Paul Winkler: Welcome. This is “The Investor Coaching Show.” I’m Paul Winkler, talking about money and investing.
Banks and the Federal Reserve
It has been an interesting couple of weeks. One of the topics that keeps coming up is banks, the Federal Reserve, what the Fed should do, how they should regulate, and what we should do with insurance.
It’s really interesting if we look back through history at how different things came to be, regarding how we insure things and what we’re going to be doing going forward regarding bank deposits. Now most people, it’s not something that they worry about a whole lot, because they don’t have enough in their bank accounts for the FDIC insurance to be exceeded.
Some people do have businesses, and they are in excess of those numbers. That’s typically where you might see that is where you have a business, and that business might have a very large sum of money in a bank just because they need it for various operating purposes.
That would be one area that I would love to see the insurance raised, just because there are companies that are operating with huge cash accounts that they have to have, and to move it around between various banks is a pain.
For most people, this is not really something to worry about.
The FDIC insurance level is higher than what most people hold in the cash side of their portfolios. It is emergency money sitting there. It’s when you get above those levels that people are talking and saying, debating as how is this going to be covered?
Well, there was a piece this week that I felt was really, really interesting, and it was on CNBC. A former Fed person talked about some of the history of how changes take place and what actually happens.
Check this out.
Fed Analysis
Interview Clip: How do you look at this other sort of debate happening around the country about, frankly, who’s at fault? I think it’s important to frame this in terms of a cycle we’ve been seeing, going back 50 years, of expansion of the implicit federal financial safety net.
That is the set of things that aren’t legally insured, but people believe are going to be rescued by officials. It goes back to the early 1970s, and in each case, what happens is that some risk materializes on the edge, on the boundaries of what’s perceived as the guaranteed part of the financial system.
The officials have a choice whether to intervene or not. Not intervening threatens financial stability, because people will reduce their probability attached to whether they’re going to intervene somewhere else. So they end up intervening more often than not. That sets a precedent that expands the implicit safety net.
And then we’re off down the road of the aftermath of cracking down on the risk, the specific risk that was the approximate cause in the last go round. But then you have a new safety net, and you still have a boundary out there, and there’s a risk that materializes on the outside of the boundary, and the crackdown on risk-taking inside the boundary, in a sense, shifting risk to outside the boundary, and you’re just going to have it play out again somewhere else.
Paul Winkler: I think that’s such an interesting analysis right there. The whole idea, people have asked me this question, and Matt Murphy actually asked me this question as well when we did an interview a couple of weeks back, but in essence, what’s going on here, it’s the belief in the system. Isn’t it kind of risky, the whole system?
Yeah, everything is.
There is no such thing as complete safety.
We often try to find safety in life, and there really isn’t, because if I don’t take market risk, I’m taking inflation risk. That’s just one example.
Banks and Risk
If I put all my money in a bank, I’m taking a risk that that bank is going to be around if it’s above the FDIC limits. If I put my money in an insurance company and an annuity, they say guaranteed, guaranteed, guaranteed.
But that is if you read the fine print based on the claims paying ability of the insurance company, the whole system really is based on the belief, and the belief is that I’m going to be able to get my money back when I need it, that they’re going to be holding it for me.
The whole system is based on belief.
And now I say, “Well, I’m just going to take it all out, and I’m going to bury it in my backyard.” Then you’ve got to hope the worms don’t eat all your cash. Put it in a safe. I’ve got to make sure that you know that something bad isn’t going to happen there.
Somebody’s not going to steal it. There are risks no matter where you are putting your money. And as I’ve often said, this is why you diversify like crazy. I like lots of broad diversification, within limits. There’s certain things, assets that I wouldn’t hold, because they don’t help to reduce the risk of the portfolio.
If you look at the academic research where there are certain things that I wouldn’t put in an investment portfolio that don’t make sense, but in general, really broad diversification, tens of thousands of companies, for example, in a stock portfolio, lots of different bonds, lots of different issuers of bonds, and things like that.
But what happens is that we look for safety, and partly, if we’re thinking about the banking system, that safety is just the belief in getting your money back, one way or another. And the reality, knowing that your cash isn’t physically sitting in that bank, but it’s sitting in somebody’s house, in somebody’s business because they’ve borrowed the money and they’re paying you interest to use your money, now that’s part of the system. If everybody wants their money back at once, there’s an issue there, because they don’t have the money sitting in the bank.
Long-term Money Lending
So he says this goes back to the 1970s, and you have this line that you walk up to. And isn’t it just human nature to have a line just to say, “Well, what if I stepped just a little bit over this?” And this was a conversation that took place this week, as a matter of fact, regarding mark-to-market. This was the problem back in 2008.
Now, he said, “If we would just focus on this mark-to-market thing, we could fix a lot of these banking issues.” And what he meant by that is that if you look at a bank’s assets, now what are the assets of the bank?
You’ve got the deposits, you put the money into the bank, but then they take that money, and they hold a little bit of it in cash. They have some of it in short-term treasuries, money market-type assets.
Short-term investments are very liquid and can be turned back into cash very quickly.
They have some of the longer-term stuff, and that’s really where some of these problems came in, and I’ll talk more about that in a second. But then they loan money out to a business, they loan money out to somebody that’s buying a house. Now, that money won’t come back to them for many years, especially in these long-term mortgages, unless they sell it.
Now, you’ll have financial institutions repackage stuff and sell it. What I mean by that is we got this block of mortgage business, and people are making payments on their mortgage, and what we could do is we could take that block of business and the payments that are being paid, and we can sell it to somebody, because it’s worth an amount of money to somebody else.
So if you have long-term mortgages out there at very low interest rates, guess what that’s worth to somebody? Not a whole lot when interest rates are higher. So even that business went down in value because of the fact that the money was locked up for so long.
Dropping in Value
Now, who does it get repackaged and sold to? A lot of times it might be mutual fund companies. And then what happens is the general public owns that stuff, because, say, a lot of times like it or not, they’re looking for safety, and they don’t recognize that it’s not safe when you lock up a bunch of money for a long period of time because of interest rates and inflation destroying, interest rates going up, and then those bonds or those mortgages go down in value when interest rates go up.
Not only do bonds go down in value, but mortgages also go down in value.
When the dollar is dropping in value, you’re not going to be getting those money payments back for many years. You might get a $2,000 payment back, let’s say that’s the person’s mortgage payment, you’ll get that $2,000 payment back 25 years from now.
Well, what’s the purchasing power of the $2,000 25 years from now? It might not be much at all. So you’re getting something back that has been depreciated significantly, and that’s the problem that you run into.
Now, the mark-to-market thing is this. Going on the books constantly and going, “What are the assets of the bank? What are the liabilities? What do they owe people? And are the assets, have they dropped in value? Are they being mark-to-market?” In other words, are we looking at what the true value of that asset is right now based on recent changes, things that are going on?
And if we’re not constantly looking at this, I don’t even remember the guy’s name, he was on CNBC, but I think he was right on, if we’re not constantly looking at this, we could have a problem on our hands. We’re going to have a problem on our hands that the bank may be in some financial difficulty, but we don’t even know it until it’s too late. So that is something that we want to be very conscious of.
Now, the thing that we’ve got to watch out for is there may be a lot of trials in trying to figure out the value of an asset all the time, especially if it’s an illiquid asset. Have you ever owned something in your own investment portfolio? Hopefully not.
Investment Portfolio Worth
Too many times, I do see people that do this, and they don’t really know what it’s worth, because it hasn’t been traded in a while. You don’t know what something’s worth unless it’s traded. That’s what I love about public equity markets, stock markets, is that they’re constantly being traded, so we know the value of these things.
Now, that can have a negative aspect too. The negative is if I’m constantly getting an assessment of the value of my portfolio, that can be unnerving, because it’s going up and down and up and down, up and down in value.
Well, the reason it does that is because there’s constantly a change in the valuation based on what somebody’s willing to pay for it that day. Now, the reality of it is my investment portfolio, I may not need it for 20 to 30 years. Who cares what it’s worth today?
I don’t really care about that.
Worry about what your portfolio is going to be worth when you actually need the money.
Which could be 5 or 10 years out. Looking at the history of market downturns, for example, they just don’t historically last that long. So I may be sitting there so worried about what my stuff is worth right now when I may not need it back for many years to come.
So it is really interesting that you’re talking about going out there on the edge. And then what happens is then the banking system comes in and says, “Hey, let’s just change these rules a little bit,” because they’ve gone out on the edge here, and this isn’t something that we anticipated.
The boundary gets moved so often, and because the whole idea in the system is not having a systemic meltdown, the government will step in and just change the rules a little bit just to make sure that people have that level of security so they’re not wanting to yank all their money out at once.
Because if they do that, then there’s a lot of other problems that are way worse than the government making sure that everybody is taken care of. That was the moral hazard, as banks might take more risk and it might jump out there and take more risk if they know everybody’s going to be guaranteed.
FDIC Insurance
Well, unfortunately, that’s kind of where regulations have to step in to make sure that they can’t do that, and maybe doing something where everything is mark-to-market so it can be seen much more quickly if there’s a problem. That might be the answer to that.
I think just a little bit more about this bank thing that has been going on. It’s interesting that a lot of people don’t really know what level of protection that they have in their banks. They don’t really understand the FDIC insurance, because often it’s done in shorthand.
Well you have $250,000, how it’s registered. If you’ve got a personal account that’s going to be $250,000. If you’ve got a joint account, $250,000 per person. So let’s say husband and wife, $500,000 and then might have a business account, $250,000.
It’s a little bit more nuanced than that. Sometimes when you have beneficiaries on the account, you actually have higher levels on the account of FDIC insurance because of the different tax ID numbers on there.
There is an FDIC calculator online if you need that.
If you’re one of these people that has a lot more in deposits, let’s say that sometimes they have business owners that do big stockholder loans to their companies and they leave it all in one account and they say, “Oh, maybe I want to spread that out so it’s not all in one account where it’s subject to maybe $250,000 worth of coverage.
I want to spread it out a little bit more.” You can actually go on there and look at it and say, “Okay, this is the way I own my account. Let’s say, in our personal account, but I have a beneficiary on that.”
Then you say, “Here’s how much money I have there.” An FDIC calculator, you go on the internet and find that, you’ll actually be able to find whether you have coverage on that. It’s a pretty cool little thing.
So one of the things that we have been talking about lately is the Federal Reserve and how some of the actions have affected the banks. People have said, “It’s the Fed’s fault. They’re doing things.”
Federal Reserve Actions
Well why, what’s going on? And I thought we’ll just talk a little bit more about that. Let me start it off. There was a lady that was on CMDC and she was talking a little bit about this very issue. So check this out.
Interview Clip: Yeah, so I think this gets down to the idea that monetary policy in the Fed funds rate is a very blunt tool, and really it only impacts the demand side of the economy. So that is really the only way that they can operate.
Now on the other hand, they do have the liquidity tools and they have been using those, they have been putting backstops in place. But as it relates to their price level stability and their maximum employment mandate, what they have, they have interest rates, that’s what they have, and they’ve reset interest rates significantly higher.
It is important to note that this is the most aggressive rate hiking cycle since the 1980s.
And what happens when you move that quickly is ultimately you break things. And that is essentially what we’re seeing in the banking system over the last two weeks.
Paul Winkler: So she makes some really good points there. That’s Kelsey Berro from JP Morgan, and she was talking about how the Fed has this blunt tool and they’re able to raise interest rates, lower interest rates, and may be able to buy bonds or sell bonds. If you buy bonds from the banks, you increase the liquidity at the banks, you increase the amount of cash that they have to lend back out and that’s what drives interest rates down.
Then you reverse that process and actually sell some of the bonds that you bought to actually increase interest rates. And then the Fed, when you hear about the interest rate increases, that’s what banks charge each other for making sure that they can meet their reserves and make sure that they meet the requirements of having so much money in reserves, in other words, not lent back out. So that’s available at the bank if somebody needs to pull their money back out.
Wages and Prices
So what happened is the banks bought longer term bonds and when the interest rates went up that drove those bonds down and I like the way she said, “You break things.” It’s so true. I mean you broke things and that was a problem in the banking system. They’re between a rock and a hard place when it comes to that.
And you go, “Well, why?” Well, because if you have such a low unemployment rate that there are hardly any people out there to be hired, that drives wages up. And when it drives wages up because people say, “Well if you want me, you’re going to have to pay up.”
When workers charge more for their labor, the company has to charge more for their products.
And when they charge more for their products, it drives the prices up and then all of a sudden you end up with this price spiral if things keep getting more and more expensive.
And if it’s rapid enough, people will buy things right now rather than waiting because it’s going to be way the heck more expensive in the future. And if they buy things now that makes companies have to make stuff right now when they don’t have the labor to do it and then they have to bid up for the price of labor even more and it’s just this spiral that can be really problematic.
So the low unemployment rate, and you think about this, how do we fix this? Well the Fed is being told, “Eh, you guys need to fix this, through whatever you guys do, whatever magic you can do.”
And I’m thinking as I’m watching these TV programs, well there’s a whole lot. If you watch these Fed meetings, it’s fascinating, because the Fed is being asked, “You need to do this, you guys need to be doing this.”
And they’re trying to dance around going, “Well that’s actually your job.” So the Fed chairman is often saying, “That’s actually your job over in Washington. You guys need to be fixing some of these things that will actually solve some of these problems.” And they have to be really careful not to point their finger back too much at the government officials that are questioning them for obvious reasons.
What Can the Government Do?
Let me just talk about that for just a second. What can the government do? Well, the government can do things to help fix immigration policies so that we don’t have so few laborers in the workforce.
And if it happens to be that relaxing the immigration standards allows high quality people who want to work to come into the country and become citizens, because their own country can’t get out of their own way and fix their government, maybe that’s what we do.
And then people get into all kinds of a scarcity where, “Oh, you’re going to be taking my job.” A lot of the time people coming in from other countries create more jobs for everybody else and take away some of the problems that we have.
So what can we do to increase the labor force? Are there things that can be done to increase productivity at companies, maybe smoothing the way. Tax policies have been used for that before.
For example, companies have been able to write off improvements in their technology much more rapidly to incentivize them to actually automate more so that they don’t need as many employees, so they don’t have that upward pressure on wage rates.
Are there things that we can be doing with money that is being wasted in some area of our economy?
Can we be doing things from a standpoint of the government saying, “Hey, you know what, we could relax some things here. Maybe we’re wasting a lot of money on different types of regulation and if we stop wasting money on that regulation, it frees up assets to do other things.
I’ve seen people tell me about their industry and go, “We’ve got to do this, we’ve got to do this.” Well that takes a lot of employees for you just to comply with government regulations. “Yeah, we wish we didn’t have to hire people to do all that stuff.”
Well if those people weren’t hired to do those things, maybe they could do other types of jobs that there’s a huge demand for and that actually produced something really worthwhile.
Demand and Interest Rates
What are those types of things? So in essence what happens is the Fed is basically given this one tool, increase the interest rates to decrease demand. And if you decrease demand, you don’t have as much demand for employees.
If you don’t have as much in demand for employees, then the wages come down and then you get rid of this inflation thing. And that’s basically what this lady’s saying we have on the interest rate side. It’s the demand side that we’re trying to focus on.
And that’s what they are doing is that, it’s a blunt instrument, as she said. It’s blunt because it’s just like trying to cut your steak with a baseball bat. You can probably do it, but the outcome doesn’t look so pretty. And that’s the same exact thing.
The Fed’s two mandates are price stability and maximum employment.
Yeah, we love maximum, we’ve got maximum employment, we’ve got too much employment. The unemployment rates are too low. You’ve got to get people that want to enter back into the workforce. How do you do that? Some of the ways I talked about.
But it’s just funny, just thinking randomly, this whole thing in France right now. We want to raise the retirement age around 62 to 64 and you’re having people just absolutely have fits. Oh my goodness, I’m going to have to work two more years.
But they’re absolutely having fits over that, and that’s why they’re wanting to raise the retirement age over there, is because we’re looking at it going, “We’ve got a shortage of people. We don’t have a high enough birth rate for this stuff.
We can’t pay the bills if people aren’t still working.” That’s what that whole debate is about over there. I don’t know if you paid any attention to it, but it’s fascinating. The rioting in the streets and all these people getting upset about raising the retirement age by a couple of years.
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