Sunday, December 09, 2007

Cash Only

When there is a run on a bank or other financial institution, the target has to raise cash to satisfy redemptions. Usually this entity would be fully invested to max out profit for depositors. To raise cash, the institution would sell its most liquid assets, stocks, bonds, money market funds etc, leaving the dogs, on the hope they improve given time. Notice good assets are redeemed for cash; the crap stays in the vault.

The State Investment Pool in Florida started out two weeks ago with 27 billion and shut the doors December 4th. Eight billion left the fund with no penalty. After the doors opened December 7, another two billion hit the exit turnstile. From Bloomberg

Florida schools and towns pulled more than $1.7 billion from a state investment pool in the two days since a freeze on their accounts was lifted, as local governments remained wary of keeping money in a fund with subprime mortgage-tainted holdings . . . . . . . . . . .

BlackRock, hired Nov. 30 to salvage the fund, walled off $2 billion of the weakest investments and imposed restrictions to limit withdrawals, including imposing a 2 percent fee on redemptions that exceed certain levels. Some governments have been willing to pay that price to get their money out . . . . . . . . . . .

Perry, the Jacksonville Electric Authority and Desoto County together paid $1.4 million in penalties yesterday to remove $66.7 million from their accounts . . . . . . . . .

This is what killed the banks in the 1930’s. The banking system collapsed not because of bad bank investments (no denying that there were plenty), they collapsed when depositors lost faith in the bank. Those first in line got their money, those last in line, got an education. The FDIC insurance stops the prospect of a bank run and keeps the depositors’ savings intact. These Fund Pools are not banks and are not insured by the FDIC.

An electric utility company and a county government agree to a 2% redemption fee of 1.4 million dollars. Maybe to act responsibly means you have to do things that are painful from time to time. If the investment pool can change the rules after the fact, whose money is it really? Could it be, these two entities examined their future accounts receivable, and figured out that the local economy has a few issues? They seem to know what they are doing. One turns off the lights; the other auctions off foreclosures.


Anonymous said...

Good post-

The 'bank runs' we will see in this deflation are not the ones of the last depression.

Where the runs will occur is in the non-bank finance sector - just what we have witnessed here.

The derivatives market is where all the insane leverage is. This will be unwound, and not smoothly.

Jim in San Marcos said...

Hi Anon 10:35

I am in complete agreement. It's going to be messy

Anonymous said...


2 questions?

1. When do you think it will really begin to unravel?, and

2. Will there be a run on my Bank Money Market and if so, should I stuff some cash in the mattress?

I am not joking. After reading the recent news articles and keeping my eyes open, I am getting concerned.
Please give me your thoughts. Thanks.

Jim in San Marcos said...

Hi Anon 10:20

I think that it is unraveling right now.

As for investment advice, I really can't suggest anything. Its either going to be hyperinflation or deflation. The politicians haven't screwed things up enough to determine which way we are going yet.

I've always suggested that you have 10% of your assets in gold or a home and 6 months savings in the bank in the bank. Have an investment savings plan for the future and stick with it.

The biggest issue that will face us is debt, the more you have the more you could be hurt. Diversity is the only thing that will win out.

Neither one of us can be sure of what will happen so your guess is as good as mine. I tend to lean toward deflation. But Social Security and Health care imply a very severe inflation threat, the tax base isn't there to support it.

The one thing I have noticed though, is that the herd is usually wrong when it counts most.

Mammoth said...

Hi Jim,
Good posts here. Someone posted a link to your site on HousingPanic.

You wrote, "The biggest issue that will face us is debt, the more you have the more you could be hurt."

Right now we are sitting on the fence trying to decide whether or not to purchase some land that is adjacent to ours.

Not as an investment, but more to just keep it open and undeveloped. Also, a pond, which is 90% on our property, straddles the property line, and we'd like to keep others away from it.

Currently we are debt-free; just unsure whether to hang another rock around our necks.

Debt from buying consumer crap is bad...not sure if buying this land would be such a bad thing, though.


Jim in San Marcos said...

Hi Mammoth

What I have been suggesting, if things get worse, you ought to be able to buy what you want at a 50 to 90 percent discount.

Undeveloped land has been a real dog for the last year, so you might get a better deal than last year and an even better deal next year.

Any thing that I discuss here is pretty general. The only thing that you would want to be careful of is the bank wanting to secure the note for the raw land using your home as collateral.

Keep in mind, the people in foreclosure paid too much for what they bought. Their wages didn't keep up with the bills.

There is very little stress when you are debt free. The decision is yours. Trust your judgment, you've done OK up to now.

Anonymous said...

Hi Jim...
I have been hearing a lot about deflation...what exactly does that mean? Do our salaries go down as well as products?

What does our economy look like in a deflation period?

Jim in San Marcos said...

Hi Anon 9:34

Your salary should be OK. What happens with deflation is that retail stores find themselves in competition with their previous customers. The wide screen is $3,000 at Best Buy and only $1,000 from Fred who bought his from the same place and is going into foreclosure.

Your dollar goes farther because people need to raise cash. In order to do it, they must sell assets. Typically 10 cents on the dollar.

Anonymous said...

Hi Jim..
Which is worse deflation or inflation?

Jim in San Marcos said...

Hi Anon 5:33

It's hard to say which is worse, It could go either way. I have been working on something that will publish this Sunday on it.

Stock Buster said...

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Stock Buster.