What if Your Bank Fails? Facts about FDIC Insurance

Chances are you've seen the news footage of angry, frightened customers lined up for blocks outside California's IndyMac Bank to get at their money before, or just after, IndyMac's recent bankruptcy. The FDIC (Federal Deposit Insurance Corporation) seized the bank this past Saturday for being inadequately capitalized, which is a fancy way of saying the bank went belly up. It didn't have enough assets to cover the money its customers had deposited there.

The FDIC has a list of 90 financial institutions that it expects may fail in the coming year, and it expects to expand that list to 150 institutions very soon.

What happens if your bank fails? Is your money really safe?

The FDIC was founded after the Great Depression to insure deposits in retail banks and in doing so to (hopefully) prevent bank runs. A "run on the bank" occurs when customers lose confidence in a bank and all of them begin to withdraw their money at the same time. This can effectively cause even a healthy financial institution to shut down very quickly. Bank runs are panicky, ugly affairs that, once started, are hard to control.

Basically, a run on the bank is a self-fulfilling prophecy: Short term loss of confidence in a financial institution leads to large scale panic withdrawals which lead to bank failure. IndyMac may well have failed on its own eventually, but what closed IndyMac even faster than its own bad decisions was a classic bank run that took place over the course of last week.

The recent hubbub over Fannie Mae and Freddie Mac was also basically the result of a bank run (except Fannie and Freddie are investment banks, not retail banks like the kind where you have your checking account). Investors all wanted out of Fannie and Freddie at the same time and panic spread like wildfire in only a few days. Since investment banks are not covered by FDIC insurance, the federal government stepped in instead. Bear Stearns was also an investment bank: No FDIC for Bear Stearns, so Bernanke personally brokered a deal to prevent an upset of the entire US financial system.

The FDIC insures your deposits in your retail bank for up to $100,000. That figure represents a total of all your deposits at a single bank. (So, if you have money at a second retail bank as well, you have another $100,000 in FDIC insurance.) Deposit accounts refer to most ordinary liquid accounts such as checking and savings accounts, and also term accounts like Certificates of Deposit (or CDs).

Say you have $100 in your checking account, a savings account with $700, and a CD worth $52,000, all at Big Wipe Bank Inc, for a total of $60,000 at Big Wipe. Your entire $60,000 is insured by FDIC, and you could safely deposit another $40,000 at Big Wipe and still be insured. This means that if the Big Wipe fails and is shut down, you get all your money back from the federal government through FDIC. You go to the bank after the failure, they give you your money, The end.

If you are married and hold joint accounts at Big Wipe, you are insured for up to $200,000 for the combined amount of your joint holdings, or $100,000 for each of you. If you have an IRA at Big Wipe (an Individual Retirement Account), your IRA is insured by FDIC for $250,000.

What if you have more than $100,000 at Big Wipe? (Or, if you are married, more than $200,000?) What should you do?

Sometimes, simply by titling your account differently, you can obtain another $100,000 in FDIC insurance. Ask someone at Big Wipe who knows what they are doing if you can add a signor and by doing so get all your money covered. For instance, if you have a CD worth $200,000 at Big Wipe in your own name, you may be able to put $100,000 of it into a separate CD with your name and your nephew's name on it. That would give you two CDs insured for the full $100,000, because they are titled differently.

Maybe you don't trust your nephew as far as you can throw him, and you'd rather not put him on your CD thank you very much. In that case, should Big Wipe fail, you will get $100,000 of your CD without any problem, but only a percentage of the amount over $100,000. Currently, the FDIC is anticipating paying out 25-50% on deposits over $100,000 at IndyMac. That means you would get as little as $125,000 on your $200,000 CD from FDIC should Big Wipe go down the tubes.

Should you pull your money out of Big Wipe if you have much over $100,000?

That depends. Most CDs come with hefty penalties for early withdrawal, so you have to factor that into your decision. If Big Wipe is in the same league as giants like Citigroup and Bank of America, leave your money alone. Those banks are not going to fail. Don't stress yourself out by moving your money all over the place out of fear.

However, if your $200,000 is in a troubled regional bank and you feel you have reason to be worried, talk first to your banker about retitling and redistributing your wealth to make certain it is all insured. You can read all the guidelines, and even use a handy calculator at www.fdic.gov and determine on your own how much insurance have before you even go down there.

In fact, I recommend you do that. You can also request a free brochure at the webiste which lists all the FDIC insurance guidelines and rules. Take it with you when you go down to Big Wipe to talk with them.

If it turns out that you do have to move some of your money to another bank in order to have all your deposits insured, please be sane and calm about it. Don't run down to Big Wipe and take a cash withdrawal of $50,000 out in front of other customers, then make a big noise and scream and cry when they say they have to plan that in advance, then set off a panic and risk getting your neck broken on the way to your car and all your money stolen.

Instead, first shop around for another CD or high-interest savings product at a stronger bank (ING has great rates and is one of the few international banks that steered clear of the subprime mess, so its solid as a rock), then have your new bank initiate a wire transfer of your funds out of Big Wipe so you don't have to turn yourself into a mugger's wet dream.

Never act out of fear. That never, ever goes well in any venue.

Maybe you are thinking, yes, yes, but what if a bunch of banks fail and I can't get my money because FDIC is freaking out too?

First of all, calm down will you? Didn't you read the last sentence of the last section?

Seondly, there are lots of things you can do to make yourself feel (and be) more secure. A good place to start is to begin educating yourself about your chosen financial institution. Did you open your account with your current bank because they have a cool hologram of the Ramones on your debit card, or because they were giving away insulated coolers that week? Fine, don't beat yourself up, just get some more facts and check them out a bit.

Go to the New York Times website and check out your bank's performance by entering its stock symbol in the rectangular box on the right under the stock averages. The box says 'Get Quotes'. (If you don't know your bank's stock symbol, you can look it up at MSN Finance by typing your bank's name in the lookup box on the left.) The 'Get Quotes' box will take you to a page that shows your bank's current stock price, as well as how the current price fares against the price for the past 52 weeks.

Has the price dropped 70 to 90% in a year's time? That's one red flag, but don't go taking all your money out just yet. At the bottom of the page you will see a list of articles about your bank that appeared in the NYT over the course of the past year. Read some of them. Look for subprime debt problems. Does your bank own a lot of debt? Were their problems with their debt-holdings resolved or are they still hanging over the bank's books?

Then look at the press releases the bank has issued about itself. (They are located under the news articles.) Red flags here include recent CEO turnover, news releases that state that everything is fine, (a bank never issues a release like that unless everything is not fine), and attempts at capital infusions (attempts by your bank to borrow or raise money) with no later releases about how happy the bank is that it got the money.

Once you are done checking out your bank, check out how it fares compared to other banks. The NYT page about your bank will show how banks that are roughly the same size and type are doing by comparison on the top right.

This all may sound boring, but here's the thing: You still can choose where to keep your money, and you don't have to wait until the world is crashing around your ears to make those choices. If banks know that depositors don't care for high risk shenanigans and they know they will lose customers over it, they may or may not change, but if you make informed choices based on your own research, not the latest doo-dad freebie offered to entice you, you will at least know your money is as safe as it can be, given the current climate.

Knowledge is as close to power as you are going to get in this arena.

Finally, keep some cash around. This is just good sense. Most homeowner insurance policies will cover cash in your home up to $200 in the event of a break in, so don't keep much more than that, but if you can, put $200 in a freezer container and keep it on hand in case of whatever. If a storm knocks out your local power or you have an emergency, it's right there to get you through a day or two at least. If your bank fails, you can pop open that freezer container and keep yourself in toilet paper until you can get down there and wait in line for the government to give you your money.

What if the government fails? Geez, how should I know? Take that $200 and get your butt across the Canadian border before they shut it down!

In the meantime, relax.

It's only money.