Where Small Businesses and the Rich Keep Their Excess Cash

According to the Small Business Administration, there are over 1.59 million businesses and 257,430 households in the United States that are currently sitting on more than $250,000 in cash. This amount is significant because the FDIC only guarantees a particular account type at an individual bank for $250,000. For entities that exceed this amount, the risk of bank failure is absorbed by the depositor. 

Obviously, this is an unnecessary and avoidable risk. It is not just a hypothetical risk. In 2013, during the banking crisis in Cyprus, a man had roughly $1,000,000 in a checking account of a Cyprus bank that went bankrupt. It was his life savings. He was left with only $100,000 because that was the limit of the Cyprus government’s insurance limits. As the article stated, “I went to sleep on Friday a rich man. I woke up Monday a poor man.” Because it is such a rare occurrence for bank failures to occur, most people do not realize the risk that is being taken by leaving over $250,000 sitting in a bank account. 

Of course, this leads to the question: What do the affluent American households and small businesses do with their excess cash to remove the counterparty risk of a bank failure?

First, if they have a significant and entrenched relationship with a bank, they will set up a “global custody” account with all cash above $250,000 directly registered in their names and all funds directly owning Treasury bills and bonds. This is what Warren Buffett does with Berkshire Hathaway’s $130+ billion cash hoard, even though he could earn higher interest rates elsewhere such as by owning short-term commercial paper. The point of having all of the money in Treasury bills and bonds is to ensure that the funds can be highly liquid and converted to cash at any time with the lowest probability of default that exists on planet earth.

The downside of this approach is that global custody accounts often involve fees to administer and short-term treasuries (of the 1-7 day and 1 month variety) pay hardly any interest at all. This could lead to a situation where someone is paying $2,500-$5,000 in annual fees for the privilege of the direct registration set-up. It may seem like an excessive fee unless you are the old man who has all of his money in the wrong Cyprus bank account in 2013 and then gets wiped out for not having the right level of conservatism. 

Short of this, the next best alternative is to invest in a Short-Term Treasury Money Market Fund. The most famous of these is the Fidelity Treasury Money Market Fund (FZFXX), which has $23 billion invested in U.S. Treasuries that are ultra short-term duration, with 80% of the U.S. Treasuries short-term debt of 1-7 days that is liquid and perpetually rolled over and only 0.5% of the assets being Treasuries with a term greater than 6 months. 

The cash management aspect of businesses is rarely discussed because it has a limited application to a general audience and most bankers would rather collect a fee for executing upon the knowledge rather than freely share it.

But there it is. For those who hold cash, the journey is usually to not think about cash management at all until the balances exceed $250,000. Then, the household or business opens up several bank accounts to avail of the $250,000 benefit in several locations (after all, it can’t better than an actual government guarantee). Once that becomes unweildy, the next step is to put the assets in a short-term Treasury money market fund–the word “treasury” is significant as it means the funds are put in U.S. government debt rather than short-term commercial paper from other banks. At last, the “final boss” stage is to set up a global custody account with direct registration at a financial institution like Northern Trust where the highly liquid U.S. Treasuries are owned outright and the counterparty risk is eliminated.

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2 thoughts on “Where Small Businesses and the Rich Keep Their Excess Cash

  1. Gregg says:

    Hi Tim,
    How about just setting up a Treasury Direct account online? Would this allow for direct ownership of treasuries without the fees associated with setting up and maintaining a global custody account?
    Thanks for any insight!

  2. Jay says:

    The FDIC insures banking accounts differently depending on the title of those assets. I have set up POD (Payable On Death) accounts and those are FDIC for $250,000 per beneficiary.

    “Because of that beneficiary interest, the FDIC currently allows you to cover as much as $1,250,000 at a single financial institution by designating up to five payable on death beneficiaries, none of whom can be covered for more than $250,000.”

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