Late last week, a consortium of financial regulators in the United States, including the Federal Reserve and the FDIC, issued an astonishing condemnation of the US banking system.
Most notably, they highlighted “continuing gaps between industry practices and the expectations for safe and sound banking.”
This is part of an annual report they publish called the Shared National Credit (SNC) Review. And in this year’s report, they identified a huge jump in risky loans due to overexposure to weakening oil and gas industries.
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Make no mistake; this is not chump change.
The total exceeds $3.9 trillion worth of risky loans that US banks made with your money. Given that even the Fed is concerned about this, alarm bells should be ringing.
Bear in mind that, in banking, there are three primary types of risk, at least from the consumer’s perspective.
The first is fraud risk.
This ultimately comes down to whether you can trust your bank. Are they stealing from you?
MF Global was once among the largest brokers in the United States. But in 2011 it was found that the firm had stolen funds from customer accounts to cover its own trading losses, before ultimately declaring bankruptcy.
It’s unfortunate to even have to point this out, but risk of fraud in the Western banking system is clearly not zero.
The second key risk is solvency.
In other words, does your bank have a positive net worth?
Like any business or individual, banks have assets and liabilities.
For banks, their liabilities are customers’ deposits, which the bank is required to repay to customers.
Meanwhile, a bank’s assets are the investments they make with our savings. If these investments go bad, it reduces or even eliminates the bank’s ability to pay us back.
This is precisely what happened in 2008; hundreds of banks became insolvent in the financial crisis as a result of the idiotic bets they’d made with our money.
The third major risk is liquidity risk.
In other words, does your bank have sufficient funds on hand when you want to make a withdrawal or transfer?
Most banks only hold a very small portion of their portfolios in cash or cash equivalents.
I’m not just talking about physical cash, I’m talking about high-quality liquid assets and securities that banks can sell in a heartbeat in order to raise cash and meet their customer needs to transfer and withdraw funds.
For most banks in the West, their amount of cash equivalents as a percentage of customer deposits is extremely low, often in the neighborhood of 1-3%.
This means that if even a small number of customers suddenly wanted their money back, and especially if they wanted physical cash, banks would completely seize up.
Each of these three risks exists in the banking system today and they are in no way trivial.
Very few people ever give thought to the soundness of their bank, ignoring the blaring warning signs that are right there in front of them.
Every quarter the banks themselves send us detailed financial statements reporting both their low levels of liquidity and the accounting tricks they use to disguise their losses.
Now we have a report from Fed and the FDIC, showing their own concern for the industry and foreshadowing the solvency risk I discussed above.
Every rational person ought to have a plan B to hedge these risks. And I would propose three methods:
1) Transfer a portion of your funds to a much safer, stronger banking jurisdiction, preferably one with zero net debt.
2) Hold physical cash. Physical cash serves as a great short-term hedge against all three risks, with the added benefit that there’s no exchange rate risk.
All you have to do is go to your nearest ATM machine, take out a small amount at a time and build up a small pool of cash savings.
3) Hold gold and silver.
While physical cash is a great short-term hedge against risk in the banking system, gold and silver are excellent hedges against long-term risks in the monetary system and global financial system as a whole.
There may be a time where we are faced with the consequences not only of a poor banking system, but also of decades of wanton debt and monetary expansion.
At that point, the only thing that will make any sense at all is direct ownership of real assets.