Tuesday, July 21, 2009

57 Banks go Bust

57 banks go broke

Fifty- seven American banks have failed so far in 2009. [Source: David Rosenberg of Gluskin Sheff]

When a bank fails in Canada, the Canada Deposit Insurance Corp makes good: CDIC insures that depositors get their money back, up to a certain limit. The Americans have a similar program. Because of this insurance, U.S. and Canadian depositors are not really at risk unless they deposit too much money in a single bank. With these bank failures happening in their own back yard, Americans are vigilant about making sure they don’t put too much money in any one bank. In 2009, there is clear danger in the US banking system; bank customers have to take the usual precautions seriously.

Why is it that a bank’s Guaranteed Deposit customer thinks so differently from a Mutual Fund customer? At the first sign of danger, Canadian bank customers review all their deposits to make sure they hold no more than the CDIC insurance maximum of $100,000 in any one bank. Amounts over $100,000 are not insured. If the bank fails, uninsured investors could lose their money.

Yet, in times of economic danger, those same customers won’t walk across the office to the bank’s mutual funds desk and redeem their stock market holdings. A stock market sell-off is way more likely than a bank failure, yet people do not protect themselves. What is it about the psyche of the average mutual funds investor that is so different from that of the average depositor, even when the investor and the depositor are the same person?

It’s the way these two different investments are sold.

A banker who persuades you to invest at today’s low interest rates will emphasize how safe Guaranteed Investment Certificates are. True, you don’t get much interest, but you are “guaranteed” not to lose. The banker’s pitch attracts investors who are afraid to put their capital at risk.

A bank’s mutual funds salesman or financial planner who sells you a stock market mutual fund will emphasize growth and higher long-term returns. The sales pitch includes a warning that mutual funds prices will fluctuate over time and that we should not sell because the stock market will be a good long-term investment even if it goes down for a while.

In other words, the mutual funds salesman prepares clients to take risk, but the GIC salesman prepares clients to avoid risk. So, at a time when 57 US banks have failed in six months, the GIC client checks his guarantee. But at a time when America’s biggest bank, stock broker, insurance company, mortgage company and car company had to be bailed out, the hapless mutual funds investor is told to hang in there and not worry.

It is clear that there are times of high economic risk, as well as times of less risk. But is there ever a time to ignore risk? Responsible investing is all about monitoring risk and making changes when financial risk changes. That change might be adjusting your GICs so that you don’t have over the insurable maximum of $100 thousand with any one bank; or it might be selling your stock market mutual funds and switching to some low-risk money market fund. But is it ever reasonable to expose yourself to big financial losses?

If those 57 American banks had been more risk averse, they might not have failed.

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