April 24, 2014

If You Are Sitting on a Huge Pile of Cash, There Is Only One Place to Park It (and It Is Not In a Bank)

For the past day, I’ve been thinking about a 65 year old man named John Demetriou.  He was from Cypress, but moved to Australia, where he spent 35 years working “days, nights and weekends in Sydney markets selling jewellery and imitation jewellery” according to The Sydney Morning Herald.  

Wanting to be in his home country, and near some of his family, he traveled back to Cypress, deposited his entire life savings of $1 million in the Laiki “Popular” Bank, but kept it denominated in Australian dollars, while he looked around to decide if he wanted to build a house.  Once he had enough set aside to cover his medical bills and some of his personal needs, he planned on using the money to give his grandchildren a head start in life, including paying for their university education.  

Then, the Cyprus banking system collapsed.  He said, “I went to sleep Friday as a rich man.  I woke up a poor man.”   It appears as if the first $100,000 in deposits will be saved, but the rest of his money, the other $900,000, will be wiped out as the bank is wound down in liquidation.  

Thirty five years of his life is gone.  All of those late hours, wiped out completely.  It absolutely breaks my heart.  People have grown so complacent with the stability of the world in the past century that they have forgotten how horrible it can get when times are tough.  That is one of the reasons I’m constantly harping on you all to familiarize yourself with financial history.  It’s why I tell you to suck it up and pay the $200 to buy now-out-of-print books like The Crash and Its Aftermath: A History of the Securities Markets in the United States 1929-1933.  The lessons these accounts can teach you can save your entire net worth, and help you avoid some pretty horrible outcomes.

In the case of John Demetriou, he is now prevented from even accessing his foreign currency deposits in an amount more than the equivalent of €300 per day.  The cashing of checks is prohibited.  I mean, it’s horrific.  Read the official decree the bank posted on its site.  To understand how it is going to be resolved, Wells Fargo’s private bank has already sent its clients a very nice breakdown of the Laiki Bank situation with known factors, explaining what is happening on the other side of the world.  They really did a good job with it.

The moral here is one that I think a lot of people take for granted: You never keep your entire net worth in a bank, especially if you have a balance in excess of the insurance limits in place by the sovereign government backing your claim on the financial institution.  

Most of you are United States citizens.  If you suddenly found yourself on a very large pile of money – maybe you sold a business, maybe you won the lottery, maybe you inherited a fortune from a long-lost relative – there is only one place in the entire world the cash should be parked, presuming the United States is still the wealthiest and most stable country on the planet: Directly with the United States Treasury, in short-term T-Bills.

TreasuryDirect

You can open an account with TreasuryDirect for free online, and it takes less than three minutes. You can use it to buy Treasury bills, bonds, and notes, Series EE savings bonds, Series I savings bonds, and more.  Right now, the savings bonds are terrible deals … all long-term bonds are, frankly, given the record-low interest rates.  But for cash equivalent reasons, extremely short-term bonds of 4 week maturity cannot be beat for safety of principal, especially if you are parking an amount in excess of FDIC insurance limits.

Nothing else is acceptable.  Even if all the banks in the United States collapsed, the primary advantage of directly held and registered Treasury bills, bonds, and notes is that you don’t have to worry about the deposits and liabilities of the institution.  Instead, you hold a direct, legal claim on a promise issued by the federal government, backed by its taxing power and constitutional requirement that all debt be honored as per §4 of Article XIV of the United States Constitution, which states, “the validity of the public debt of the United States, authorized by law … shall not be questioned.”  If that domino falls, nothing except a remote farm in the outer reaches of Canada, sitting on top of a secret silver mine with significant hoards of ammunition and food, would have done you any good.  When you need funds, you can transfer enough for your expenditures from your TreasuryDirect account to your financial institution with almost no effort.

This should be common sense but, sadly, people forget it when times are good.  Take the company that represents my family’s largest public securities holding, Berkshire Hathaway.  The $40+ billion the firm keeps in its legendary emergency cash hoard is parked in Treasury bills, bonds, and notes!  Do you know how much higher profits would be if those balances, earning 0% effectively, could generate 3% or 4% in alternative cash equivalents?  The risks aren’t worth it.  If management suddenly started putting all of the spare liquidity in auction rate securities or commercial paper, I’d get very worried.  

Spare cash, until used, is stuck in T-Bills.  That’s the rule.  It’s a simple one for those of you who exceed the FDIC limits.  Repeat it to yourself until you can’t forget it.  It’s not some meaningless platitude.

When you’ve designated money that absolutely 1. must be liquid, 2. must be stable in nominal terms (precluding commodities such as gold or silver), and 3. must be safe, nothing else comes close.  There are no alternatives.  You go to the pillar that, if it falls, all other banks have already failed.

If any of you are out there and have your entire life savings sitting in an account far in excess of the FDIC insurance limits, I am pleading with you to please consider the safer Treasury direct registration.  There are plenty of short-term options, like the 4-week T-Bills, that have negligible interest rate risk.  Otherwise, you are taking on an absolutely pointless exposure that achieves nearly nothing for you, but leaves you vulnerable to catastrophic wipeout in the event of another banking crisis.

Where do people think these giant corporations keep their cash?  Do people actually think that Apple has a checking account with $100 billion in it?  Or that McDonald’s parks all of its money in certificates of deposit?  They must just never consider the question at all.  

Do you not realize that if the bank that issues your credit card fails, it is entirely possible, depending on the legal structure of how the card was setup, that your card won’t be approved anywhere?  It dies.  Instantly.  These things can happen.  They haven’t yet, thanks to the intervention of the various government regulators (who, despite the press, did a really good job, all things considered, when the world was collapsing a few years ago).

Remember Benjamin Graham’s rule: More money has been lost reaching for an extra point or two of yield than stolen at the barrel of a gun.  It’s the most dangerous way to increase risk; a lesson the depositors in many of these countries are just now learning.  When it comes to liquidity needs, safety always trumps profitability.  The goal of liquidity is not to make you money; it’s to be there when you need to reach for it.

Update: The finance minister is now predicting that amounts in excess of €100,000 will see losses of 40%.  Perhaps, if he is lucky, Demetriou might be able to get back the first €100,000, plus 60% of the next €900,000, for a total of  €640,000.  If this comes to fruition, he will have lost €360,000, or 36% of principal.  It’s still life changing, but not nearly as painful as it could have been.  I hope it works out for him.  I can’t stop thinking about his situation.  Part of the problem is that he’s not exactly clear on what he owned; was it Australian currency parked in reserve or some sort of Australian dollar denominated money market fund that happened to be registered with the bank as a custody agent?  

  • Marc

    I take it every denomination of bank deposits would be equally at risk. (savings accounts, CDs, etc.) How about money market funds? Are those equally at risk too? Suppose you hold $X in a bank or brokerage, and X is greater than FDIC limit for the bank and X is larger than SIPC limit for the brokerage. If the bank/brokerage goes down, anything over than X disappears? In 2008, many banks went down and Lehman went down. I’d always assumed the depositors/brokerage customers were made whole somehow, even if their assets exceed the insurance limits. Did that not happen and everyone took a haircut?

    • Gilvus

      Joshua answered that question over at Investing for beginners. Click here and scroll down to the section on MMA vs. MMF.

      In fact, I’m surprised he didn’t link to that very article above, but he’s probably running in zombie mode right now.

      • Marc

        Got it, thanks for the link!

  • http://www.facebook.com/myles.ussher Myles Ussher

    Any thoughts on US citizens placing funds in a Canadian band denominated in Canadian dollars?

    What about purchasing Swiss Annuities denominated in Swiss Francs?

  • Tony Tsang

    I would be interested in hearing your thoughts on the safety of cash and securities held in brokerage and investment/retirement accounts. How does one keep their assets safe in this case? I know there is SIPC for amounts up to a limit, but where does someone like Berkshire Hathaway park all of it securities?

  • Anon

    Thanks for a very good article.

  • http://twitter.com/QuberaWealth Qubera Wealth

    So do you hold any gold?

    • http://www.joshuakennon.com/ Joshua Kennon

      Nope. Not an ounce. One of the businesses does have silver reserves, though, but they are negligible relative to assets.

      I’ve written about gold on the site in the past and have held it before. I’m not hostile to it as long as people understand that it is not an “investment” because it is not inherently productive. An investment must produce something of surplus value – farmland, a business that generates profits, a bond that pays interest.

      A gold mine could be an investment but a pile of gold couldn’t be.

      At best, a fixed amount of gold (in coin or bars) can be a short-term trade or, in highly inflationary economies, a store of value.

      If I were really concerned about the economy collapsing or something, I’d prefer large quantities of silver, copper, and other metals, myself. I’d also make them at least work for me. Melt down silver bars and create candlesticks, silverware, picture frames, etc. That way it wasn’t just sitting there useless.

      But no, no gold right now. I’d be open to buying some in the future, I suppose, but as a trade or a store of value in specific economic circumstances.

      • Andrew

        Good move staying away from Gold. I do wonder now if the miners aren’t oversold though. Many trading below book value, while still paying margins. Presumably some of the juniors will have to close up shop or go out of business though.

        Unfortunately I have a large position in Gold out of fear of inflation that has dropped significantly in value. Fortunately I’ve found your site though and can hopefully learn what real investing involves.