As the Washington debt limit spectacle grinds on, financial advisers might want to consider their options with regard to cash management if for no other reason than peace of mind.
Granted, in the event of a full-blown default by the U.S. Treasury, “we are all in a world of hurt,” according to Eric Lansky, director at StoneCastle Partners LLC, a cash management firm.
However, with a full-scale default seen as a remote scenario, Mr. Lansky said investors could be protected from a more plausible short-term default or downgrade of U.S. debt by seeking the shelter of Federal Deposit Insurance Corp.-backed cash investments.
“Most people keep their cash in money market mutual funds or Treasuries,” he said. “However, my understanding is that if there is a default or downgrade, Treasuries and money funds would immediately be impacted, whereas FDIC-insured accounts would not.”
Mr. Lansky, whose firm works with a network of community and regional banks to offer investors FDIC insurance on multimillion-dollar cash accounts, clearly would benefit from a move toward more FDIC-backed products.
But he does make a case for the way that FDIC insurance is funded by bank assessments and is therefore not immediately linked to weakness in the Treasury.
In addition to the basic bank savings account, which provides FDIC coverage for up to $250,000, there are also FDIC-insured brokerage sweep accounts.
Mr. Lansky's firm offers FDIC coverage for accounts larger than $1 million, and there is also a certificate of deposit version from Promontory Interfinancial Network LLC for larger accounts.
But a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act extends FDIC protection to cash accounts that exceed $250,000 for investors willing to forgo interest on those accounts.
Mr. Lansky acknowledged that FDIC protection in light of the growing debt limit noise out of Washington is more about investors' peace of mind than anything else at this point.
“FDIC insurance might be good for an adviser who has already gone to cash and is really risk-averse,” he said. “If you feel there's a potential for default but that it will be quickly resolved, then FDIC-insured accounts may be best.”
In a longer-term default scenario, the picture is much less clear.
“Default [by the U.S. government] is a threat to money funds and the entire banking system,” said Peter Crane, president and chief executive of Crane Data LLC, which tracks the money market fund industry.
“Without the backing of the U.S. Treasury [in the event of a full scale default], the FDIC insurance fund would last about 45 minutes,” he added. “FDIC insurance calms people's nerves because they assume there's a government guarantee behind it, but I don't think anyone would get all warm and fuzzy about FDIC if it weren't backed by the Treasury.”
However, Mr. Crane pointed out that regardless of the rating, U.S. Treasuries will remain the world's safe-haven security — a point illustrated by the relative inactivity across the financial markets as the political debate rages on.
“If there was real risk right now, then rates on Treasuries would be at 8%,” he said. “But if you weren't reading the papers and you were just watching the financial markets, you wouldn't even know there was anything going on.”
One-month T-bills, for example, which are considered most vulnerable to a short-term default or downgrade, saw yields climb from 0.01% on July 1 to 0.07% on July 26.
One factor that is not being considered by many of the pundits, according to Mr. Crane, is the market forces of an investment community that is starving for yield.
“If one-month Treasuries get to 10 basis points, investors will be jumping in to push that yield down,” he said.
“Right now, nobody is suggesting that Treasuries will default and then not pay, but some people think there might be a temporary default,” Mr. Crane added. “If the U.S. is downgraded to double A, then in effect, double A will become the new triple A.”