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The Smart Take:
There has been a lot of misinformation regarding and uncertainty caused by the recent bank failures. You may have concerns about whether your money is at risk whether at a bank or at custodians such as Charles Schwab, Fidelity, Pershing, or TD Ameritrade.
Hear Kevin Kroskey, CFP®, MBA give a brief summary of what happened at Silicon Valley Bank and explain why your bank account should be thought of as a loan to the bank (because it is!). Conversely, he’ll detail key investor protections you benefit from by not having your account a general liability of a bank but a segregated account under custody at either a bank or brokerage. He’ll go further and explain how “securities” — money market funds, mutual funds and ETFs — held in your investment accounts allow additional safeguards and segregation of your assets.
You’ll learn about coverage you may have through the Securities Investor Protection Corporation (SIPC), excess SIPC coverage custodians may have to protect affluent investors, and, as an example of the safeguards, what happened to investors’ segregated accounts held at Lehman Brother’s bankruptcy during the GFC.
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Intro:
Fantastic episode on the way today. Welcome to Retire Smarter. Walter Storholt here with Kevin Kroskey, wealth advisor, CERTIFIED FINANCIAL PLANNER™ at True Wealth Design. Find us online at truewealthdesign.com. I know we’re going to be talking about some banks and some recent current events happening in the financial landscape and dominating the news a little bit. Can’t wait for Kevin’s perspective on all of that. But Kevin, first of all, it’s just been a couple of episodes since we’ve had you on, and Tyler’s been holding down the fort for a while, so good to catch up with you.
Kevin Kroskey:
Yeah, I feel like it’s been this conspiracy. You guys tell me you’re recording on a certain day. I don’t get the invite. And then, next thing I know, there’s an episode released, and Tyler’s killing it and doing a great job.
Walter Storholt:
He somehow slipped-
Kevin Kroskey:
Replaceable.
Walter Storholt:
He somehow slipped into the logo, and it’s just like this subtle takeover that’s happening. Exactly.
Kevin Kroskey:
We have a growing team, and I’m really happy about that. And I don’t think we’ve announced that it’s been a couple months now, but since I am actually on today, let me go ahead and take the liberty. But we had basically the third, well, I guess, looking back over the last few years, we’ve had Ron Wyatt and his team partner with us and in our Pittsburgh office, and we had Capital Financial Group, Peterson, reached out to us and thought we were doing a good job from what he knew of us, and asked us to take care of his clients as he retired. And we had another one at the tail end of last year, and have just been working through that integration and onboarding process of clients from Plans to Prosper, who’s also in Western Pennsylvania, very near where I grew up. And we have a very strong advisor, Audrey, that joined us as part of that too.
So we’ve been growing, we’ve been busy, and it truly, it’s been an honor. You have these advisors that spent their career in the business, and they’ve picked us to go ahead and continue to take great care of their clients. So we don’t take that very lightly. It’s a lot of work that’s involved, and I’m really happy and proud that we’ve been able to do that and things continue to go well. So that’s part of the reason why, not just that you and Tyler have been tricking me with the scheduling of the event, but I’ve been doing a lot of work on some of those transitions. There’s a lot of details that need to be carefully managed, and make sure that we understand everything, get everything well integrated, and continue to take great care of those clients.
Walter Storholt:
That’s just how we were able to take advantage of you, with all of the other things you were juggling. So that just made the takeover that much easier. But yes, great to hear that you guys are having such great partnerships all across the board and expanding the True Wealth family. Always enjoy hearing about that and what’s going on in your world. So thanks for the updates on that front. Shall we dive into the big topic at hand? You are living under a rock if you don’t know about bank crisis and all sorts of other issues that pop up from that. And it’s easy to let your emotions take over here, Kevin, and get worried about your money, and is it going to affect me? And how’s it going to wrinkle overall into all of the other parts of our financial lives? I don’t know. Are we calming the waters today? What approach are we taking here?
Kevin Kroskey:
Well, yes, I think so. Hopefully, we’ll provide some clarity. I’m chuckling here because online, and the internet’s fantastic. I mean, you can go on to Google or ChatGPT or whatever it may be these days, and there’s so much information that’s out there, and there’s so much bad information, unfortunately. Just because there’s information, you don’t know what’s good or bad, and it certainly doesn’t necessarily convey wisdom to you. So as I was experiencing the last week, and watching some of these news stories, and seeing people that were being interviewed on some of the talking head shows that people may be watching, whether it’s the 24-hour news or specific financial news, or just the general nightly news, or your local paper. It’s interesting, I was reading these, and I was listening, and there was just so much incorrectness that I was being confronted with.
And this is an area I’m not a banking analyst and expert, but I know a pretty good deal when it comes to markets and how these instruments work. And hopefully, I can convey that today. But it’s interesting because you see when you have this knowledge, and you see all this misinformation that’s out there, it’s like, “Man, that’s wrong. That’s wrong. Oh great, my clients are listening to this guy or gal; I’m going to get ten questions about this tomorrow and undo all this disaster.” And then you go, and you read something else that maybe you’re not an expert in, and you just take it for face value. Be like, “Wow.”
Walter Storholt:
You don’t realize that same phenomenon is happening on so many different issues, right?
Kevin Kroskey:
Oh, totally. I mean, I love a good biography or nonfiction stuff that’s on Netflix, but some of this stuff I watch, and if it’s related to finance, you don’t know who the director is, you don’t know if they’re informed, or what motives they may have. And then I’ll watch some of this stuff, and 10 minutes I’m in, I’m like, “Okay, there’s so much incorrectness, and there’s definitely an angle here, and I’m just going to turn it off.”
Walter Storholt:
Oh my gosh, wow.
Kevin Kroskey:
So, it’s difficult, too, those things that we’ve talked about many times over the years, things you know, things that you don’t know, you don’t know, and everything in between. And a lot of times, clients come to us to be that clear guide to them and help make sense of the world that we’re in. And certainly make their financial life planning work for them.
So I think the news stories have gotten better over the last few days, from what I’ve seen. There was certainly a lot more scattershot early on, but nonetheless, we’ll do a quick redux here on the whole SVB thing, talk about what I think that means. And then, importantly, Aaron Seil and I collaborated on an article that we have out on our website, it’s called Understanding Investor Protections. And it goes into some of the investor protections that people don’t appreciate that they have, or don’t fully understand that they have, for your investment accounts, not your bank accounts, but for your investment accounts at places like Schwab, Fidelity, TD Ameritrade, Pershing, these big financial institutions. I’ll highlight some of those differences today. The article, if you prefer to read, it’s about 2,000 words. There’s some graphics that go there as well, but we’ll certainly touch on this today as I go through here.
And we’ve used this quite a bit to go ahead and help allay some concerns that clients have had, questions that they’ve had, over the last several days. So we’ll see where else it goes. There’s so much to talk about, but really my point in doing this is just to try to bring some clarity around this, and really what does it mean? What kind of risks are we actually taking? And then also, what does this likely mean for markets as well? Nobody has the crystal ball, but I think I can at least make a few semi-intelligent comments there. So that’s on the agenda for today. So it’s good to have the Warren back to my Buffett, Walt, you ready to dive in?
Walter Storholt:
I am ready. And this is why, because back when I was in journalism, like true journalism, one of the fun parts of it was you got to become an expert on a lot of different subjects. Well, “Expert,” you had to learn about a lot of different subjects. So something would happen. Like the local courthouse caught fire one day, and all of a sudden, I was learning all these things about fighting fires, and courthouse documents, and how those are kept, and what was at risk, and all of these different things. Then you add this into your little basket of knowledge in life. But now, with everyone being a journalist because of social media, everyone has to go through that constant evolution. So locally, not too far from your neck of the woods, train derailments, and its national news, everybody in the world’s becoming an expert on train derailments.
And I feel like it’s the same thing with this financial crisis, and with the bank issue, is all of a sudden we’re all having to pretend we know what’s happening with the banks, and we knew what SVB was before it happened, and all this other stuff. So that’s why it’s so hard, so complex, and so deep to try and put it all in a nice little basket. It’s just such a vast thing to understand with so many layers. So one of the things I love about being the Warren to your Buffet, I suppose, that’s quite the compliment, Kevin, is how you can make the complex a little bit simpler and easier to understand, so we can get a little smarter in the process. So can’t wait for your breakdown.
Kevin Kroskey:
All right, you got it. So here I’ll give the quick rundown as I understand it on the bank failure. So, I think as many or most have heard now, this Silicon Valley Bank, or SVB for short, was really concentrated from a client-based standpoint for a lot of these tech entrepreneurs, a lot of VC, or venture capital, companies, early-stage technology companies. And one of the things that people may have heard, they may not, but a lot of times, these companies aren’t profitable. And they’ll go out, and they have to raise money from VC investors. Those investors are typically concentrated through venture capital funds. So some of the largest VCs are in Silicon Valley and San Francisco. So the people that run these funds may have a multitude of companies that are under their funds. So we’ll come back to that in a minute, but that’s ultimately what caused the bank run, that client concentration. And not that it was just these companies all talking, but you had these VC fund managers that were really directing their companies to go ahead and move some money.
So if we go back to pre-COVID, and we’ve talked about this a lot, but you had growth companies particularly, Walt, I remember doing in an episode, something to the extent that technology companies cannot continue to outperform. And that was, I think, mid-2021, and maybe it looks prophetic now, but it was common sense, at least as I and many others saw it. Maybe not so much to most at that point in time because you’re in it, and you just saw the stuff going up. But part and parcel with that, these VC companies were bringing in money, so they were going ahead and selling an equity stake, and bringing in money, and they were putting it into SVB, using that to go ahead and fund their operations, so on and so forth.
And because they had some money coming in, but they weren’t making money, they consumed quite a bit of it. So that happened. And then when COVID happened, not only did we have zero interest rates, but the government really, literally was providing not just monetary stimulus through the Federal Reserve, but they provided fiscal stimulus. So they were issuing tax credits, a few rounds of those, like American Opportunity Credits, things like that. So, people were getting checks in the mail or bigger tax refunds. And also, the businesses were getting pretty significant refunds as well in credits. The Paycheck Protection Program or PPP, or ERC, I think that was the Employee Retention Credits. And so what you saw throughout the banking systems were deposits, because money was created, were just inflated quite a bit. When you looked at the year-over-year growth, deposits went up quite a bit.
Interest rates were near zero, so they weren’t really paying their depositors anything, so it wasn’t that big of a deal. But banks basically have this money, short-term money, that you can demand back at any time, and they put that to work through loans. But it takes some time to make loans, and there has to be demand for them. So what banks may also do, is then invest some of those excess deposits into securities. And this is where SVB was a bit of an outlier. So on two fronts, it was the client concentration that I mentioned, and then disproportionately, they invested a lot more of those excess deposits into securities. It’s not like they were taking a ton of risk. They went out, and they bought treasury notes. So generally, it was about a five-year note. And at that time, the Federal Reserve was saying actually, even through the early ’21, the Fed was saying, “Hey, we’re going to keep rates at or near zero through the end of 2024.”
So perhaps that helped SVB and other banks feel comfortable about taking a little bit longer duration risk. And ultimately, I think, as we know what happened last year in ’22, sure, we had some inflation showing up, but then it was like, “Hey, is it transitory or not?” And then we had all this pent-up demand from the lockdowns. You had supply chain issues because of COVID and the lockdowns. In hindsight, now, we had a lot of people that did not return to the workforce. So you had the workforce; it was shrinking, pushing up wages. Oh, then, by the way, you had Russia invade Ukraine, creating an energy crisis and really skyrocketing prices there. And then China’s Zero COVID policy, which, not too long ago, they finally moved away from, but China was locked down for a very long time. So you had all of this stuff working together, and inflation was rampant for a while.
We’ll see what the future holds there, but it’s still pretty high. So the Federal Reserve started raising rates incredibly aggressively throughout 2022. As we’ve talked on the podcast before, and I’m sure as any investor has seen on their statements, ’22 was not a great year to be an investor. You had technology stocks broadly went down about 30%. You had value stocks went down much less than that, generally single digits. But you had bonds; if you just had Aggregate US bonds, they went down more than 10%. So it was a tough year for investors. But that’s also made it a tough year for banks because as interest rates went up, yeah, maybe they had to start paying a little bit more money on the deposits, there’s still not much. I just logged into my Chase account, and Walt, I see them earning a whopping 0.01% on my checking account, woo-hoo.
Walter Storholt:
Wow, 01? Nice.
Kevin Kroskey:
Yes, it’s not zero; it’s better than 001. Yeah, I’m thinking positive here. But yeah, so rates started going up, money maybe started going out, banks started competing and raising some rates. But on those assets that SVB bought, generally again, about five-year treasury notes, and I didn’t necessarily know this is from a banking analyst standpoint, it’s pretty unique accounting, but they have two types of securities, maybe more. But one is available-for-sale, or AFS, all these wonderful acronyms. And the other was HTM or held-to-maturity. So, what SVB did, was put a lot of these notes into the held-to-maturity. And what that meant for them was they really just didn’t have to mark them down. So again, think of interest rates as they went up, the prices of the bonds went down. It’s a teeter-totter relationship.
So that’s why those bond returns were negative in ’22. And why you, as an investor, saw that negative number on your statement on the bank balance sheet? They just put what they paid for it; they put their cost-basis on it. Sure, they may have noted separately that, “Hey, there’s an unrealized loss on these positions,” or maybe they put in a footnote. And to my understanding, that’s what SVB did. It used to be in a table and prominently displayed. And then, as it got worse and the bank’s balance sheet deteriorated, ended up in a footnote.
Walter Storholt:
Just going to hide that a little bit.
Kevin Kroskey:
Yeah, let’s make it in a, hey, eight-point font sounds a lot better than 12. Let’s put it down there with a little footnote. And so, things go, that got tough. And then, the bank run started happening from some of those VC fund general partners and their portfolio companies. So it was a classic run on the bank. It was fully disclosed in the annual report. Again, it moved to a footnote. It was disclosed in their 10-Ks. The banking regulator saw it.
This is how banks work. They’ve taken deposits, and as somebody that takes money down to the bank, you should think of it, and I’m sure most people did not think of it this way, but you are giving the bank your cash. And basically, it’s a loan to the bank. It’s a loan that you can demand back at any time, but it is, in fact, a loan. And sure, there’s FDIC coverage, and in this case, all of the depositors, whether they were insured under the FDIC limits or not, were made whole. But there’s certainly no guarantee of that going into this. So cash in the bank is cash in the bank, but there can be some dollars at risk.
So we’ve had a lot of those conversations with clients. But real quick, if you look back further in time, go back to the GFC, there was about, from what I see on the Fed’s website, actually, the FDIC’S website, there was about 28% of uninsured deposits that were lost. IndyMac Bank was a big one. It was a bank in California. I think the number was about 270 million of uninsured deposits were lost, and those depositors were not made whole. So there’s no guarantee that you’re going to get anything above FDIC limits. We’ll see if those limits change more, but certainly, anybody that had money at SVB Bank is very lucky that they got their dollars back. But again, I think we’re all learning through this, and if we didn’t know it already, we’re certainly being reminded of it that the bank, the cash at the bank, is a short-term loan to the bank.
It is a general liability of the bank; even though it has your name on the account, it’s a liability of the bank. It’s not necessarily your asset. So I don’t know, Walt, I’m curious. I mean, you do a lot of podcasts. You probably have talked to a lot of people about this, being the smart guy that you are, but that’s something that it’s just; people don’t think of it that way. When they think of their bank deposits, they think like, “That’s incredibly safe.” And I’m not saying that it’s not safe, but there’s risk in the commercial banking system, particularly above certain limits.
Walter Storholt:
Yeah, no, I think it makes sense. Perhaps I just am lucky for having been in the industry, not as an advisor, but involved in the industry for a while now, having that perspective that the banks have all this money at their disposal, why wouldn’t they go and find ways to use that to make more than what you are making from them as part of that, “Loan,” to them?
So yeah, I appreciate that perspective, and it’s easy to then see how, with all of those other factors that you were talking about, like, “Oh yeah, 2021, 2022, a little bit busy in the financial world, a lot of things going on, a lot of things moving and shaking in our world, and drastic changes and new territory, new ground in terms of interest rates, and all these other things happening.” It’s not surprising that somebody screwed this all up along the way, but what’s shocking to me is it sounds like you’re telling me, Kevin, this was telegraphed. This was disclosed in advance of happening. It just had gotten moved to the footnotes, and people just weren’t paying enough attention, and it just slid under the radar, I mean?
Kevin Kroskey:
Well, again, it was some of that client concentration. I mean, it was there. I don’t know if they weren’t paying attention. Somewhat of a funny story if your name isn’t Jim Cramer, but Jim Cramer gave a buy recommendation for Silicon Valley Bank in early February when they were trading north of $300 per share. And obviously, that went to zero.
Walter Storholt:
And he was like, “They’re way undervalued. Room to grow.” Yeah.
Kevin Kroskey:
You got it, so that’s … I don’t think there was a single banking analyst that had SVB as a sell. I saw several; JP Morgan had them issued a buy-rating back in November. And these are people that this is what they do, day in, day out. They analyze banks. So banks, again, it’s their job to go ahead and take in deposits, and they’re short-term, and then they invest longer term. That’s how banks work, how much of a longer term, and how much interest rate risk they take; different banks’ balance sheets look differently. Silicon Valley Bank was definitely an outlier. I’m not saying it’s going to happen to other banks, but I don’t think it will, candidly. Or I think with the protections that were put in place by the treasury, the Fed, FDIC, I don’t know, maybe you have some very small banks go out, but these banks can-
Walter Storholt:
So that word, “Contagion,” that became real popular the past week, of this becoming a more systemic issue across the board, not getting that sense that we’re heading for a-
Kevin Kroskey:
I don’t think this is 2008; let me put it that way. I don’t think there’s anything close to 2008. Sure, I mean, there’s a lot of banks. Might you have another bank that goes under or something like that? But yeah, it’s possible. I mean, you have people that do; people are emotional. I mean, that part of the brain works quicker than your rational part. And so you’re going to find people that are going to be doing dumb things. I’m very bullish on people making bad decisions. It just, it’s inevitable. So maybe there’s going to be a collection of people that make these decisions and move a bunch of money out of banks. I don’t know where they’re going to put it, necessarily. Is it all going to go to JP Morgan? Or these other very large institutions?
I have accounts at Chase; I have several accounts at local community banks; I can tell you Chase is my least favorite to work with. I mean nothing to them. They’re a global financial institution. But true story, just recently, I moved money around. I’ll talk about why in a moment because we’ve been advising clients to do something similar that I do for the company and for myself personally. But I needed to move money around, and I said, “Hey Chase, I’m moving money around for payroll, and for this, I need to get my limits increased.” And so, they increased my limits, went through a credit review, I think, from 100,000 to $500,000 a day. So great, I can move more than enough money for payroll for things like that, and I can keep my money working for me elsewhere rather than at the 0.01%. Literally, the week after I get that increase, and go under the credit review, the first ACH transfer that I put in, it gets rejected.
I’m like, “What’s going on here?” And then it’s all cryptic. You can’t call somebody directly; you have to call in. And that department, there’s a relay number that you have to go to. So you call one person, you tell them the issue, then you get transferred to this other department. They can’t really give you any information, and they say, “Try it again,” or talk to your local person. So long story short, I’ve been using these transfers for the last three years between these bank accounts. It’s like clockwork. If they just look at the history in the account, “Okay, he does this all the time, not a big deal.” Well, they’ve been, it’s probably 50/50 that they’re going through these days, and it’s just ridiculous. But I go to my community bank, where they know me, banked with them for a while, they have my financial statements, and personal financial statement and all that.
I call them over the phone. I say, “Hey, I’m having a problem with Chase. Can you go ahead and send a wire to the Chase account? Send it the other way?” And I get it done. Those relationships to me matter a great deal. Chase’s footprint’s great. Their technology is great. There’s no relationship there. It’s a huge company. They don’t even know who Kevin Kroskey is, nor do they really care. I’m sure there’s a lot of people that we work with that feel the same way. That’s one of the reasons why they work with a firm like us. We’re not big bureaucratic, hierarchical organization. We’re a boutique firm. We all have skin in the game.
But yet, clients’ money and their dollars are held at these too-big-to-fail financial institutions in many cases. So to me, that’s the best of both worlds. You get the very safe safekeeping of your assets, but you don’t have to deal with the bureaucracy like I had to deal with in just moving money from Chase after I went through their credit review process and got a favorable outcome. And then get summarily denied from moving money around for payroll purposes. So did that sound like venting a little bit, Walt?
Walter Storholt:
Just a little bit. But I mean, it’s fun to hear some venting every once in a while because it’s real. It’s a real story. I mean, it’s what you’re going through, what you’re feeling, and probably other people feel it too.
Kevin Kroskey:
Yeah, so related to that, and then I’m going to move on to talking about the custodians here after this. But it’s pretty remarkable that these companies were able to move the amount of money out of SVB, as they were, as quickly as they were. I think something like $42 million is what you heard being requested, and a lot just went right out. So apparently, maybe that’s one of the reasons why these companies liked banking with SVB because they didn’t have to go through all the brain trauma that I have to go through in working with Chase.
Walter Storholt:
Yes.
Kevin Kroskey:
And it is what it is. We’ll see what that may mean over time because, obviously, in this case, you have that risk of a bit of a bank run. So that’s the bank side of it. So I’m not going to get into all the FDIC stuff, but I think the important takeaway is really to think of your cash at the bank as a loan to the bank. Yeah, sure, it may be insured up to an amount; maybe the FDIC does unlimited insurance going forward. Who knows? It’s not there yet. But be cognizant about what risk you’re taking. It’s probably not as safe as what you’re perceiving it before.
But when we move over into the custodians, the big difference that you’re going to hear me say, probably several times, over the next several minutes, is that your assets are going to be segregated. Not just that they have an account with your name on it, but they are not going to be a general liability of the financial institution like your bank account is at the bank. So that’s the key, I keep on saying it, I don’t want to sound like I’m singing it, difference between your accounts at these financial institutions for the investment accounts and your bank account. The assets are going to be segregated and are not a general liability of the financial institution.
And probably the best example I can think of this is Walt, I don’t know if you were in the financial world at the time, but Lehman Brothers going bankrupt in 2008, was a seminal moment. And Lehman Brothers was incredibly complex. They had insurance companies; they had a broker; they had a bank; several companies under the portfolio company; and several different products that they created out there too. Some of the products that they had, where people lost a lot of money because Lehman Brothers did go bankrupt, and they were claiming pennies or dimes on a dollar sort of thing. But they also, I think, it was like 106 billion or so that clients had, in terms of these segregated investment accounts that were not a general liability, that were fully recovered. So, Lehman Brothers is one of those worst-case scenarios that we have, looking back over the last 20 years or so.
And all of those assets were fully recovered because they were segregated, and they were not, let me repeat, they were not a general liability of the financial institution. And this stuff can get complicated. Like I mentioned, Lehman Brothers had many companies. So, on one side, you see the Lehman name and say, “Okay, I’m fine.” But then you have a Lehman product, and in that product, they’re providing an underlying guarantee that “Hey, this is going to be a bond-like investment, and it’s backed by the full faith and credit of Lehman Brothers.” Well, that goes away into bankruptcy, and people ended up losing money, but those segregated assets were fully protected.
So, it can get complicated. I don’t want to make it sound like it’s super easy. Even you look at Schwab or some of these companies, Schwab has a bank, they have a brokerage. There’s several companies under their financial holding company. So sometimes you have to really dig in a little bit deeper and really understand what credit or custody to risk you’re really taking. And most people probably aren’t going to do that, but that is something that we have to do for our clients, and certainly understand those risks.
Walter Storholt:
So many different layers and ways to protect. And it’s just adding more and more definition to the word “Diversification,” really, I think is what this whole crisis is brought up. And thinking, “Wow, there’s even …” You think just having money in cash or at the bank is diversification, but it sounds like there’s an even next level of diversification for a lot of your clients that you’re always keeping an eye on it, and investigating for even these things that are improbable to happen. But we want to be protected against them?
Kevin Kroskey:
I would say I’ve heard stories already of, not to single any sort of, stereotype anybody, but something I was-
Walter Storholt:
You’re already ranting today and venting; go for it.
Kevin Kroskey:
I heard a story. Somebody who’s supposedly in line at the bank, this is probably fifth-hand, so who knows? Who asked for $500,000 of cash out of her account. And of course, the bank could not just give that; they don’t for security purposes and other reasons, but those kind of behaviors, I mean, you don’t have to go out and open up ten different accounts. One of the things that we like when clients start working with us is simplifying and consolidating accounts. We do work with all the major custodians. We work with Schwab; we work with TD Ameritrade, that is becoming part of Schwab. We work with Fidelity; we work with Pershing, which is wholly owned by Bank of New York Mellon. Interestingly, that last one, Bank of New York Mellon, has a special designation one of 30 institutions globally. They are a globally systemically important financial institution.
This was an outcome of the financial crisis. And just looking at saying, “Hey, some of these institutions are so interconnected, they really have to have better reserves, better capital ratios, and better plans to go ahead and unwind in the case of something bad happening.” And you probably also have seen Credit Suisse has been in; they’ve been in the news for a while. This bank has been in trouble, been losing their people; clients have been leaving them. This isn’t anything new, but they are, too, one of these global SIFIs, if you will, SIFIs, Systematically Important Financial Institutions. So I’m curious to see what’s going to happen here. I don’t think, again, I’m not an expert. I don’t pretend to be one on this. I saw that they got some money from the Swiss Bank today, but you’re probably; they have a bunch of good assets. I wouldn’t be surprised if they sell that and get back to their banking roots.
But if something really catastrophic did happen to them, we haven’t had any global SIFIs go away. It would almost be, I don’t want to say, a good test case to see what would happen, but they’re just designated as they’re too interconnected; colloquially, they’re too big to fail. So that’s something that’s different with Bank of New York Mellon and Pershing, compared to some of these others. Schwab came under a lot of pressure. It didn’t really make sense to me. If you looked at their balance sheet, they also had a lot of those same treasury securities that had unrealized losses. But that was, I think, a little shortsighted. And you’ve seen their stock price go down and then back up quite a bit over the last few days. So there’s been a lot of just, I think, knee-jerk reactions. And it probably will continue to be for a while.
Before I leave the investor protections, there’s a couple things I should mention briefly. There’s something called SIPC coverage, the Securities Investor Protection Corporation. It’s not the same as FDIC; it’s somewhat similar. You can go to the website and read about it, but it’s 500,000 per account. There’s cash; it’s a little bit different. Even in the case of Bernie Madoff, even though he was committing fraud and really never invested his client’s money, SIPC paid a fair amount of money to the victims of Bernie Madoff. So not a lot of people are aware of that. And then I know we’re running along here, Walt, you let me vent too much.
Walter Storholt:
Sorry. No, it’s good. I like it. Well, we’ve missed you for a few weeks, so you got some extra wiggle room on this episode.
Kevin Kroskey:
Here’s something that I think is really important and also isn’t understood. So not only I mentioned about the custodians and the segregated accounts. But now, think about what you hold within those accounts. You’re going to hold, whether it’s an individual stock, that’s pretty straightforward. But if you own a fund, whether it’s a mutual fund or an exchange-traded fund, what about that? And here, too, it’s so investor friendly. I’m not talking about you take an investment into a diversified basket of stocks or into a bond fund. You’re trying to take specific risks there, whether it’s the risk of owning companies or lending to companies. That’s how you should be thinking of it. It’s a little bit more complicated than that, but on a broad brush, that’s it. But if those companies go away, well, what then? This was a question that just came up the other day.
Well, I just had a conversation earlier today. Client had a large rollover of a pension plan. It was nearly $2 million, and it’s sitting in Fidelity, in a Fidelity money market fund. So not in cash, but it was a money market fund. And so again, that fund, and those assets in that fund, weren’t Fidelity’s assets, but they were segregated within the fund. And then when you go into the fund as well, and this could be, again, it could be a mutual fund, exchange-traded fund, what have you, those are separate companies. And those companies don’t really have employees. And this is all regulated on the Securities Laws, dating back to the 1930s and ’40s. But you have this division of labor there. So think of Vanguard or Dimensional Fund Advisors, who we use quite a bit; even though they’re the investment advisor, they don’t own the mutual fund.
Rather, they’re appointed by the mutual fund board to go ahead and manage the fund. Then that fund also has a separate custodian that really handles and takes possession of the securities, the stocks and bonds, what have you, within the fund. That separation between the management of the advisor and making those decisions, and the custody of the funds, it’s mandated by Securities Laws. And those are, again, all segregated. You have banks that are holding that as well. All those banks go through public accounting. And in those cases, those are not general assets of the bank. They are segregated assets. So not only do you have the segregation of your assets with your accounts at the custodian, at the Fidelity, at the Schwab, at the TD Ameritrade, and they’re not a general liability of those companies, also within the underlying investments that you’re likely to own in those accounts for the mutual funds and the ETFs, you have something very similar.
You have that separation of church and state. You have that transparency; you have those checks and balances. It’s all set up to be that way to really avoid fraud and abuse. And it’s worked really well for about 100 years now with those Securities Laws. And one final comment that I’ll make there is if we just go back, it was sometime last year, Walt, I think last summer, it was something to the effect of red flags of an investment fraud. There was a big fraud that was, unfortunately, being perpetrated throughout Northeast Ohio. And we just were talking about that since it was in our backyard and how to be on the lookout for that. And the-
Walter Storholt:
That would be Episode 107 for those who want to go check that out.
Kevin Kroskey:
Thank you. And we went right through there and talked about how, again, there was no custodian, there was no separation of church and state. People were just writing checks to this guy’s company, just like Bernie Madoff’s commingling the money. It was just a fancy IOU, supposedly backed by real estate, but it really wasn’t. And again, private investments can be okay, but you need to have a heightened due diligence process there. Having an auditor, having a custodian is still very important. Private doesn’t necessarily mean bad, but it does mean riskier because some of these protections aren’t the same as what you have under the Securities Act for mutual funds, and ETFs, and things like that.
Walter Storholt:
So, what are you keeping your eye on, moving forward, out of what we’ve seen from the crisis so far?
Kevin Kroskey:
I’ll give you my opinion. I’m not going to shy away from this.
Walter Storholt:
Okay. I mean, you’re on a roll today. You might as well go with it.
Kevin Kroskey:
Yes, I’ve got all this pent-up vocalization.
Walter Storholt:
And this is why you have to regularly be on the podcast, get this stuff off your chest, it sounds like?
Kevin Kroskey:
I will be, and I’m taking a moment here to pause as I skim through to see what’s happening in the market because it’s changing so quickly. So here’s my gut, and I’m just going from the gut here, and as I do that, let me, I guess, first say it’s always important to be highly diversified in your portfolio and your investment strategy. It’s always important to know what risks you are taking with each investment, within themselves, and also their contribution to the whole of your portfolio. You really want to build something that’s robust; I’ll call it robust to chaos. Regardless of what happens with growth, with interest rates, with whatever it may be. So that’s first and foremost.
The thing that I think is really interesting right now is what’s happening with interest rates. I mean, you’ve just had some really crazy moves in interest rates. They were going up quite a bit, and we went from really expecting the Federal Reserve to price in about a half a percent increase at the meeting this month and about a full percent over the course of this year to that swinging back fully the opposite direction with actually decreasing rates a full percentage point by the end of the year. And I surely don’t know what they’re going to do, but there’s still a fair amount of inflation that’s out there. There’s all kinds of problems with the CPI.
There’s some lagged components that are there. There’s a producer price index that’s still fairly high. It’s in the threes now, but it’s closer to four than it is to three. And you have short-term rates, if you look out just three months or so for treasury bills, that are still pretty darn close to 5%. And if you go out to a 10-year rate, it’s about; it got down to a low of about 3.3. It’s actually up to about 3.6 as they look at the market here on March 16th, at 2:55, timestamped.
So, we’ve had a ton of volatility, and it just seems like when you’re building that portfolio, sure, 5% sounds better than 3.5. But one of the things that you need to think about, too, is when interest rates fall, having a little bit more duration, like you do in a 10-year or seven-year bond, compared to something that’s only a few months, can really give you a little bit more oomph, if you will, technical term there, Walt, oomph, to offset equity price declines. And so usually, you want to keep some duration in there, some longer data bonds. But with the rate moves that we’ve seen recently and inflation still being pretty sticky and fairly elevated, I’m questioning how much duration we have in our portfolio, and I’m expecting to send out a client letter and be making some tweaks to our portfolio here. So that’s all I’ll say.
I don’t want to get too far into the weeds and certainly don’t want to discuss specific investments on the podcast. But for our clients that are listening, we’re going to release this podcast a little bit ahead of schedule, hopefully, to bring a little bit more clarity and reassurance to all the uncertainty that’s been going on. But do expect some changes. I mean, the markets are changing pretty quickly, so who knows? I mean, what I’m seeing now, could be gone in a day or two. I’ll make that caveat.
But I fully expect that we’re going to be buying some shorter-term bonds and going to be yielding close to that 5% rate that I mentioned, and it’s going to be less credit risk in the portfolio, which should be good in some different environments. It’s easy to say you’re going to do that, and people may be thinking that, even that aren’t clients, say, “Oh, I’m going to do that.” But then you have to ask yourself, “Well, where am I going to take it from?” None of this “I’m going to buy more of it; where am I going to take it from?” And then that gets into a whole other portfolio construction process. So it’s never as simple as it seems, but it should always be process-driven, and it always needs to be highly diversified and robust to chaos.
Walter Storholt:
Fantastic. Well, thank you for the excellent breakdown of everything, Kevin. Really enjoyed all the detail in today’s episode, and good having you back on, of course. And if you have any questions for Kevin that have come to mind from listening to today’s show or want to talk with an experienced advisor on the True Wealth Team and see if you might be a good fit, you can just go to truewealthdesign.com, click on the Are We Right for You-button to schedule your 15-minute call with an experienced advisor at True Wealth Design. Again, that’s truewealthdesign.com. Also linked in the description of today’s show. And you can always call (855) TWD-Plan if you prefer the phone method, (855) 893-7526.
Also, in the show notes of today’s episode, we’re going to link to the blog post that Kevin and team worked on about understanding those investor protections some more. If you want to check out some of the graphics and some additional details about that. And we’ll also link back to episode 107 if you want to learn a little bit more about that local fraud that happened in the Ohio area that we covered a couple of months back. Check that out there as well. Kevin, any final words, or are you worded out for today’s episode?
Kevin Kroskey:
No, I think just in general, if you look back, pre-COVID, markets were just rolling, and then we had a blip for COVID, and it didn’t take very long for markets to recover. So I think most people got a pass there. And then 2022 hit, and I think a lot of people got a wake-up call. Maybe a lot of people had some, what I would call unnecessary losses from non-robust investment processes and decisions, and it just doesn’t seem like it’s going to be smooth sailing anytime soon. So hopefully, people are making smart decisions. Hopefully, people have somebody that’s trustworthy and competent they can work with. And if they don’t or if they want a second opinion, we are happy to be that second opinion and be a sounding board for them.
Walter Storholt:
Again, we got links for you in the description of today’s show, or just go to truewealthdesign.com to get in touch that way. Kevin, thanks for all the help on the program, and looking forward to what we’ll have on tap next month.
Kevin Kroskey:
All right. Thank you, Walt.
Walter Storholt:
All right, take care. That’s Kevin Kroskey; I’m Walter Storholt. Thanks for taking the time to join us. We’ll see you next time on Retire Smarter.
Disclaimer:
Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.
