This topic is not meant to scare people, but it is a reality check about the safety of your life savings when the funds are held in a US bank.
Given the sometimes shaky nature of the banking system, it helps to understand just how secure your funds are in the banking system. We are not advocating pulling all of your money out of the bank and stuffing it into your mattress, but it does help to understand how well your funds are protected from the financial collapse of a bank.
Most people believe that their savings are fully protected as long as the bank or savings and loan is a member of the FDIC (Federal Deposit Insurance Corporation). The FDIC is a quasi governmental agency that was set up in 1933 to instill confidence in people after over 50% of the banks in the USA failed during the start of the Great Depression. During those days, when a bank failed, the depositors lost all of their savings, which caused people to pull money out of otherwise solvent banks, which in turn led to their downfall.
Legally, the FDIC is not a part of the government and was set up as a private insurance company that receives no funding from the government. Member banks pay insurance premiums to the FDIC, and the FDIC insures deposits up to a certain limit. The FDIC officially refers to itself as “an independent agency of the United States government.”
Up until the 1980s, the top limit for insured funds was $25,000. During the Reagan era this was increased to $100,000 per depositor. In 2008, when the latest banking crisis emerged, the limit was temporarily raised to $250,000 per depositor. The temporary increase expires on December 31, 2009, when it reverts back to $100,000 per depositor. Given the current economic concerns with the banking system, it is likely that the FDIC will push for a higher permanent insured amount. The important part to note is that the insurance coverage is per depositor, not per account.
It is also important to note that the insurance covers bank deposits only, which includes savings deposits, checking account deposits, bank-issued CDs and money market deposit accounts (MMDAs). The FDIC web site contains an article entitled Insuring Your Deposits, which explains that most joint accounts (husband-wife) are currently insured for up to $500,000.
The underlying problem with FDIC insurance is explained best by Ric Edelman in his excellent personal finance book entitled, “The Truth About Money”. He explains that agencies such as the FDIC “have demonstrated their ability to handle occasional failures,” but “never were designed to cope with a system-wide collapse.” The scary part according to Ric is that it appears that the FDIC may only have $1.25 on hand for each $100 of insured deposit.
So what do you do to protect your life savings? It looks like diversification of savings accounts is one option. In other words, if your savings exceed the insured limits, move some funds to a different account at a different bank. You also want to make sure that any investments you have with your main bank are insured under the FDIC insurance program. Not all investments are insured.
The good news is that FDIC claims that, “Since the start of the FDIC in 1933, no depositor has ever lost a penny of insured deposits.” It is also very likely that if the banking system ever does start to collapse, the government will likely step in to shore it up. If they do not do this, we are all in trouble, because the FDIC’s assets only cover a small percentage of the value of the accounts that they are insuring.