On: Legal Framework for Big Banks Puts Depositors at Risk - DC Public Banking Center

A word to the wise:

In the U.S. and Great Britain, the Federal Deposit Insurance Corporation (FDIC) and the Bank of England in 2011 jointly published Resolving Globally Active, Systemically Important, Financial Institutions. This document provides the legal framework for seizing deposit accounts in failed banks and converting them to stock in the reconstituted bank in order to preserve the soundness of the bank.  This background piece describes the legal position of depositors as unsecured creditors in bankruptcy. The FDIC's document also uses the terms "unsecured creditors" and "unsecured debt holders" to include depositors in the following statement (p. 8):

The unsecured debt holders can expect that their claims would be written down to reflect any losses that shareholders cannot cover, with some converted partly into equity in order to provide sufficient capital to return the sound businesses of the G-SIFI to private sector operation.

In addition to the FDIC encouraging big banks to seize deposits during bankruptcy to maintain the stability of the banking system, depositors in the U.S. face an additional risk of loss under U.S. bankruptcy law among all sizes of banks that invest in derivatives.  During bankruptcy, derivative counterparties receive "super-priority" status above all other creditors, including depositors.  This means that derivative holders will get all of the bank's assets before any other creditors, including depositors, are paid.  Harvard Law Professor Mark J. Roe describes the legal framework created under federal bankruptcy law in his Stanford Law Review article The Derivatives Market's Payment Priorities as Financial Crisis Accelerator.  Roe concludes that "the major [Dodd-Frank] financial reform package Congress enacted in response to the financial crisis lacks the needed changes" to limit derivative super-priority risk.

Source: Legal Framework for Big Banks Puts Depositors at Risk - DC Public Banking Center

Tom Usher

Tom Usher

To be clear and regardless of the FDIC/BOE joint paper, "Resolving Globally Active, Systemically Important, Financial Institutions," deposits within FDIC limits remain FDIC insured within FDIC-insured institutions.

Depositors for whom the deposit-amount limits under the FDIC are too small, should take seriously the suggestion of the Public Banking Institute that they, those depositors ("public agencies, pension funds, business[es], nonprofits, and individuals"), "move their deposits immediately to institutions that do not invest in derivatives."

Depositors who do not believe the government that the FDIC would not run out of money to pay off FDIC-insurance beneficiaries in full should also consider moving their money from those banks that invest in derivatives.


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  • Tom Usher

    About Tom Usher

    Employment: 2008 - present, website developer and writer. 2015 - present, insurance broker. Education: Arizona State University, Bachelor of Science in Political Science. City University of Seattle, graduate studies in Public Administration. Volunteerism: 2007 - present, president of the Real Liberal Christian Church and Christian Commons Project.
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