Tuesday, July 15, 2008

How to Protect Your Money

Jimmy Stewart is no longer with us, so a run on a bank is likely to lead to its collapse. That's the lesson of Bear Stearns, and the lesson was repeated again with the recent federal seizure of IndyMac, just last year the 9th largest mortgage bank in the country. IndyMac's collapse was precipitated by the flight of hot money--brokered deposits that are paid high interest rates but which can evaporate in nanoseconds. In this case, they did evaporate in nanoseconds after publicity about IndyMac's problems. Oddly, following the Federal Deposit Insurance Corp.'s seizure of IndyMac, large numbers of depositors lined up outside its branches to withdraw their money. After the FDIC seizes a bank, making a withdrawal doesn't change things. If your account(s) are fully insured, they will be entirely protected after the federal takeover. If your account(s) are only partially insured, you took your loss at the moment of federal seizure and withdrawal thereafter won't make you any better off.

In order to protect your money, you have three options:

FDIC Insurance. The FDIC insures your deposits at any particular bank up to $100,000 per customer. The FDIC totals up all your accounts to calculate your coverage, so if you have $10,000 in your checking account and $98,000 in a CD, you are uninsured to the tune of $8,000. If you have an interest in one or more joint accounts, your interests in all joint accounts will be totalled up and you will have an additional $100,000 of coverage. For example, if you have a joint account with your spouse which has $120,000 in it and a joint account with a parent with $90,000 in it, your personal interests total $105,000 and you are $5,000 uninsured. IRAs are separately insured for an additional $250,000. There are nuances to the FDIC's rules and you should go to www.fdic.gov for more information. You can count on the federal government to stand by its deposit insurance commitment, because anything less would lead to the collapse of the financial system. If a portion of your bank accounts is uninsured, pull it out of that bank and put it in another bank. You get a clean slate with each bank. The rules for credit unions are the same, and you may get a slightly higher interest rate from a credit union.

U.S. Treasury securities. You can invest in U.S. Treasury bills, notes and bonds, and get unlimited protection for your money. These are direct obligations of the United States, and will be paid, period. U.S. savings bonds are also entirely safe, but there is a $5,000 per year limit on your purchases of savings bonds, so they aren't of much use when you have a large sum of money you prefer not to lose. You can buy these investments directly from the Treasury Department (at www.treasurydirect.gov). Treasury bills, notes and bonds can also be purchased through brokerage firms. Savings bonds can be purchased through banks and credit unions. Among other things, you can get inflation protection from Treasury securities called TIPS and savings bonds called I-bonds.

Money market funds that invest only in U.S. Treasury securities. If you want to keep your money liquid, but still get the protection of U.S. Treasury securities, invest in a money market fund that holds only U.S. Treasury securities. There are a number of such funds offered by mutual fund companies--use your favorite search engine to find them.

None of these options pays very high interest rates. But, given that almost all asset classes are dropping in value, low interest rates are better than a poke in the eye with a sharp stick. While you can always keep your cash in a safe deposit box or in your mattress, you have the problems of physical security and inflation. Cash earns zero interest, so its value is sure to diminish as the inflation monster roars.

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