Introduction to Safety and Protection of Money in the United States
When it comes to safeguarding your money in the United States, two primary forms of protection stand out: Federal Deposit Insurance Corporation (FDIC) insurance for bank deposits and the ldquo;Full Faith and Creditrdquo; of the U.S. government for bonds. Both offer distinct advantages and limitations, making it crucial to understand the nuances of each before deciding which form of protection is best suited for you.
Understanding FDIC Protection
The Federal Deposit Insurance Corporation (FDIC) is a government agency that ensures the safety of deposits in federally insured banks. The FDIC promises to pay the nominal rate and face amount of any bonds at maturity, providing a level of security and guarantee for bank deposits. However, it's essential to note that the FDIC's protection does not come without limitations:
1. Limited Coverage: The FDIC has a per-depositor cap on the amount it can insure. After this cap, additional funds are not covered, leaving you vulnerable to potential losses.
2. Potential Losses: If you need to sell a bond before maturity, you may incur a loss due to changes in interest rates. Rising interest rates can cause the bond to sell for less than its face value, negating the initial investment.
Government Bonds: The ldquo;Full Faith and Creditrdquo; Guarantee
In contrast, government bonds are backed by the ldquo;Full Faith and Creditrdquo; of the U.S. government. This term refers to the governmentrsquo;s commitment to pay the nominal value of the bond at maturity. The ldquo;Full Faith and Creditrdquo; is a strong statement of confidence and trust, as it implies the government has the power to collect taxes and issue currency to honor its financial commitments.
However, it's equally important to understand the limitations associated with government bonds:
1. No Guarantee of Earnings: While the ldquo;Full Faith and Creditrdquo; of the U.S. government offers a high degree of safety, it does not ensure that you will earn a specific amount of interest. The bond's yield is influenced by market conditions and interest rate fluctuations.
2. Federal Reserve Influence: The Federal Reserve can influence the value of government bonds through interest rate policy and monetary measures, which can affect the bond's performance.
Comparing FDIC Bank Deposits and Government Bonds
Both FDIC bank deposits and government bonds provide a significant level of safety, but they cater to different financial needs and goals:
1. Protection Cap: FDIC insurance is capped at a certain amount, while the ldquo;Full Faith and Creditrdquo; of the U.S. government offers a broader guarantee.
2. Earnings Potential: You may earn more by investing in government bonds compared to a savings account, as the yield on bonds is typically higher than the interest rates on savings accounts. However, this also means you are subject to market risks.
3. Loss Protection: If you hold government bonds to maturity, you are protected against losses, whereas FDIC insurance does not cover losses if you need to sell a bond before maturity.
Additional Considerations: Unclaimed Funds and FDIC Insolvency
It's also crucial to understand the limitations of FDIC insurance aside from the per-depositor cap:
Unclaimed Funds
1. Forgotten Funds: Unclaimed funds can be lost if these are forgotten about or if your deceased parents did not claim them within 18 months after a bank failure. If the bank fails, unclaimed funds are not turned over to the state after 7 years, but are instead confiscated after just 18 months. This situation is more akin to a bank robbery than a legitimate insurance claim.
2. FWAC Limitation: The FDIC can borrow funds from the Treasury, but there is a limit to how much it can borrow. Congress can authorize more, but this is not always the case. Beyond this, the FDIC's ability to pay out funds becomes more questionable, as it relies on the governmentrsquo;s ldquo;moral obligationrdquo; to fulfill its promise.
FDIC Insolvency and Government Role
In the event the FDIC runs out of money due to bank closures, the government steps in with borrowed funding. This borrowing is limited and dependent on congressional approval, meaning that if the government doesn't intervene, the FDIC insurance program could become unstable.
The ldquo;Full Faith and Creditrdquo; of the U.S. government, on the other hand, is more robust. It encompasses the power to collect taxes and define money, ensuring that the government has the means to honor its financial commitments, even if it needs to borrow or issue debt.
Ultimately, both FDIC bank deposits and government bonds offer a significant level of protection, but they differ in terms of earnings potential, risk, and the nature of their guarantees. Understanding these distinctions will help you make an informed decision based on your financial goals and tolerance for risk.