Citigroup can limit demand deposit withdrawals and money funds can too
Apparently, some of the ‘best reforms’ now being instituted in the U.S. to prevent a liquidity crisis in the future include limitations on demand deposits (hat tip Karl Denninger). What financial institutions are trying to prevent is a bank run in whatever form it can take – via depositors in the case of IndyMac and Washington Mutual and via interbank loans in the case of Bear Stearns.
Citibank has come up with an innovative solution – turn demand deposits into 7-day deposits:
Seen on a recent Citibank (C) statement: "Effective April 1, 2010, we reserve the right to require (7) days advance notice before permitting a withdrawal from all checking accounts. While we do not currently exercise this right and have not exercised it in the past, we are required by law to notify you of this change."…
I called Citi about it and they said the warning applies only to customers in Texas and that the notification had been mistakenly included on statements nationwide. Whatever the explanation, it doesn’t exactly inspire confidence in Citi. I’ve got nothing against Citi as a general matter — I have friends who work there, and know some account holders who are generally satisfied customers. But it’s hard to believe a bank would be sending out a notice like that on its statements.
This may be good for Citi but I wonder how it is legal. After all, the point of a demand deposit is to provide safekeeping for one’s money. Otherwise, with interest rates at zero percent, why not just keep your money under a mattress? I find it hard to believe that Citi can simply decide to require seven days notice. I am sure that Citi uses the standard credit card tactic of issuing all affected account holders a notice in full legalese of the changes that are being instituted, giving them an option of closing their account.
Nevertheless, this strikes me as a gross breach of trust – and a good reason we do need a consumer financial protection agency. Consumers simply do not have the financial acumen or alertness to spot this kind of move down the slippery slope to making all demand deposits into time deposits. How many customers would get a legalese notice informing them of their rights and options and simply disregard it because it is too hard to understand or sent in the same manner as less important junk mail from Citi? And what’s to stop Citi from changing this to 14 days or 21 days?
An interested commenter on the cited article above pointed to this particular passage in a recent SEC proclamation which effectively does the same thing for money fund deposits – turning them from demand deposits into time deposits.
Suspension of Redemptions: The new rules permit a money market fund’s board of directors to suspend redemptions if the fund is about to break the buck and decides to liquidate the fund (currently the board must request an order from the SEC to suspend redemptions). In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund is now required to notify the Commission prior to relying on this rule.
This innovation was buried near the end of a press release from 27 Jan 2010 entitled “SEC Approves Money Market Fund Reforms to Better Protect Investors.” Again, the logic is the same; to prevent a money fund from experiencing a ‘bank run’ as some did after Lehman failed, the fund may suspend redemptions for an undetermined period. Translation: just when the economy is in a panic, you could have all access to your funds blocked indefinitely.
While these demand deposit restrictions may safeguard individual institutions, they are unlikely to safeguard the system. You have to understand the psychology of a bank run. A demand deposit like a savings or checking account is a bank liability because the money is owned by the depositor. She is merely storing it at the bank for safekeeping and ease of use. Bank runs happen because of fractional reserve banking – in which the bank does not have all of the deposits on hand because it has lent out these funds to earn a profit. Thus, if everyone simultaneously appears and demands deposit funds, the bank would be wiped out.
Depositors understand this; and, thus, when a bank’s solvency is in question, the psychology of a run becomes self-fulfilling. In a bygone era before insured deposits, bank runs were about actually losing one’s hard earned cash. During the Great Depression, it was imperative that one got one’s money out first. Those who get their money out last were wiped out.
But today it is not about fear of losing one’s money as much as about fear of losing access to one’s money. Bank deposits are insured up to $250,000 for individuals and $500,000 for married couples. Moreover, customers at insolvent banks now being seized regularly by the FDIC have largely seen no problem in accessing their money when their institution fails. So, right now, most people believe they will eventually receive all of their deposited funds. The key word here is eventually. If a bank run occurs in a world of insured deposits, it occurs much more because people fear they will temporarily lose access to their funds for an undefined period of time. Most people understand they will eventually receive their money, as the FDIC seizures demonstrate.
Restricting demand deposits in a way that makes it unclear when people will have access to their funds – especially since they need daily access to their checking account or money fund – makes them more likely to withdraw funds before everyone else does. Where would you rather have your funds: at an institution with withdrawal restrictions or at one without limitations on access to your funds? In essence, the Citi and SEC proclamations make the affected institutions more vulnerable, not less. This also makes the whole system more brittle and subject to the panic that uncertainty generates. If we do see another panic and liquidity crisis, watch what happens.
Citi Warns of Withdrawal Gate – Seeking Alpha
> And what’s to stop Citi from changing this to 14 days or 21 days?
Or 365 days?
I have not been a fan of this idea of a Consumer Protection Agency … but if Banks were to become preditory, then maybe it’s worth talking about. The biggest problem I have so far is that no one promoting this idea has been willing to provide some sort of a “straw man” proposal as to how might this Agency would be, to whom it would report, and how many of its employees would be lawyers. It seems to me that Congress should not be delegating a lot of power to another unaccountable bunch of government employees.
Yet another agency – this time for consumer financial protection – is what people fear. But if you have any better ideas, let’s hear them! The fact is banks are selling people dangerous products and these products need to be regulated by an agency of a ‘regulatory mindset’ i.e. protecting people from fraud and coercion. In my view, the fact that the Fed was such a poor regulator was a large part of the problem in the U.S. bubble.
We need consumer protection against predatory lending – particularly in credit cards and mortgages.
> But if you have any better ideas, let’s hear them!
At the moment, I don’t. Before Sept. 2008, I had never heard the terms MBS, CDS, Tranche or AIG. It’s been a hellava lot of work for me to dig thru mountains of material to teach myself (with the help of blogs like this one) what all this means. To be frank, it’s very confusing .. since it’s clear that a lot of the material in the financial world is proprietary and not open to public inspection.
As I pointed out in the first comment, where is a prototype of this agency. No one should be expected to buy anything “sight unseen”. And certainly as we have seen with Agencies like the EPA and the FDA, they don’t work for “the little people” .. so why should the CPA?
Come up with an org chart for this Agency. How is it going to function. Will it be able to refer criminal proceedings to any enforcement Agency .. or will it be like the NTSB .. able to make recommendations .. but not able to force, or enforce, their recommendations. And what happens when this Agency becomes “heavy handed” .. as they invariably will? What happens when Obama (or some future Obama) appoints a lot of anti-finance people to key positions?
What would it take to get a “working group” up for those people, many who seem to be professional economists, to put together a 50-100 page working paper that outlines your ideas?
Or we could just move to a narrow banking model and prevent banks from
engaging in a whole host of practices which are now the subject of regulatory
debate. But Congress won’t go there. It would be preferable to prevent a
problem from occurring than establishing regulation in response to a
In a message dated 2/21/2010 09:53:13 Mountain Standard Time,
Yet another agency – this time for consumer financial protection – is what
people fear. But if you have any better ideas, let’s hear them! The fact
is banks are selling people dangerous products and these products need to be
regulated by an agency of a ‘regulatory mindset’ i.e. protecting people
from fraud and coercion. In my view, the fact that the Fed was such a poor
regulator was a large part of the problem in the U.S. bubble.
“I find it hard to believe that Citi can simply decide to require seven days notice.”
I found it hard to believe that we’d ever embrace torture or a doctrine of pre-emptive war, too, Ed. But when you own the government in all three of its branches, you can do just anything you want. As we all know, Citibank has liquidity problems, so profound it would seem that they conveniently forget to pay insurance premiums from time to time from the escrow accounts they manage as mortgage holder. And when you’re all ready to charge something on a Citibank run VISA card, occasionally you’ll learn that your account may have been compromised unexpectedly by a “merchant snafu” which requires them to put a hold on your account until they can get a new card to you. Little things, no doubt, but when taken together with something of the kind Denninger reports, you begin to grasp the full dimensions of their problem. I think he’s right, I’d pull any demand deposit account I had with Citibank.
This gives the “Move Your Money” campaign a rallying call, doesn’t it?
It most certainly does.
I can’t get on board with your calling for a Consumer Protection Agency. One, customers, or the market as they make up, should invalidate moves like this by moving their money. I tell everyone I know to move their money from the big banks to a local credit union or smaller community bank. If customers punished companies that enacted these silly policies, then these policies wouldn’t be developed in the first place.
This leads to your second point that customers are too ignorant to take notice of these policies. It is true that consumers don’t take the time to read all the legalese that accompanies monthly statements; I am guilty of that myself. However, I think we have the responsibility to do so. When you create agencies that supposedly protect the populace, the citizens get lazy. They irrationally assume the government is taking care of them so they don’t use the matter between their ears. This applies to the FDA, SEC, and essentially every other watchdog government agency.
The reason these agencies are a false protector is they are run by government organizations. The leaders are easily bribed, or influenced, by lobbyists. The policies set are based to help those folks more than the citizenry. Then the government workers who enforce the policies are entrapped in a bureaucratic maze that limits their ability and punishes innovative thought. It creates the mentality where they try to avoid mistakes or responsibility because that is the only thing that can hurt their career.
We are much better letting the American citizens realize that they are on their own and need to act accordingly. They will do so and will hopefully take their business elsewhere when inane policies like this are enacted.
So fraudulent practices on behalf of the banks are supposed to be ignored?
In a message dated 2/21/2010 11:42:59 Mountain Standard Time,
We are much better letting the American citizens realize that they are on
their own and need to act accordingly. They will do so and will hopefully
take their business elsewhere when inane policies like this are enacted.
we shouldn’t use regulators – who do eventually get captured by industry as an excuse to absolve ourselves of our own responsibilities. Moreover, we can’t trust the wisdom of a regulator more than we can trust the market to take corrective action. However, there are two points in having regulators.
The first is fraud and deceptive practices. While we can’t expect perfection, we should expect a robust prosecution of fraud and deception in financial services in the same way we do with drugs, food, automobiles, etc.
Second, we need to eliminate the byzantine regulatory maze in financial services: the OCC, FDIC, the Federal Reserve, the SEC. The whole apparatus is counterproductive. In establishing consumer protection, we should be looking to align it with/under an existing regulator which has primary responsibility for financial services, probably the FDIC.
What I would propose is not adding regulatory structures but combining them. For instance, the Commodity Futures Trading Commission (CFTC) should be an agency that reports to the primary banking and financial services regulator – again, perhaps, the FDIC, the point being that a JPMorgan Chase is both a bank and a commodities trading firm so we need a holistic structure that takes this into account.
Your FDA example is a very good analogy. That is the kind of protections consumers need in finance – not as another layer of regulation but as a holistic protection against fraud and deception.
Marshall’s view of just hiving off commercial banking into a utilities model of boring here’s your toaster with your savings account banking is the only other way to accomplish this.
If the actions taken by the banks are fraudulent, as Marshall implies, then the recourse should be through the court system. Fraud statutes exist so those who have been defauded have legal recourse. A staff of regulators or bureaucrats will not provide consumer protection.
Edward points to my FDA example, and I agree it is a good analogy. The FDA really provides very little protection. Any problems with a food or drug provider is never discovered by the government. It is either the consumers or the producing company that eventually bring to light the problem. The same goes for the NTSB. The Toyota predicament is a prime example. The government comes in after the fact demonizing Toyota. The reality is Toyota will suffer due to lower future sales as consumers stop buying and the lawsuits that are being filed.
And, the official policies developed by the FDA are controlled by the lobbying efforts of the food and drug providers. Do you really think our food is safer than it was before the FDA? All the chemicals, pesticides and steroids that are “government approved.” Or, did the lobbies do a number on the policy makers.
The problem is people feel the government is proactively protecting us with these organizations. We don’t think about these issues because we think we are protected.
I agree that we should strive to make the current agencies more efficient and effective, but the calls for efficient government have been in existence since the start of governments. I like to be optimistic, but optimism without reality is dangerous or naive. I worked in a government agency in DC. Our better bet is creating laws that severly punish fraud and other corporate malfeasance as a deterrent. Of course, this probably still won’t stop morally corrupt folks like Madoff or some of those in banking.
You need both, but we don’t seem to have sufficient resources in the Dep’t of Justice to fight fraud.
On the basis of your logic, we shouldn’t have an FDA, an EPA, and SEC because the legal system can take care of everything.
Kinder,you’ve bought into the anti-regulatory propaganda of the kleptocrats, because you have the causality wrong. It goes de-fang the regulators to increased product problems to preceived regulatory failure to claims that regulation doesn’t work and is unnecessary. Of course it doesn’t work! That is a self-fulfilling prophecy if you de-fang the regulators. Look at the SEC where resources were diverted HUGELY to terrorism and away from Fraud.I have personally witnessed the regulatory agencies emasculated over a 30-year period. The problems you now see are the result of a concerted effort at non-regulation, particularly under George W. Bush – putting people who are ideologically opposed to regulation in control of the agencies and reducing their funding.Wake up! The reality is regulators are always the first line of defense. It is extremely facile to think individuals can be protected against a wealthy multi-national in the courts alone. Again – regulation has to ALWAYS be a first line of defense. I find it mind-boggling unrealistic to think courts alone can solve any systemic problems like fraud. If that’s your solution get ready for financial Armageddon, that’s all I can say. And you will deserve the depressionary collapse that results for allowing these frauds and deceptions to go unchecked.I mean why don’t we just get rid of police officers for god’s sake – and let criminals be prosecuted in court too? C’mon, use your brain.
Just to reiterate Ed’s point, first, the people who rail about “excessive
regulation” seek to gut civil litigation. They don’t want anything (bad)
done to corporate elites. Second, they’re either intellectually dishonest
or completely ignorant about the limitations of civil litigation to limit
civil fraud. Effective regulation is almost always the most efficient answer
to market failures (as Ed explains, everything else is way too late and
must rely on general deterrence of future frauds).
In a message dated 2/21/2010 15:58:17 Mountain Standard Time,
Edward Harrison wrote, in response to kkinder94:
you’ve bought into the anti-regulatory propaganda of the kleptocrats
because you have the causality wrong. It goes de-fang the regulators to
increased product problems to claims that regulation is unnecessary. Of course,
that is a self-fulfilling prophecy if you de-fang the regulators. Look at the
SEC who’s resources were diverted HUGELY to terrorism and away from Fraud.
I have seen the regulatory agencies emasculated over a 30-year period.
The problems you now see are the result of a concerted effort at
non-regulation, particularly under George W. Bush – putting people who are
ideologically opposed to regulation in control of the agencies and reducing their
Wake up! The reality is regulators are always the first line of defense.
It is extremely facile to think individuals can be protected against a
wealthy multi-national in the courts alone. Again – regulation has to ALWAYS be
a first line of defense. I find it mind-boggling unrealistic to think
courts alone can solve any systemic problems like fraud. If that’s your
solution get ready for financial Armageddon, that’s all I can say. And you will
deserve the depressionary collapse that results for allowing these frauds
and deceptions to go unchecked.
I mean why don’t we just get rid of police officers for god sakes – and
let criminals be prosecuted in court too. C’mon, use your brain.
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I think you are making too large a leap to say I want to disband the police. However, I still think you give the “front line” protection too much credit. Please provide me with a few proactive detections of major fraud by the SEC, FDA, or other front line folks. I am sure there are a few, but the vast majority of their enforcement comes after the wrongdoing. I have no problem with laws being passed to mandate action by corporate America. And, I would love to see harsh legal ramifications for wrongdoing.
I think what we really need is more transparency. The whole CDS problem would not have happened if these instruments were traded on a public exchange were transparency existed. This is also the reason for general accounting rules for corporations. Get transparency out there and things work better.
I agree that the banks have hijacked many in the government, including the kleptocrats you mentioned. We should, as Mr. Auerback points out, separate the investment and depository banks. I don’t see that as regulation as much as common sense.
My views aren’t driven by anything but my first hand experience of working in the government as well as having experienced a routine audit, which did nothing to really ensure I wasn’t defrauding clients. It just tested my ability to find this report or this bill and jump through hoops. Again, it would be great if these groups were more effective. If they were, I would be up for using them. I just don’t see it getting better considering how the government works.
I can clearly see you hate my views, but I do appreciate having a forum like this to discuss issues, and you do a great job of educating folks with your solid writing.
I definitely don’t hate your views at all. We are probably more ideologically aligned than you suspect. But, I am looking at this outside of ideology (where my knee jerk reaction is typically libertarian i.e. less government, more market failure).
With regards to regulation, I am trying to look at this practically. The best analogy I can make here is this: Sports.
The legislature, which makes laws (like the Credit Card Act about to go into effect tomorrow) is akin to the Rules Committee in a sport. Legislation sets the rules of the game. Like the referees in a sporting event, regulators are there to enforce the rules in real time – to prevent rule infractions and cheating. You can’t wait until after the fact – after the game is over to adjudicate legally – that doesn’t make sense.
Only when a situation demands special consideration does it reach the sporting league’s governing body – a sports equivalent of the courts (say, a handball by Thierry Henry in a World Cup qualifier) but these should be exceptional circumstances. The yeoman’s job day-to-day of rule enforcement must be done by the referees in sports, cops in law enforcement, and regulators in product and business standards.
That’s all I am saying here. In effect, I am saying you have to have a beat cop – a first line of defense to control frauds and criminals, and to prevent potential frauds and criminals from forming due to a lax environment. Obviously, you can go overboard – and we most certainly will eventually. AND I might add, my ideological bias makes me believe government will generally be somewhat inept at regulatory implementation as your experience shows.
But, right now the problem is too little enforcement (and while there are countless proactive enforcements by the FDA – an organization I have known for 30 years, by the way – since the days of Jimmy Carter and Patricia Harris – or the SEC, the question you ask cannot be answered. It’s like asking how many crimes did the police prevent by their mere presence. That’s an unknowable thing.)
Have you seen the Brooksley Born posts we have written? I reckon you’ll agree with the thrust of those posts given your comments on CDS.
See this one:
and this one:
Comment on those posts if you have a chance.
That’s not true. The experience in regard to the S&Ls shows just the
opposite. The law enforcement officials came in only after the regulators
began to detect fraud. You mix up cause and effect. The lack of proactive
detections of fraud by the SEC, FDA, etc., is symptomatic of the fact that
these organisations have been denuded of resources. And it is also
symptomatic of the anti-regulatory ethos that took place under the Bush years, when
regulators were encouraged to look the other way and let the “markets”
police themselves. We saw how well that worked out.
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