On City of Erie Cash, Missed Revenue Opportunity, Deposit Insurance and Banking.

Today starts with an interesting observation about the city's cash holdings, revenue opportunities with the cash held by the city and the need for treasury management, and Banking and Bank runs.

Welcome! This is just an interesting note today to address and set up an interesting discussion about banking: the city holds $117,559,285 in its deposit account, which is well over the FDIC insurance limit of $250,000. However, the city maintains the balance is collateralized, meaning the deposit is backed up with assets by securities held by the City of Erie and its agent in the City’s name. This basically means a custodian is holding a basket of assets that could essentially insure the deposit. This is not a bad thing necessarily. Below I will give a little color on banking crises, PNC’s status and stability, the effects and aftermath of the 2008 crisis, and federal government policy regarding bank failures and its rationale. Not addressed here, but also worth noting that the $486,132,206 in pension fund assets are held in an account with $500,000 in insurance for equity balances (stocks and securities) and $250,000 in cash - the likelihood of an investment account held at a financial institution is even less probable than the highly improbable event of a banking failure.

The risk of PNC or counterparties with custody of City cash balances going insolvent is extremely low. PNC, whom I assume holds the city’s deposits and is the probable agent referenced, is a bank approaching Too Big To Fail status. The Federal Government has made it clear that while regional banks can be seized by the FDIC and see potential losses for depositors over the FDIC limit, large institutions that play important roles in our financial system get different preferential treatment. In a bank-run scenario, the Federal Government would likely deem its failure a systemic risk and outright guarantee deposits or strongly (some could say coerce - this happened in the 2008 crisis when banks were essentially forced into buying failing institutions) recommend that another, larger financial institution buy its assets and assume its liabilities (deposits) which would make depositors whole. Given the recent regional bank turmoil, I thought it was worth noting. The investment fund’s assets are well above the $250,000 insurance protection and are also exposed to potential loss if the financial partner fails). It is also worth noting, to rebuild some confidence for anyone reading this who might have worried about the revelation that nearly all the city’s cash was at risk, PNC was one of the partner banks that contributed cash as new deposits in one of the banks that recently ran into severe difficulties, joining the likes of Goldman Sachs, JP Morgan, Citi, Wells Fargo, and would never have taken that action if it wasn’t highly capitalized, liquid, and able to meet any withdrawal demands. In my eyes, this was their purchase price into the TBTF club and placed them under the blessing of the Federal Reserve and Treasury Department, making them a critical institution.

PNC is significant, but the other banks mentioned are significantly bigger - but that doesn’t matter. PNC is big enough to get

special treatment. If that’s fair is a whole other debate, I would argue not. The thing is, if confidence starts collapsing in banks, the fear spreads rapidly, and other banks which might not have had issues would suddenly be met with a huge amount of withdrawals and find themselves in a bank run situation, and this would spread throughout the total financial system, and the whole system would come down. The US banking system relies on fractional reserves, meaning that banks essentially lend out your money multiple times, assuming that it is highly unlikely that all depositors would demand the return of their money all at once. So when you invest $1 at a bank, that turns into $5 of loans. Managing this balancing act is called asset liability management. Due to this system, confidence is critical so that people don’t rush to pull their assets because if they do, there wouldn’t be enough money to cover all the deposits. So if a bank like PNC failed, confidence in all larger banks would quickly collapse, and you would look at a 2008-like situation or even worse. For those that don’t remember, the 2008 recession that started as a financial crisis turned into a full-blown recession that destroyed property values, collapsed the stock market, caused massive unemployment, damaged municipal balance sheets and pensions, and led to nearly a decade of very low, below-trend GDP growth. You could also argue it set the stage for the current banking (mini) crisis, as the zero interest rate policies put into place by the Fed to help reverse the recession had to be kept in place up to the end of last decade, and the system became heavily reliant on those low-interest rates. Now, with the Fed increasing rates by 100s of percent, business, and investment models are failing. 

Concerning PNC’s position, it’s more than just an issue of depositors losing money. The bank goes beyond “traditional banking” - holding deposits and making loans. They are a prominent participant in the capital markets, serving as a counterparty (someone you enter into a financial transaction in which there is some form of obligation from one to another) to many other institutions. Financial institutions participating in the capital markets would default on counterparty agreements in a bank run and insolency situation. If PNC failed, it wouldn’t just be depositors taking a big hit; it would be other banking and financial institutions who trade with PNC and suddenly find themselves holding worthless trading positions, which is a situation that could dramatically spiral into a financial crisis. This is why it’s very likely classified as a systemic institution by the federal government. It is a significant counterparty to many financial institutions, from banks to corporations to insurance companies. Its collapse would wreak havoc on other financial institutions’ balance sheets, leading to even more significant insolvencies that spiral further and spread across the system. The government makes the bet that rushing to provide guarantees to large banks and telegraph that behavior as soon as there are signs of distress in the banking system will likely cost far less than what would happen if the fear spread and suddenly lots of banks are facing bank runs, and you have large scale insolvencies. A situation like that would set the country back years and result in very painful conditions for everyone, rich and poor. But just by suggesting they will backstop large banking institutions, it prevents bank-run scenarios by giving depositors confidence that their money is safe.

In summary, the City holds a lot of cash in deposit accounts at a bank beyond the FDIC insurance limit, but they say the cash is collateralized. Additionally, even if some crazy events led to turmoil at its banking partner, which I presume is PNC, there are several reasons why I don’t think there is even a remote chance of issues with uninsured deposits. If the bank ran into issues, it would likely search for a buyer of its assets, generating cash to cover deposits. If that fails, they would likely find a strategic partner to buy the bank and assume assets and liabilities. And if THAT fails, at the end of the day, as a major banking institution, as the federal government and its representatives have made clear, it will not be allowed to fail, and the FDIC, Treasury Department, and the Federal Reserve working together would guarantee all of its deposits. This was long and somewhat complicated, but I thought it was an interesting tidbit about the city’s finances and an excellent opportunity to explain a little about banking crises and the federal government’s policies regarding bank failures. I hope you found it interesting.

(one thing unclear to me from the source documents is that $117 million is listed in the city’s checking account, but I am unsure if that includes the component units such as the Erie Metro Authority, Parking Authority, etc. To present the information, the Erie Metro carries $9.6 million and is backed by collateral held by a custodian as required under Act 72. The Parking Authority carries $10,741,929, which is also collateralized. The Parking Authority carries 1.95 million, is not collateralized or insured, and is held by a Broker Dealer (securities account). Finally, the Redevelopment Authority carries $93,597. I’d be interested to know if that is included in the $117 million figure or could this additional cash also be earning interest (admittedly, for the amount listed, it might be more trouble than its worth, even if all of it was invested in 3-month treasuries its only about $400,000 for the two authorities with ~$10 million. But hey, leave no stone unturned, right?

Thanks for reading, and if you thought this was informative or interesting, please share this page or comment below. It all helps spread the content. If you have any questions about what was covered, more detail on the data, or any other items you want to discuss, drop a comment here or on social media. I’m happy to have a conversation or answer questions.