Banking Q&A: We Answer Your Questions

by the Schwab Center for Financial Research
March 10, 2009

Each month, we receive thousands of questions from Schwab clients. Here, we tackle the top questions on banking, with answers and guidance that we believe will address some of your most pressing concerns.

If you have a question that doesn't appear below, we have more Q&As on timely topics in the box at right. If you have a question that we haven't already addressed, you can submit it using the Editor Feedback form at right—we may include it when we add new questions and answers.

To talk to a Schwab investment professional about your particular circumstances, please call 800-435-4000.

On Banking

Can the Feds force the banks to start loaning the dollars they were given?
FDIC insurance is now up to $250,000. Is that permanent?
What is fair value?
What does LIBOR stand for?
What's the relationship between T-bills and LIBOR, and why is it important?

Can the Feds force the banks to start loaning the dollars they were given?
The government doesn't actually have much leverage to force the banks to start loaning the dollars they have been given because the Emergency Economic Stabilization Act of 2008, didn't require them to do so. As a result, key members of Congress are relying on the "bully pulpit" to make this point, and to generate a public outcry that forces the banks into action.

There's a very real possibility that Congress will rewrite portions of the financial rescue plan in order to put more real pressure on banks to increase loans, modify existing mortgages, and take other steps to jumpstart the credit markets and the economy.

FDIC insurance is now up to $250,000. Is that permanent?
The Federal Deposit Insurance Corporation (FDIC)—which covers checking and savings accounts, money market deposit accounts and certificates of deposit at member banks—The temporary increase of FDIC insurance coverage to $250,000 for all insurable capacities has been extended through December 31, 2013. If not further extended, FDIC coverage will revert to $100,000 on January 1, 2014.

For more on FDIC insurance, see "Protecting Your Cash Assets."

What is fair value?
"Fair value" has a number of possible meanings, but we assume you're asking about it in the context of the mark-to-market accounting rules companies use to value assets on their balance sheets. Mark-to-market accounting means the company must value the assets on its books according to the market price for those assets. It was implemented to better represent current asset values.

Mark to-market accounting is straightforward in cases where assets have liquid markets (like the stock market), but difficult for assets that don't have observable prices. For illiquid assets (also called Level 3 assets), the value is based on assumptions regarding the price one could receive if the asset was sold.

Mark-to-market accounting is particularly important when looking at investments in banks and brokers—write-downs in their assets have forced them to try and raise additional capital to maintain FDIC-mandated capital ratios. What's more, with so many financial companies holding mortgage-related assets, further declines in home prices translate into further write-downs, resulting in a negative spiral.

There have been calls to suspend mark-to-market accounting to allow banks to slow the decline in the value of their assets. However, this doesn't solve the problem—the market still wouldn't know what the assets on the books are worth.

What does LIBOR stand for?
LIBOR stands for London Interbank Offered Rate, which is the rate banks charge each other for borrowing funds in the London wholesale market—basically, the amount it costs one bank in Europe to borrow funds from another. To learn more about LIBOR and how it works, read this article by Brad Sorensen, "Uncovering the Mysteries of LIBOR."

What's the relationship between T-bills and LIBOR, and why is it important?
The difference, or spread, between rates on the 3-month Treasury bill and 3-month LIBOR is called the TED spread, and it indicates how willing banks are to lend money.

The TED spread tracks the difference between what banks charge other banks for a 3-month loan versus the rate they'd get if they put that money in a 3-month T-bill instead. The higher the spread, the less confidence banks have in each other as compared to investing in Treasuries, and the less likely they are to make loans of any kind.

Historically, the spread between T-bills and LIBOR has averaged fewer than 50 basis points, or 0.5%. In October 2008, the TED spread peaked at 484 basis points (4.84%), the highest reading since Bloomberg started tracking the statistic in 1984. As of February 19, 2009, it has fallen to 94 basis points (0.94%), an indication that credit conditions are slowly improving.

However, the still-wide TED spread shows that banks continue to opt for a very low return on safe, short-term Treasuries rather than pursue their normal business of making higher-yielding loans to individuals, corporations and each other.

And when banks aren't making loans, it decreases the "velocity" of money in the economy—how fast money is lent, spent, and invested, which helps the economy grow. That's why jumpstarting lending activity is one of the major areas of concern for the Treasury and Fed as they seek to get the economy rolling again.

Many economists say the TED spread falling below 100 basis points would be a sign that the credit markets have begun to loosen, and that the economy may be on its way back toward recovery. The TED spread appears to be moving in the right direction, but it's still far from indicating that credit conditions are back to normal.

Important Disclosures

The temporary increase of FDIC insurance coverage to $250,000 for all insurable capacities has been extended through December 31, 2013. If not further extended, FDIC coverage will revert to $100,000 on January 1, 2014 for all insurable capacities except IRAs and certain other self-directed retirement accounts and plans. Unless the increased coverage is extended, deposit insurance coverage for CDs with a maturity date after December 31, 2013 will revert to the prior FDIC coverage on January 1, 2014, regardless of when you purchased the CD. You should not rely on a possible extension of this increased coverage in purchasing CDs.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

©2009 Charles Schwab & Co., Inc. All rights reserved.

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