The Shadow, the hero of a 1930s radio show, could see the evil lurking in the hearts of men. Unfortunately, consumers can’t always see the trouble lurking in another kind of shadow — the shadow bank — until it’s too late.
This was certainly true of money-market mutual funds during the 2008 financial crisis. Set up decades ago to look and act like bank accounts without the regulatory hassles of being a bank and paying for deposit insurance, the money fund business model worked until it didn’t.
After suffering big losses on Lehman Brothers debt, a major fund was unable to redeem customers’ funds dollar for dollar. It “broke the buck” in industry parlance. Clients suddenly realized that, unlike a bank account backed by the Federal Deposit Insurance Corp. (FDIC), a fund could lose their money. Massive withdrawals — a classic “run” — ensued, necessitating unprecedented government intervention.
Congress has prohibited future taxpayer rescues, but regulators have not yet fixed money funds. Sensible observers assume that eventually funds will be required either to act like mutual funds and let share prices float, along with the actual value of underlying investments, or to put up capital to protect customers if investments lose money.
Unfortunately, a powerful, multitrillion-dollar industry has grown up around money funds, and it continues to fight such commonsense reforms.
This should serve as a lesson to regulators about a new shadow bank — the reloadable prepaid card. Like bank accounts, the cards offer direct deposit of paychecks and online bill paying.
They’re a hot product: Americans are expected to load more than $200 billion onto them this year, up over 600% since 2009. The cards can be simpler and (sometimes) cheaper than traditional bank accounts, particularly for small balances, making them popular with young people and lower-income households. And they can be an effective way to stick to a budget or teach financial responsibility to kids: You can’t spend more than the amount loaded on the card.
For now, most issuers voluntarily provide FDIC insurance to protect principal, but a few, like American Express, have chosen to forgo it on some cards. And other issuers could change their minds.
Regulators should mandate FDIC coverage before another giant industry grows up with a vested interest in avoiding deposit insurance rules. Otherwise, cardholders could suffer losses or face delays in accessing their money if an issuer gets into trouble.
The Shadow was able to “cloud the minds” of his enemies. Don’t let shadow banks cloud yours. Stay away from money-market funds or uninsured prepaid cards if you want your money 100% safe and there when needed, in good times and bad. Put it in a real bank account insured by the FDIC.
Sheila Bair is the former chairman of the FDIC. The opinions expressed in this commentary are solely hers.
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