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Fed's Collateral Damage

Updated: Apr 26, 2023

The U.S. economy and the stock market keep running into obstacles as of late. The economy is still dealing with a post COVID-19 pandemic inflation. Inflation is the most problematic issue facing the U.S. and world economies. Raising interest rates is the Federal Reserve Bank’s (Fed) primary tool to fight inflation. The Federal Funds Effective Rate increased from .08% to 4.83% since February 2022.

When interest rates rise, newly issued bonds start paying higher rates to investors, making the older bonds with lower rates less attractive and less valuable. Banks invest in bonds and hold them on their balance sheet. Special balance sheet accounts called held-to-maturity accounts (HTM), allow banks to value the bonds at their purchase price, not market value. For example, if the bank purchased a 30-year bond, it would not adjust the value of the bond in this account unless it was sold at gain or loss. Unrealized losses aren’t necessarily an immediate problem for the banks as they can hold onto the bonds in HTM accounts indefinitely. The problem occurs when they must sell the bonds at a loss to cover redemptions. Selling these bonds to raise cash should be one of the last options. Instead, banks should turn to attract new deposits by increasing rates, selling CDs, or even selling additional shares of stock.

How does this impact your assets held at Charles Schwab / TD Ameritrade?

Charles Schwab & Company started as a broker-dealer. To improve its customer service, it created Schwab Bank. Combined, they have over $7 trillion in assets.

Schwab Broker-Dealer

The broker-dealer at Schwab accounts for 90% of the assets held at Schwab. People typically open investment accounts such as IRA, Roth IRA, SEP IRA, and Trust accounts. Securities Investment Protection Corporation or SIPC insurance guarantees accounts at the broker-dealer. The SIPC provides $500,000 worth of protection against missing assets, including $250,000 deposits. At first glance, this amount doesn’t appear high enough; however, assets such as stocks, bonds, ETFs, and mutual funds are segregated. These assets are wholly owned by investors and segregated from Schwab assets; therefore, they will not be impacted by a Schwab liquidity issues.

Schwab Bank

Bank deposits are insured by the Federal Deposit Insurance Corporation or FDIC. Standard FDIC insurance provides up to $250,000 per depositor per insured bank, based on an ownership category. So, you could get insurance for an individual account and additional insurance for a joint account. The same applies to trust accounts. All the deposits at Schwab Bank are protected by FDIC insurance. That includes all our investor checking accounts and savings accounts and CDs.

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