Sunday, July 13, 2008

In The Wake Of IndyMac: A Brief Tutorial On What Happens If A Bank Fails

The IndyMac bank failure, the home mortgage crisis, and accompanying reports of troubles experienced by Countrywide, have undoubtedly sparked questions in the minds of consumers about the security of our banks and deposits. Many of us were raised by our parents on tales of bank failures during the Great Depression. At the time, when a bank failed, your assets disappeared. Thanks to the Federal Deposit Insurance Corporation (FDIC), that problem is mitigated; it is charged with insuring deposits in banks and thrift institutions up to $100,000 per depositor in individual accounts and $250,000 in retirement accounts.

But still, many people want to know what to expect in advance if a bank should fail. Via the Overthrow blog, I learned of the Bankrate website, which published an interview with an FDIC spokesman, David Barr, about the procedure. [Ed. Note: The Overthrow blog no longer exists.]

According to Barr, no prior notice is issued. The announcement, via news release, which will be spread by all the usual media outlets, is normally made after the bank closes and the FDIC becomes the receiver. What happens afterward depends upon whether or not a buyer for the bank has been found.

If a buyer has been found (Barr claims a buyer usually is found immediately):

- The bank usually closes on a Friday and reopens the following Monday
- Assets up to the $100,000 limit will still be available during the interim. This includes debit and ATM cards.
- Checks will continue to clear.

If a buyer has not been found:

- The bank closes, again generally on a Friday.
- Assets will be unavailable to the depositor during the interim. Bankcards and ATMs will not work, checks will not clear.
- Beginning the following Monday, FDIC will begin mailing checks to the customers for their insured portion of their deposits, along with a final statement so they'll be able to reconcile their checkbooks to see which checks haven't cleared. If they have checks that haven't cleared, they'll have to contact those merchants to make other arrangements.

Deposits above and beyond the insured amount do not completely disappear. As Barr explains it, such people become creditors of the failed bank's receivership. As the FDIC sells the assets of the failed bank, they'll make periodic payments to the creditors. The good news for the uninsured depositors is that they're top-tier creditors, meaning they must be satisfied before money flows down to other tiers. But you won't necessarily get the full amount. The amount uninsured depositors receive for their excess funds can vary from 40 cents on the dollar to 100 cents on the dollar; on average it's around 72 cents on the dollar.

Read the full post to find out about the disposition of mortgages and other loans. In general, customers should continue to make their payments as usual until notified to do differently.

A companion post on Bankrate projects the likelihood of bank failure. In general, they expect the bigger banks and savings and loan associations to survive the mortgage debacle and ensuing credit crunch, albeit somewhat battered and bruised. Smaller banks may not fare as well, although failures are expected to be spotty. The FDIC insures approximately 8,500 institutions; 79 of them are on the agency's secret list of problem banks as of December 31st, 2007. Being on the problem list doesn't mean that a bank will fail; in fact, the agency says historically about 13 percent of banks on the list fail. However, the mortgage debacle is a negative departure from historical trends.

Of course, Bankrate's analysis presumes we will have conditions conducive to a normal recovery. They do not account for a spate of terror attacks, natural disasters, entry into another war (Iran, for example), or the prospect of other nations suddenly dumping dollars en masse or refusing to finance our debt. Any or all these factors could crash the economy completely.

One way to keep all deposits covered by insurance is to make sure no single account exceeds the insured limit. In another post, Bankrate discusses an innovative way to accomplish this through the use of CDARS.

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