No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

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Rowan Oak
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No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by Rowan Oak »

When you have money at a bank, you have a lender-borrower relationship with the bank. The bank borrows money from you and lends money to others. As George Bailey explained in It’s a Wonderful Life, the bank doesn’t have your money in a safe. It’s in “Joe’s house, and Kennedy’s house, and a hundred others.” Or in Silicon Valley Bank’s case, it’s in long-term bonds that the bank intended to hold to maturity but lost value after interest rates went up sharply.

When you have money at a broker, the broker is only buying and keeping things for you. They do have it in a safe so-to-speak. Your money is in stocks, bonds, mutual funds, ETFs, etc. There is an exact mapping between what the broker says you have in your account and what the broker keeps for you. The broker doesn’t invest your money in long-term bonds for itself.
https://thefinancebuff.com/brokerage-ac ... -fdic.html

No FDIC Insurance – Why a Brokerage Account Is Safe
March 13, 2023 BY Harry Sit
“If you can get good at destroying your own wrong ideas, that is a great gift.” – Charlie Munger
hachiko
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by hachiko »

Doesn't your cash have to sit somewhere? Fidelity doesn't have massive safes with hundreds of thousands of paper notes in them.
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JoMoney
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by JoMoney »

hachiko wrote: Thu Mar 30, 2023 9:44 pm Doesn't your cash have to sit somewhere? Fidelity doesn't have massive safes with hundreds of thousands of paper notes in them.
Your cash is swept into a "core" settlement fund which the default for is usually a money market mutual fund. The mutual fund is it's own entity, and the securities owned by the fund are actually held by a third-party custodian (usually a trust bank that has to meet other qualifications and regulations to be a qualified custodian.)
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
hachiko
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by hachiko »

JoMoney wrote: Thu Mar 30, 2023 9:50 pm
hachiko wrote: Thu Mar 30, 2023 9:44 pm Doesn't your cash have to sit somewhere? Fidelity doesn't have massive safes with hundreds of thousands of paper notes in them.
Your cash is swept into a "core" settlement fund which the default for is usually a money market mutual fund. The mutual fund is it's own entity, and the securities owned by the fund are actually held by a third-party custodian (usually a trust bank that has to meet other qualifications and regulations to be a qualified custodian.)
Oh, that's not the default for Schwab, I see it is for Fidelity. At Schwab it sweeps into an FDIC insured account.
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JoMoney
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by JoMoney »

hachiko wrote: Thu Mar 30, 2023 9:55 pm
JoMoney wrote: Thu Mar 30, 2023 9:50 pm
hachiko wrote: Thu Mar 30, 2023 9:44 pm Doesn't your cash have to sit somewhere? Fidelity doesn't have massive safes with hundreds of thousands of paper notes in them.
Your cash is swept into a "core" settlement fund which the default for is usually a money market mutual fund. The mutual fund is it's own entity, and the securities owned by the fund are actually held by a third-party custodian (usually a trust bank that has to meet other qualifications and regulations to be a qualified custodian.)
Oh, that's not the default for Schwab, I see it is for Fidelity. At Schwab it sweeps into an FDIC insured account.
Fidelity has an FDIC sweep option as well (which is the only choice for the core sweep if you open a CMA brokerage account.) On other brokerage accounts they usually default to a Government Money market mutual fund. There is also an option for something called 'FCASH' which appears to be a 'free credit balance' held by Fidelity, and not a 'security' but a cash holding by the broker, which would likely be covered under SIPC as cash and not a security... I'm not sure when or why someone would use the 'FCASH' option.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
hudson
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by hudson »

Vanguard Safety: https://www.bogleheads.org/wiki/Vanguard_safety
Holdings held by J.P. Morgan Chase
Edit: and others....maybe The Bank of New York Mellon, Brown Brothers Harriman & Co., and State Street Bank and Trust Company
Last edited by hudson on Fri Mar 31, 2023 3:01 pm, edited 1 time in total.
afan
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by afan »

As of the last time I checked, and it has been a while, Vanguard used more than one custodian. Different funds had different custodians. There are only a few institutions that have the scale to do custody for the volume of assets that Vanguard manages. Vanguard used several of them. Things may have changed.
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by alex_686 »

afan wrote: Fri Mar 31, 2023 1:40 pm As of the last time I checked, and it has been a while, Vanguard used more than one custodian. Different funds had different custodians. There are only a few institutions that have the scale to do custody for the volume of assets that Vanguard manages. Vanguard used several of them. Things may have changed.
I don't think this is true. There are really one 2 custodial banks in the US. These business are extremely low profits centers that thrive on economies of scale. Having worked with both of these banks I can't think of any reason why scale would be a issue.

There is a edge case for securities that are not DTC eligible. These are mostly foreign securities. In this case it makes more sense to have a local custodial bank hold the assets.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by afan »

alex_686 wrote: Fri Mar 31, 2023 1:53 pm
afan wrote: Fri Mar 31, 2023 1:40 pm As of the last time I checked, and it has been a while, Vanguard used more than one custodian. Different funds had different custodians. There are only a few institutions that have the scale to do custody for the volume of assets that Vanguard manages. Vanguard used several of them. Things may have changed.
I don't think this is true. There are really one 2 custodial banks in the US. These business are extremely low profits centers that thrive on economies of scale. Having worked with both of these banks I can't think of any reason why scale would be a issue.

There is a edge case for securities that are not DTC eligible. These are mostly foreign securities. In this case it makes more sense to have a local custodial bank hold the assets.
Perhaps we need to clarify what we mean by "custodian"? More than 2.
Major players in the custody services market are Bank of New York Mellon, Citigroup, JP Morgan Chase, State Street Bank and Trust, BNP Paribas, Northern Trust Corporation, HSBC, Societe Generale Securities Services, Brown Brothers Harriman & Co.
https://www.reportlinker.com/p06277938/ ... source=GNW
Note that State Street acquired BBH, so the number of custodians went down by one. But not to 2 total.

https://www.institutionalinvestor.com/r ... Custodians
The World's Largest Custodians
Some content in this section is locked. To get access to all of the research, please subscribe here or login.

Overview
BNY Mellon Is World’s Biggest Global Custodian for Eighth Straight Year
For the eighth year in a row, BNY Mellon takes the No. 1 spot in Institutional Investor’s annual ranking of the World’s Largest Global Custodians. The firm’s total assets under custody climbed to roughly $25.08 trillion for the 12 months through June, according to II estimates, from an estimated $24.31 trillion the previous year.

State Street Corp. kept its No. 2 position. During the same period its assets declined to $21.35 trillion from $22.06 trillion.

With $20.47 trillion, a slight drop from last year’s approximately $20.5 trillion, J.P. Morgan again ranks third.

For many global custodians, asset growth was flat year-over-year. Total assets for the 15 banks in the ranking stand at $131.15 trillion, a gain of well below 1 percent.

To view the complete list of firms ranked by total custodied assets under management, click on the Leaders tab in the navigation table to the right.
I used to check the custodians for my mutual funds, thinking that this was somehow useful information. I realized that, even holding mutual funds with a variety of companies, the custodians were the same relatively small number of banks. But as of my last check, it was more than 2.

What does a mutual fund company consider in picking custodians? I certainly do not know. Fees? Services? Perception of the security of their operations? Diversification of risk? Other things? It would be interesting to hear.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by alex_686 »

afan wrote: Fri Mar 31, 2023 2:52 pm What does a mutual fund company consider in picking custodians? I certainly do not know. Fees? Services? Perception of the security of their operations? Diversification of risk? Other things? It would be interesting to hear.
Lots of banks do custodial stuff. There are lots of services that corporations need for this type of stuff. For public funds it is basically State Street or BNY Mellon. Steep step down to #3. Based on assets held, not the number of accounts.

Fees dominate the question.

There are just not much in extra services that a custodial bank can offer. It is either a working institution or not. i.e., either it is functioning like a custodian or not. Clearing the bar is a binary question, not a matter of how high one jumps over.

Why need security? The custodial bank is holding the assets in a segregated account which is being audited multiple different ways. If the audit is off the custodial bank pays you.

Why would you need diversification? The assets are segregated. You not affected much if the bank blows up. (note quite true. We ran through regulatory required business continuity plans if they did but you get the idea).

I mean, you don't pick a custodian for their reporting. Just the most ugly stuff where the design hasn't been updated forever. When I left, the letterhead of BNY Mellon was still the old BoNY one. (Operations is weird. Today I am working with Chase and Dean Witter because it is still too expensive to rename their back office)
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: No FDIC Insurance – Why a Brokerage Account Is Safe by Harry Sit

Post by rossington »

Is the implication that since banks know they have insured deposits they can take more risk... than brokerages that need to be more conservative to protect their investors?
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