that it may
>> punish banks which are not
>> depending on risky loans. A
>> good example is a bank offering
>> a high interest rate on a
>> reward checking account.
>> Without understanding reward
>> checking, regulators may see a
>> 4% rate on a checking account
>> to be hot money. In reality,
>> the bank is able to pay 4% for
>> a number of reasons unique to
>> reward checking accounts. It's
>> not necessarily through the use
>> of risky loans.

Have you heard of "higher the risk, higher is the reward"? So what exactly is the so called 'risk' that is associated with these so called 'reward' checking account in comparison to the comparable non-reward checking accounts? None!

Yes, that's right! There is no risk that the people who buy 'reward' checking take in addition to what they otherwise would take by buying a non-reward checking account. Therefore the so called 'reward' rate that they get is creating a systemic imbalance.

Perhaps the regulators are simply doing their regulatory duty when they are looking into both 1) risky loans and b) high deposit rates.

.

1
Comment #3 by Anonymous posted on
Anonymous
.

>> Perhaps the brokers are
>> benefiting by some margin for
>> each transaction but I am
>> certainly not getting "the best
>> rate/rates" available.

Perhaps? Why perhaps? They definitely are benefiting for each CD sold. And that's the way it should be. Most brokerage houses are 'for profit' businesses, so it is but natural that they are after the benefit of selling whatever product that they can sell.

>>
>> They have consistently had
>> lower rates (to the point that
>> I've chastised them about it)
>>
>> I am certainly not getting "the
>> best rate/rates" available.
>>

It is not your broker's job to make the 'best rate/rates' available to you. They are simply in the business of selling various CDs - of various durations - of various interest rates - of various call features - of various payment-terms - to their clients.

If you as a client are able to find a better deal on your own ... well then all means go for it. On the other hand if some clients are finding the convenience of a central marketplace of CDs under one roof albeit with slightly lower rates better then ... be it.

.

1
Comment #4 by Anonymous posted on
Anonymous
As far as I know the brokers take 0.25% to 0.5% from the banks paying interest rates, therefore, Brokered CD will always pay less then bank's rate, unless the bank sell the contracted CD exclusively to the brokers to fulfill.
The administrative cost to the banks is lower and the banks benefit from brokered CD on expense of the investor (saver) by not getting full listed CD interest rate.

1
Comment #5 by Anonymous posted on
Anonymous
The truth is, and this is always the case, that the government and all of the Wall Street crooks want everyone to put their money back into stocks, equities, etc. so that they can rip you off again and again and again. It is obvious that they are fictitiously keeping interest rates down so that people have to put their money into their risky investment vehicles.

1
Comment #6 by Anonymous posted on
Anonymous
.

>> The truth is, and this is
>> always the case, that the
>> government and all of the Wall
>> Street crooks want everyone to
>> put their money back into
>> stocks, equities, etc.

Err ... who is this 'government'?

On this 4th July shall can we agree that this government is 'for the people by the people'? ... So what you are claiming is that the government - the people - that is - you - your relatives - your colleagues - your neighbors is wanting you to put your money in stocks/equities ... and that this is the truth ... Hmm ... interesting if this is true.

Now coming to the crooks of Wall Street ... Who are they? Are they the individuals/institutes who are owners of the stocks? Institutes such as Calpers maybe? Calpers of course caters to California Public Employees. So these are your Teachers, Nurses, Firefighters, and Police. Are they crooks? And is that the truth? ... Interesting.

>> so that they can rip you off
>> again and again and again.

So it is your own government and it is your own community people that are ripping you off again and again? Wow.


>> It is obvious that they are
>> fictitiously keeping interest
>> rates down so that people have
>> to put their money into their
>> risky investment vehicles.

Fictitiously? No. Low interest rates are for real. This is no fiction. In Japan and in Europe also the interest rates are low. Have you noticed people who buy/refinance the houses? They are gettinf real low interest rates ... nothing fictitious about it ... Really!

.

1
Comment #7 by Anonymous posted on
Anonymous
The risk that a customer takes with a reward checking account is that the customer will forget to make the 12th of the 12 required debit transactions that month -- and thereby lend the bank $20,000 for one month at nearly zero interest.

If that happens three times a year, the net interest rate for a supposed 3.5% account that defaults to 0.1% is
(9/12)*3.5% + (3/12)*0.1%

=2.6%

Not bad, but not 3.5% either.

1
Comment #8 by Anonymous posted on
Anonymous
.

>> The risk that a customer takes
>> with a reward checking account is
>> that the customer will forget to
>> make the 12th of the 12 required
>> debit transactions that month --
>> and thereby lend the bank $20,000
>> for one month at nearly zero
>> interest.

No. Wrong answer.

Risk is defined as 'exposure to the chance of injury or loss'. What you are describing here as risk, is no risk at all. That's because whether or not the customer completes 12 debit transactions, there is absolutely no loss (of principal) involved.

If you are thinking of lost opportunity of earning profit, then that is merely a notional matter. It is not a real loss. It is not equal to losing even 1 cent of capital.

So think again - what is the 'risk' here? And if there is no risk, why is there a 'reward'?

Therefore the fact that there is reward offered without any risk, means there is an imbalance in the system here, which the regulators better look into.

.

1
Comment #9 by Anonymous posted on
Anonymous
"The truth is, and this is always the case, that the government and all of the Wall Street crooks want everyone to put their money back into stocks, equities, etc. so that they can rip you off again and again and again. It is obvious that they are fictitiously keeping interest rates down so that people have to put their money into their risky investment vehicles."

By Anonymous, at 9:10 AM, July 04, 2009

You got that exactly RIGHT!

1
Comment #10 by Anonymous posted on
Anonymous
At the current time, the institutions that offer those reward checking accounts apparently get paid fees by Visa or MasterCard for debit transactions.

Very convoluted deals that are sure to become less favorable over time.

1
Comment #11 by Matt (anonymous) posted on
Matt
Anonymous@11:24am:

The fictitious interest rates that are being referred to here are the below-market, depressed rates caused by the Federal Reserve's monetary policy. The Fed can alter the supply of money to target a particular interest rate. As you no doubt learned in Econ 101, if demand is constant and supply is increased, the price (interest rate) falls.

I also find it humorous that you talk about market forces of risk and reward and in the next breath say this why regulators must force banks to lower interest rates. The bottom line is that the only reason you can't pinpoint risk is because the government insures all deposits. I find it odd that you say that risk is the same for all banks and imply that prices should therefore be the same for all banks. First, that is a gross oversimplification of the factors that affect prices. Second, the solution to that problem is to remove the effective monopoly the FDIC has in deposit insurance. Should poor people pay for insurance up to $250k when their account is $100? Maybe. Maybe their premiums are subsidized by higher depositors. Or maybe it's the other way around. We wouldn't have to theorize if there were options.

1
Comment #12 by Anonymous posted on
Anonymous
.

>> The fictitious interest rates
>> that are being referred to here
>> are the below-market, depressed
>> rates caused by the Federal
>> Reserve's monetary policy.

As you no doubt learned in Econ 101, Feds are created by the congress, which as you no doubt learned in History 101 is 'for the people by the people'! In other words the monetary policy is of our nation not of the Feds. If the congress does not agree with Feds, if the congress finds the monetary policy is not helpful, then of course they ( we ) have the power to dissolve the Feds.


>> I also find it humorous that
>> you talk about market forces of
>> risk and reward and in the next
>> breath say this why regulators
>> must force banks to lower
>> interest rates.

Actually I find it humorous that you are seeing things that are not there. I never wrote anything like regulators must force banks to lower rates - rather I merely wrote that 'regulators need to look into these matters'. What I imply is that upon doing a thorough study/investigation/fact-finding they need to form the regulations so as to curb unsustainable systemic risk.

Are risk-free higher rates causing systemic imbalance, therefore systemic risk? ( My guess is they are. ) Because of this is the whole system is at risk of failure? ( My guess is perhaps it is. )

And remember each bank failure potentially causes FDIC a real loss of millions. This loss is collectively shared by the premium we all pay by participating in the FDIC insurance. In other words - we all are victims here.


>> The bottom line is that the
>> only reason you can't pinpoint
>> risk is because the government
>> insures all deposits.

No. Government does not.

Maybe you need refresher Econ 101. FDIC is not the government. ( And neither is NCUA. )


>> I find it odd that you say that
>> risk is the same for all banks
>> and imply that prices should
>> therefore be the same for all
>> banks.

As I wrote before, you are seeing things that are not there!



>> the solution to that problem is
>> to remove the effective
>> monopoly the FDIC has in
>> deposit insurance.

By all means .. do so. I assume that you are a fellow citizen, so please go right ahead and do the needful to end it.


>> Should poor people pay for
>> insurance up to $250k when
>> their account is $100? Maybe.
>> Maybe their premiums are
>>> subsidized by higher
>> depositors. Or maybe it's the
>> other way around. We wouldn't
>> have to theorize if there were
>> options.

This is the only part of your message that I agree with wholeheartedly.

Mutual Funds deduct their expenses from shareholders by adjusting the NAV each day appropriately. If banks / credit-unions also spread the premiums they pay to FDIC/NCUA fairly across their deposit base, then I'm all for it. ( Maybe they are already doing it? I don't know. )

.

1
Comment #13 by Anonymous posted on
Anonymous
ECON 101 has nothing to do with what is taking place in our government today. Do some research beyond what the POLITICIANS from both parties only want us to hear.

The LOBBYIST power brokers control CONGRESS, the WALL STREET money brokers control the FEDS. They are all beholding to one another while the blue collar workers are left holding an empty bag and very bleak future.

1
Comment #14 by Anonymous posted on
Anonymous
Let us keep speculation like LOBBYIST controlling CONGRESS, and WALL STREET controlling FEDS aside, especially on the day-after we celebrated our independence day.

Fact is: we the people control the Congress, and Congress controls the Feds on our behalf.

Speculation such as LOBBYIST & WALL STREET is controlling everything around you is utter non-sense.

1
Comment #15 by Anonymous posted on
Anonymous
Matt,

I am yet to hear any announcement from government that they have started insuring all deposits.

The other day I heard Obama's announcement that government has warrentied the GM vehicles. Do you think I missed similar announcement regarding the deposits?

??

1
Comment #16 by Anonymous posted on
Anonymous
LOBBYIST are controlling CONGRESS?

That's preposterous. Last I checked it was the ALIENS who were in control & before them it was the RUSSIANS. :-)

1
Comment #17 by Anonymous posted on
Anonymous
Banking Guy thanks for a great item. To me Sheila is the 900 pound gorilla here. If she ever gets her grubby hands on the NCUA I'm in trouble.

Until then, I am good. Sure hope it never happens.

1
Comment #18 by Susie (anonymous) posted on
Susie
Re: CD's in California- any reason why you left out Broadway bank? (LA based, several branches)
3.00% APR 3.05% APY on 24 months?
I looked for fine print and I don't see any hitches. Please advise-

1
Comment #19 by Anonymous posted on
Anonymous
Once again they (the news, media, & the general public) get it wrong! The bank failures have nothing to do with brokered deposits, but everything to do with the bank officers running the institution into the ground by imprudently growing their investment and loan portfolios in anyway they could to generate higher net margins. This argument is like blaming a candy store for getting sick to your stomach after gorging on a whole bag of candy and chocolate – “they made it too easy for me to stuff my face with sugar”. These deposits were not forced onto the bank, the banks sought out these deposits b/c they decided they wanted to make more money through bad and unsound loan & investment practices, no matter how much risk was involved. We all have a responsibility to understand the root causes of our current economic environment before we start casting stones. Ignorance makes the situation worse and does not solve anything.

1