Everyone is afraid of falling off the "fiscal cliff." But there's another dangerous countdown clock about hit to zero.
And no one is talking about it, even though it will spell even more financial problems for us all.
At midnight on December 31, 2012, the Transaction Account Guarantee (TAG) program will expire.
The TAG program was initiated at the height of the credit crisis when depositors were fleeing banks for fear they would go under.
To quell what was turning into a run on banks, the FDIC upped regular deposit insurance from $100,000 to $250,000 and under the TAG banner initiated unlimited insurance for all non-interest bearing transaction accounts.
It's the second part that's important because that's the piece that will soon come to an end.
When the unlimited insurance expires, corporations, businesses and depositors — whose soon- to- be- uninsured deposits, which total some $1.4 trillion, are likely to flee smaller banks — will rush into money market funds and seek the safety of short-term U.S. Treasuries.
This will create serious negative repercussions affecting our economic future.
The Unseen Perils at the Bottom of This Cliff
Here's how each of those actions will affect the economy and you personally.
First, the too-big-to-fail (TBTF) banks that created the credit crisis and spawned the Great Recession are much bigger now than they were in 2008, and are about to get even bigger.
Because the failure of any one of America's big five banks would implode the global financial system, they will never be allowed to fail. That makes them a fortress for depositors, regardless of expiring guarantees.
The same isn't true for the smaller banks that will start disappearing.
U.S. corporations are sitting on at least $1.75 trillion in cash. Most of those funds are being held in checking and transaction accounts.
When the unlimited insurance on their deposits expires they will move some of their money elsewhere. But, on account of large payroll and other transaction account services corporations are reliant upon, a lot of that cash will still be parked at the biggest banks.
Cash on deposit at other institutions, greater than what will be insured, which is $250,000 since that higher insurance guarantee was made permanent, will gravitate to the big banks because of their fortress status.
But, it's not just big corporations that will park their money at big banks. Most other businesses that have transaction accounts with balances above the covered $250,000 limit will start moving their accounts to the TBTF banks for the exact same reason.
The problem for the economy is that TBTF banks are going to have to make bigger and bigger loans and orchestrate far-reaching lending schemes that encompass wide swaths of the population (as they did with mortgages) to accommodate the greater economies of scale their huge size demands. That's going to lead to massive concentrations of risk, which the TBTF banks have proven has been, and will be, their downfall.
Personally, for you and me as small consumers of banking services, there will be less competition, and borrowing and transaction costs will rise.
Community banks will start disappearing. Access to credit at the local level will be replaced by impersonal lending factories, which as a result of their economies of scale will not likely be willing to bear the one-off risks of financing small business start-ups and small business' credit needs, at least not without charging significant "risk premiums."
Second, in the Federal Reserve no-interest rate environment, depositors were more comfortable leaving their money in insured accounts than chasing tiny yields on the short-term instruments available to them. With the expiration of unlimited guarantees many corporations and businesses will start looking for some yield on their idle cash.
The reason they will start reaching for yield is that companies, whose treasury managers are counted on to shepherd cash balances, will want to add income to their huge cash hoards and can no longer justify parking cash just to be safe.
Money market funds will be the preferred parking place for a lot of that cash. Even though money market funds don't pay much, they allow quick withdrawals and are considered a good substitute for non-interest bearing checking accounts at banks.
But, there's a problem with money market funds. They aren't guaranteed.
They were back when the Federal government was guarantying all financial parking lots at the time of the crisis, but no more. The Securities and Exchange Commission has been trying to get money market funds to set aside capital reserves, like banks have to do, but to no avail.
What's potentially problematic is that if billions of dollars of cash goes seeking some yield in money market funds, fund managers are going to have to put those new monies to work.
And where do a lot of money market funds go to buy short-term interest bearing instruments so they can offer the best yields to potential billion-dollar customers?
Too often they turn to European banks issuing short-term paper, unfortunately.
If money market funds see huge inflows as a result of cash coming out of uninsured checking accounts, they will start reaching for yield themselves. And we know where that can lead the economy.
Personally, for the rest of us starving for yield, some of those money market funds may start looking more enticing. But, they aren't insured and you may be heading into a trap.
Even More Unintended Consequences
Lastly, and this is as convoluted and complicated as it gets, a lot of the cash coming out of bank checking accounts is going to go into short-term Treasury bills and notes.
The unintended consequences of that happening are going to spread through the capital markets and end up causing economic problems on top of the ones we already have.
Right now the Treasury issues about $30 billion of one-month T-Bills every week.
If the majority of the $1.4 trillion sitting in banks in soon to be uninsured accounts heads into these most liquid instruments it would take a year of issuance to satisfy that demand.
Now, don't forget, the Federal Reserve is buying some $45 billion a month of Treasuries and agency paper. And, what about money market funds? If they get flooded with cash, they too will be buying the short- term issues spit out by the Treasury.
Not to complicate things, but what happens if there is actually some deal on the fiscal cliff that results in smaller deficits? Oh, the Treasury wouldn't have to issue as much new debt as it doe s now.
The demand for short-term Treasuries could very conceivably turn their yields negative.
What happens then? As if corporations, pension funds, and people aren't yield starved enough. Will the further implosion of yields and the continuing destruction of fixed income cause everyone to reach further and further out on the risk curve?
It's already happening. Junk bond funds are seeing record inflows as investors are clamoring for yield.
And just like what's going to happen with money market funds, issuers of junk are rushing to soak up the cash being waved at them by the funds trying to place their customers' new money.
Personally, are you going to get caught up in that rat race and end up in another trap?
There's no question that the fiscal cliff is on everyone's mind and certainly front and center in the financial news and press.
But, if we don't look hard and fast at what could happen, and probably will happen when TAG becomes just another legacy of the credit crisis, we may miss the naked truth that the flames of the next great financial conflagration are being fanned starting January 1, 2013.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
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