The Logic and Logistics of Market Flight and Repatriation
Taking assets out of the market and putting them back in
Since we've had several recent guests on Financial Sense Newshour discuss the security of the world's financial markets, I thought it might be time to address whether or not, and how, one should or could pull oneself out of the financial system.
If you'd like, you can skip directly to "The Logistics of Heading for the Financial System's 'Exit' Door."
How Worried Are You about the Financial System?
The first question to address when it comes to pulling out of the financial system is one of scope. Are you concerned about:
- Systemic risk
- A crisis in the entire financial system
- Specific market risk
- A crisis in the stock/equity market
- A crisis in the bond/credit markets
- A crisis in the futures market
- Company risk/issuer risk
- The safety of your banking institution
- The financial condition of a specific municipality, government, or state
- The financial condition of a specific company
I'll be blunt. If the entire financial system really is about to collapse, it won't matter if your money is in the stock market, the futures market, the bond market, the real estate market, foreign currency, precious metals, money market, or tucked under your mattress. Widespread chaos in the financial system would likely lead to social unrest and disruptions in supply systems that would affect basic survival: food, energy for transportation, etc. (disruptions in the credit markets in 2008 brought us dangerously close to supply problems in the grocery industry in the US, for example). It likely wouldn't matter how much money you had or where it was stashed, but it would matter whether or not you had food, water, medicines, etc. and where they were stashed. At least in the short term.
In short: if a systemic failure were to occur, for a time, use-value likely would pre-empt exchange-value or price-value. Thus asset classes—or perhaps better said, things—with higher use values (think consumable commodities) may be more likely to maintain price value in the period immediately following a systemic collapse.
However, it's my guess that a systemic collapse would not be permanent, or would lead to the swift creation of a replacement financial system over a period of several months or more. At the end of all the negotiations among nations and restructurings and regulation changes, it's my opinion that those with assets would still have those assets, they just may be worth less than they were before the meltdown—in the short term. Over the long term, those assets may not recover their "peak value," but they may recover some value.
But if you really, truly, in your heart of hearts believe Financial Armageddon is on our doorstep, buy a house on a property with water rights in a rural neighborhood, grow a huge garden, convert your vehicle to run on biofuels or waste products, begin storing food and water, and start building strong relationships with your neighbors. I'm not kidding. (I'm also not denigrating this lifestyle; it's how I grew up—minus the biofuels.)
Specific Market/Asset Class Risk
I doubt there's a true "safe haven" or truly "low risk" asset class out there right now. Even "cash" has its own risks. I think what 2008 decisively taught us is that most financial instruments and financial entities are so interrelated at this point that a blow to one is, at some level, a blow to all, primarily because investor confidence in "the system" is so fragile, and because the system itself is so—forgive the word—incestuous, which makes the system itself fragile.
I think Jim Puplava's been pretty straightforward on Financial Sense Newshour about his belief in the following:
- Economic conditions are likely to remain challenging for some time.
- The credit markets are likely to experience a significant problem in the near future. Jim is particularly concerned about government debt.
- Market volatility is likely to remain high for the foreseeable future.
Boiling it all down: we're probably in for an extended period of uncertainty and difficulty in most asset classes, although each may temporarily cycle up or temporarily look better than the alternatives.
Company Risk/Issuer Risk
Ah. Here's the meat of what I want to say about managing risk!
We often look back to the Great Depression as our yardstick for "how bad can it get?" Yes, Black Tuesday was dramatic and traumatic, but many companies trading on the markets at that time survived and thrived. Yes, some banks went under, but others didn't. The reality is that when shocks hit the system, certain companies, institutions, and governments are better prepared than others to weather the storms.
Given that the system is fragile, and given that most asset classes are likely to continue to be volatile for the foreseeable future, my best suggestion is to do your homework on the specific financial institutions you do business with and the specific issuer of the stock or bond you invest in, to gauge their possible resilience from market shocks.
There are steps you can take to protect your own assets.
- Protect against short-selling of stock shares in your account
- Do not add margin to your account.
- Some brokerage firms automatically open your account as a margin account, so double-check with your brokerage firm as to whether or not your account is authorized for margin.
- If you have margin, pay it off and remove margin ability from your account.
- Do not sign any letter(s) authorizing your broker to sell your securities short.
- Do not add margin to your account.
- Research the financial health of ALL the financial institutions you personally have assets with or financial obligations to (bank, broker, mortgage loan company, credit card company, etc.), and of the issuers of any debt instruments you're invested in (companies, municipalities, states, countries). We strongly recommend that you use several of these strategies when assessing the safety of each financial institution.
- Check your financial institution's ratings with a ratings agency or service, such as Bankrate.com's Safe & Sound® ratings, Bauer Financial's Star Ratings, TheStreet.com's Ratings Screener (or visit TheStreet.com's Weiss Safety Ratings), or Veribanc® Inc. AM Best, Moody's Investors Service, Fitch Ratings, and Standard & Poor's also rate the safety of financial institutions and some companies (and their debt issuance). (Note: PFSGroup has not performed any due diligence or quality review of these dealers/companies/agencies, and assumes no liability for providing this information to you. We recommend you perform your own due diligence on these firms before doing business with them.)
- Visit the Office of the Comptroller of Currency's website, and review their "Quarterly Derivative Fact Sheet" for the derivative exposure of 25 of the US's largest banks.
- Review the institution's financial statements.
- Registered broker/dealers are required to file annual audited financial reports with the Financial Industry Regulatory Authority (FINRA; search for your broker/dealer's reports). The "Annual Audited Report" (Form X-17 A-5 Part III) gives information on the firm's financial condition.
- Publicly traded companies are required to disclose their financial data (usually easily located on the "Investor Information" area of their corporate websites).
- For futures contract participants, futures commission merchants (FCMs) and retail foreign exchange dealers (RFEDs) must file monthly financial reports with the Commodity Futures Trading Commission (CFTC; see Financial Data for FCMs on the CFTC's website).
- For Federal Deposit Insurance Corporation-insured (FDIC) institutions, visit the "Analysts" page and research your depository institution. The "Statistics on Depository Institutions" tool is very useful.
- For National Credit Union Administration-insured (NCUA) institutions, visit the "Credit Union Data" page and research your credit union. The "Find a Credit Union" link will help you to locate your credit union and easily view its Financial Performance Report and 5300 report.
- Write a letter directly to the CEO of the financial institution or company outlining your concerns.
- In addition to checking for complaints with the institution's regulatory organization, see if there are any complaints against the firm with the Better Business Bureau.
Basically, if the company you invest in or the institution that holds your assets is financially sound, it's more likely to survive a significant event than an institution that was already shaky before the event occurred.
How Much "Insurance" Applies to My Investments/Accounts?
First, a bit of clarification. In general, the following insurance or backstop programs are not designed to protect assets against loss of value or fraud, but rather are designed to facilitate the management and transition of books of business in the event of a bankruptcy, or replace certain levels of missing assets.
This is not an exhaustive list, but covers the most common assets and types of institutions.
Generally, for the following, the "insuring" agency or body is listed somewhere on your statements and/or on the institution's website. For accounts with many types of assets, this information is usually outlined in the "fine print" near the end of the statement.
Commonly, broker/dealers are members of the Securities Investor Protection Corporation (SIPC). Either search the database of SIPC members on the SIPC website, or check your statements from your broker and/or your broker's website to see if your broker/dealer is a "member SIPC."
As for the SIPC Fund resources: "The 'SIPC Fund,' as defined by SIPA, consists of cash and U.S. Government securities aggregating $1,181,851,883" ("Notes to Financial Statements," Annual Report 2010, SIPC, 29 April 2011, p 17).
As for the nature of the SIPC, the SIPC specifically states: "It is important to understand that SIPC is not the securities world equivalent of FDIC–the Federal Deposit Insurance Corporation" ("Why We Are NOT the FDIC").
What SIPC Covers
- Cash claims up to $250,000 per customer
- Securities (stocks, bonds)
Maximum coverage: $500,000 per customer
(See "Terms of SIPC help" under What You Need to Know About the Claims Process on the SIPC website.)
What SIPC Does Not Cover
- Commodity futures contracts (unless defined as customer property under the Securities Investor Protection Act)
- Investment contracts (such as limited partnerships) and fixed annuity contracts not registered with the U.S. Securities and Exchange Commission under the Securities Act of 1933
(See What SIPC Covers... What it Does Not on the SIPC website.)
Account with an FDIC-Insured Institution (most US banks)
Not all banking institutions are FDIC members, so either search the database of FDIC members on the FDIC website, or check your bank's online info or review your statement to see if they are.
You should also keep tabs on the health of the FDIC's own balance sheet:
State of the Deposit Insurance Fund
During 2009 and 2010, losses to the DIF were high. As of December 31, 2010, both the fund balance and the reserve ratio were negative after reserving for probable losses for anticipated bank failures. For the year, assessment revenue and lower-than-anticipated bank failures resulted in an increase in the reserve ratio to negative 0.12 percent as of December 31, 2010, up from negative 0.39 percent at the beginning of the year. ("Management's Discussion and Analysis," 2010 Annual Report Highlights, FDIC, emphasis added.)
What FDIC Covers
Generally up to $250,000 per account or ownership category of the following:
- Certificates of deposit
- Money market deposit account (not to be confused with a money market mutual fund, which is not covered)
What FDIC Does Not Cover
- Mutual funds (including money market mutual funds)
- Life insurance policies
- Treasury securities
- Contents of safe deposit boxes
(See Insured or Not Insured? on the FDIC website.)
Account with an NCUA-Insured Institution (most US credit unions)
Either search the database of NCUA insured institutions on the NCUA website, or double-check your credit union's website or your statement to verify they are an NCUA member. Some credit unions are privately insured.
As with the FDIC's Deposit Insurance Fund, you should keep tabs on the health of the NCUA's Share Insurance Fund: "NCUA agency-wide efforts improved the National Credit Union Share Insurance Fund equity ratio from 1.23 percent January 1 to 1.28 percent in December, and the Insurance and Guarantee Program Liabilities balance rose from $758.7 million to $1.23 billion over the same period" ("2010 Performance Results Highlights," Annual Report: Resilience and the Road Ahead, 30 September 2011, p 40).
What NCUA Share Insurance Fund Covers
Generally up to $250,000 per individual account holder, per federally insured credit union:
- Savings accounts
- Share draft (checking) accounts
- Money market accounts (not to be confused with money market mutual funds, which are not covered)
- Share certificates (certificates of deposit)
What NCUA Share Insurance Fund Does Not Cover
- Bonds (corporate or municipal)
- Mutual funds and other securities
- Insurance products
- US Treasury securities
- Contents of safe deposit boxes
(See Frequently Asked Questions on the NCUA website.)
Futures Commission Merchant Accounts
Futures accounts are not insured.
(See "How Is My Futures Account Protected" on the National Futures Association website.)
What to Do if Your Institution Fails
If a bankruptcy or other interruption of normal business occurs with your financial institution, you'll want to act swiftly to file claims with the appropriate insuring or "backstopping" agency or claims processor. A few resources along these lines:
- Securities Investor Protection Corporation (SIPC) Claim Help Center
- FDIC's "When a Bank Fails - Facts for Depositors, Creditors, and Borrowers"
- NCUA's MyCreditUnion.gov's "What to Do If Your Credit Union Closes"
If you are concerned about the financial system, and want to pull your assets out of it, the question becomes: How far do you want to run?
I want to be totally out of the system
When I say totally "out of the system," I'm referring to the equivalent of the "Mattress Banking System," where you would sell out, cash out, and bury or hide the proceeds. In this scenario, you would have no banking, brokerage, or futures accounts, and you wouldn't hold any paper-equivalent of any asset (such as stock certificates). All assets would be close to hand, and likely would be tangible, or converted to "things." (See the rural relocation plan mentioned above.)
I don't trust a specific market
This seems pretty straightforward: it's essentially equivalent to portfolio rebalancing. In this case, you'd move your assets to markets you feel more confident in (from bonds to stocks or vice versa, or into cash, for example).
I'm worried about the health of my broker/dealer or financial institution
This is going to involve homework, since you'll need to find a new broker/dealer or financial institution (see resources on financial strength above) and transfer your assets into an account there. The account opening process is fairly swift in most cases, but transferring assets between entities can take several weeks.
Before I get in to the nitty-gritty of moving your assets out of the electronic system, let's cover the entities likely to be involved:
- The issuer of the stock shares or bond: generally a company, a municipality, a state government, or a country. (Read more about issuers.)
- The transfer agent for the stock shares or bond: a bank or trust company an issuer uses to keep track of individuals or entities that own their stocks and bonds. Sometimes issuers act as their own transfer agents. (Read more about transfer agents.)
- Broker/dealer or clearing firm: entity that holds typically holds your shares in electronic format in your behalf. (Read more about broker/dealers and clearing firms.)
How Do I Find the Transfer Agent for My Bond or Stock?
If an issuer uses a transfer agent, the information generally will be listed in the "investor relations" or "investor information" area of the issuer's website, usually in the "shareholder services" or "stock information" section.
The Securities Transfer Association, Inc. offers a list of members on its website.
And let's cover what your options are for holding your investments:
As an individual investor, you have up to three choices when it comes to holding your securities:
- Physical Certificate
— the security is registered in your name on the issuer's books, and you receive an actual, hard copy stock or bond certificate representing your ownership of the security.
- "Direct" Registration
— the security is registered in your name on the issuer's books, and either the company or its transfer agent holds the security for you in book-entry form. The "Direct Registration System" (also known as "DRS") allows investors to transfer securities held this way.
- "Street Name" Registration
— the security is registered in the name of your brokerage firm on the issuer's books, and your brokerage firm holds the security for you in "book-entry" form. "Book-entry" simply means that you do not receive a certificate. Instead, your broker keeps a record in its books that you own that particular security.
(slightly rearranged from "Holding Your Securities—Get the Facts," U.S. Securities and Exchange Commission, 03/04/2003)
By default, most brokerage accounts hold customers' assets in "street name."
And let's be realistic about the liquidity (ease of trading) of the three above options, which would include transaction speed and size of the market available to you.
- Without being reintegrated into the electronic system, physical certificates themselves are not easy to sell because they have a limited market (your neighbor, perhaps). Reintegrating into the electronic system can take several weeks, and may involve fees.
- Direct registration shares (which are still electronic) are moderately liquid, as some issuers and transfer agents offer a limited internal market for certain kinds of shares. You can transfer your electronic-format shares with the transfer agent/issuer to your brokerage account fairly easily, but the transfer itself may take several days to several weeks.
- Street name registration offers the broadest market for your shares—any exchange that trades that stock or bond—and thus generally the most ease in selling your shares.
Getting Physical Certificates
Process for Getting Physical Certificates
This is pretty simple: just contact the entity currently holding your assets in electronic format (likely your broker, or, if you participate in direct registration, the issuer or transfer agent) and request delivery of your physical certificates.
Things to note:
- Your broker might require this request in writing.
- You might be charged a fee per certificate (usually one per company or specific bond) by your broker and/or by the transfer agent/issuer.
- Your broker may only accommodate moving the shares to the transfer agent or issuer for direct registration. You would then need to contact each transfer agent or issuer directly to request delivery of your physical certificates.
- It might take several weeks for the electronic assets to convert to physical certificates.
- Due to the difficulties and timeframes involved with re-introducing physical certificates into the electronic trading system, your broker may no longer be willing to hold open an account that is, from their standpoint, essentially empty (just like a bank wouldn't be thrilled to keep your checking account open after you'd pulled out all your funds).
Pros of Getting Physical Certificates
- Your shares can't be short-sold by any financial entity.
- You may more easily be able to use your securities as collateral for a loan (per the SEC's "Holding Your Securities—Get the Facts").
Cons of Getting Physical Certificates
- Unless your neighbor is willing to purchase your shares (which you'd then sign over to him or her), your physical certificates will have to re-enter the electronic system to be tradable (see process for reintegration into the electronic system below).
- This process may involve opening or re-opening a brokerage account.
- This process can take weeks and can involve fees.
- Certain types of certificates take more effort to re-introduce into the electronic system.
- If your certificate is lost or stolen, specific procedures must be followed (see steps for replacing securities certificates).
- Replacement certificates usually involve a fee.
- Address updates must be sent to all transfer agents or issuers for your physical certificates.
- Re-registering shares (for example: from joint tenants with rights of survivorship to a trust name) could involve reaching out to each issuer/transfer agent to make this change on each certificate, which could need to be re-issued, which would likely involve a fee per certificate.
- Your homeowner's or renter's insurance policy may or may not provide coverage for your certificates stored at home.
- Should something happen to you, tracking down all your physical certificates could be a challenge for your heirs and beneficiaries.
If you own a stock you don't plan on selling for a long time, holding it in certificate form is probably okay. But if you hold a certificate that you'd like to sell if things got choppy in the market, this likely is not a workable option.
Reintegrating Your Assets if You Fled the System Completely
This, again, seems pretty straightforward. You can either contact all the entities with which you used to transact business and ask if they are willing to re-open your former accounts, or seek out new relationships. In either case, it's likely a few weeks—and a few trees' worth—of paperwork.
Reintegrating Direct Registration Assets
As mentioned above, since they're in electronic format, you can easily transfer your direct registration assets into a brokerage account via a transfer process; this process can take a few days or a few weeks. Contact your existing broker to request the appropriate transfer of assets form and get the applicable instructions.
Reintegrating Paper Certificate Assets
Contact your broker to see if they will accept the certificates directly for deposit to your account. I'd suggest sending your broker a list of the trading symbols and number of shares per certificate so he or she can run the list past their risk department.
- In some situations, certain certificates may not be able to be directly deposited into your brokerage account—such as some "penny stock" shares—although exceptions may be made for accounts that already hold a significant level of "quality assets." In these situations, you may have to deposit the shares in direct registration with the issuer or transfer agent first (there may be a fee involved) to get the shares in electronic format.
- This whole process generally takes a few weeks. If your shares must first be deposited with the issuer or transfer agent to be converted into electronic shares, and then transferred to your brokerage account, the process may take even longer.
For this reason, if you are considering selling your shares or bond, it's best to start the reintegration process well in advance of when you think you may want to liquidate that particular asset. I have worked with clients who have started the stock-certificate-deposit-to-brokerage-account process when a stock was at one price, only to have that stock price change significantly by the time the shares were finally available for trading.
- Mail your certificates to the issuer, transfer agent, or broker via a "traceable", insurable method. That way you'll have "proof of delivery."
- Do not sign, or appoint your broker/dealer or other entity as Attorney or Agent, on the reverse of the certificate; rather, request an "Irrevocable Stock or Bond Power" form (sample Irrevocable Stock or Bond Power form) from the issuer, transfer agent, or broker, and use that to appoint an Attorney or Agent for the shares. In the event that the broker/dealer is unable to work with your shares, they should return the certificate to you. If a specific entity has been appointed Attorney or Agent on the back of the certificate, you may have to get a new certificate from the issuer before another entity can work with the assets, which may involve a fee.
- Do not mail your certificate and your signed Irrevocable Stock or Bond Power in the same envelope—it's almost like sending a signed, blank check; rather, mail them completely separately and use a tracking method for each.
Does It Make Sense to Pull Out of the Financial System?
What it all boils down to is a balance between your desire for safety (if you're worried about systemic risk) and liquidity (ease of trading).
As an investor, you need to do whatever you need to do to be able to sleep at night. If that means pulling everything out of the financial system, then so be it.
For most investors, I'd suggest an alternate strategy of really doing your homework on the financial institutions you do business with, and the solidity of the issuers of any debt instrument you hold. I do think risk-averse and wisely managed institutions and companies likely will pull through any Sturm und Drang that lies ahead.
For my money, I'd rather have my assets in a financially sound institution where I can move in and out of investment opportunities at will—because volatility and even trauma create opportunity—rather than hold them in a fashion—such as in certificate form—where I'd be dependent upon a weeks-long risk review/account opening process. That way, I'd really be at the mercy of the system!
About Cathlyn Harris
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