We Prefer A More Secure Financial Institution
By Paul Lamont
July 29, 2008
***We caution that this is not legal advice, so please consult your own legal representative and your own account agreement.***
As we referenced last April, it is very important in a deleveraging environment to hold your U.S. Treasury Bills at a secure financial institution. Calling brokers and reps up and asking them if your funds are safe at their institution is like asking the fox if the chickens he is guarding are safe. What do you expect them to say? Since we are independent and only work for our clients, we have been diligently researching the different types of asset custodians. Here is what we found:
Trust Company - According to the American Bankers Association: “Assets held in custodial accounts in the trust department of a bank do not become assets of the bank and are segregated from the bank’s assets.” More importantly, “Account ownership in the assets remains vested in the individuals or entities for whose benefit the bank is acting as custodian and the assets are not subject to the claims of creditors.” The FDIC has confirmed this. Since this is the strongest claim of ownership, retirement and high net worth accounts are held in custody accounts at a Trust Company when you open a LTA U.S. Treasury Bill Account.
Brokerage Firm – A conservative brokerage firm is the next step down in ownership claim. Only two brokerages in the country have made it through our selection process (the third we had to pull accounts from due to a merger). Why is this even a concern? Securities held at a brokerage firm are in ‘street name.’ This means they are registered under the name of the brokerage at the DTC, the system-wide clearing company. Brokerages then record on their books that they hold securities for the ‘benefit of the owner’ held at the DTC. What an individual client of a brokerage firm really owns is a percentage of the securities held in the client pool. This is not full ownership. If an investor has a margin account, the brokerage company may lend out those securities. (Even if you do not, but the brokerage firm promotes margin accounts, securities lending could diminish the client pool in a systemic crisis.) Also highly leveraged client bets may create losses that affect the entire client pool, as happened in the failure of MJK Clearing. So in our view, accounts held at Wall Street investment banks and brokerage firms that deal with leveraged players are not secure. When presented with the evidence, most folks would prefer to deal with only highly rated financially stable brokerage firms.
Bank – Frankly, we do not want to be depositors or creditors at any bank. Banks are even wary of lending to other banks. Instead, cash can be held at more secure institutions. Debit card and check writing capabilities can also be obtained at institutions less likely to be ‘bailed’ out by the government. As John Bovenzi, the FDIC's chief operating officer, recently stated: IndyMac bank “is as safe and as sound as any bank in the country right now.” (Cough.) As we discussed two months ago, comparing bank stock prices is the best determinant of financial health if you have to have a bank account. While stock prices can change, perceptions do create reality.
Worst Case Scenarios
We will continue to search for higher ground during this seventy year flood. If you have read our past reports, you know that we try to stay out ahead of the herd. But we also have to admit, that while we are doing everything we can, something may happen that we cannot stay ahead of. This credit crisis is one for the history books. Funds may be unavailable for extended periods of time. So with that, we give you the worst case scenarios:
“Since assets held in trust, fiduciary and custodial accounts do not become assets of the bank (title is held by the account’s owner(s)), it follows that none of this property is subject to the claims of the bank’s creditors. As a result, a failure of a bank will have no adverse effect. In the event that a bank with trust, fiduciary or custodial powers fails, the FDIC will seek to transfer responsibility for administration of the accounts to a successor trust institution as quickly as possible. Provided this effort is successful, the account beneficiaries would need to either accept this new arrangement or make provisions with the successor bank for alternative arrangements. Therefore, the safety of trust, fiduciary and custodial assets is not dependent upon whether the bank has assets greater than its liabilities. Property held in these accounts belongs to the owner(s) of the accounts and would be unaffected by a bank failure.” - American Bankers Association
“When a brokerage firm is closed due to bankruptcy or other financial difficulties and customer assets are missing, SIPC steps in as quickly as possible and, within certain limits, works to return customers' cash, stock and other securities. Without SIPC, investors at financially troubled brokerage firms might lose their securities or money forever or wait for years while their assets are tied up in court. SIPC either acts as trustee or works with an independent court-appointed trustee in a brokerage insolvency case to recover funds. The statute that created SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities - such as stocks or bonds -- that are already registered in their names or in the process of being registered. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $100,000 on claims for cash.” - SIPC
“Since deposit account assets become assets of the bank, it follows that the depositor would become a creditor in the event a bank failed. However, the FDIC insures depositors for up to $100,000 per individual per bank.” - American Bankers Association
Over-the-limit depositors are at the mercy of the FDIC.
We have had quite a move down in the major stock indices over the last two months. We wouldn’t be surprised if we corrected upwards for a few weeks. This would set up the major down wave for the fall. We hope you are able to secure your funds. If you would like assistance, please contact us. Expect Friday afternoons to get more exciting, as that is when the FDIC historically announces bank failures. The fire sale forecast last October continues.
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***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.
Copyright ©2008 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at firstname.lastname@example.org, or call (256) 850-4161.