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Comment by hn_throwaway_99 | Hacker News Reader

Through all of this I can't help but be reminded of the 2008 financial crisis and think "this is not going to end well." One part of that crisis was Icelandic Banks making a huge push for savings all over the UK and other parts of Europe ("IceSave") with the promise of better interest rates. When it all went belly up those savers realized these Icelandic banks were not quite the same thing as UK banks and Iceland refused to make depositors whole.

If Robinhood had offered this as a normal bank with FDIC insurance I would have been impressed. For now it just seems they're just moving a little bit higher up the risk/reward curve and trying to pretend the risk is the same.

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SIPC insurance is entirely different from FDIC insurance.

FDIC insures the value of your deposits. SIPC covers the case where your broker or mutual fund cannot keep operating (eg. pay the help)

In a case like that all of your stocks and bonds are still there and have most of their value, but you can't get at them because there is nobody to process the transaction. Somehow the holdings need to be transferred to another brokerage or liquidated, and SIPC is there to make sure the resources exist for that happen.

Circa 1970 there was a crisis on "Wall Street" in the sense that many brokerages failed, see

https://en.wikipedia.org/wiki/Securities_Investor_Protection...

for a backgrounder on why we have the SIPC.

The danger that the FDIC protects us from is even more pernicious because fractional reserve banking is one of the most dangerous things people do. By design the assets and liabilities of a bank are very close to each other, in fact far larger than the equity of the bank. If the depositors want their money out, a bank might not be able to support the cash flow -- which means depositors REALLY want their money out.

The stock market on the other hand is "risky" because stocks can go up and down, but it is not dangerous systemically because if your stocks went down you have to accept that they went down. The bank is legally required to pay you back what you put in and promising to do that 100% of the time is a big promise. If people don't trust banks and banks don't trust each other then you can't cash your paycheck, get money out of the ATM, buy groceries, and then you really have a problem...

You seem to be indicating that SIPC wouldn't protect the liquid (cash) assets in the account, only reunite you with your stocks/bonds/etc. Based on the SIPC site [0] this is incorrect, and they get you your cash as well: " SIPC works to restore to customers their securities and cash that are in their accounts when the brokerage firm liquidation begins"

[0] https://www.sipc.org/for-investors/what-sipc-protects

This is correct but most people don't carry a lot of cash in their brokerage account for very long. They either use it to acquire securities, or they move it out to a real bank account. So SIPC is not equipped, financially or logistically, to act like the FDIC.

Incidentally, here is a really good article about what happens when the FDIC takes over a bank:

https://www.npr.org/templates/story/story.php?storyId=102384...

>This is correct but most people don't carry a lot of cash in their brokerage account for very long. They either use it to acquire securities, or they move it out to a real bank account. So SIPC is not equipped, financially or logistically, to act like the FDIC.

My understanding is that:

- "Cash" in brokerage accounts is usually actually some form of investment, and is usually listed as such (eg, as a deposit, money market fund, etc). The SIPC protects the holding of the investment, not the value of the investment, so if the fund goes bad, there is no protection.

- Cash in brokerage accounts is cash, and is not very common. It isn't going to make any interest, because it's not being invested by either the account holder or the brokerage, unlike fractional reserve banking. The SIPC protects this, but that's because it shouldn't have been at risk anyway.

The Robinhood account is thus confusing. If it is offering interest, then it's not cash, but a cash investment, and the actual value of the investment, which is what the clients would actually care about, isn't protected at all.

Edit: it appears they've pulled the announcement. Reading into that apology, maybe it was some sort of sweep into FDIC-insured bank accounts? But if so, how could that possibly offer 3% return?

I'm glad to see they're rethinking the details and promotion of this new service. I don't see how they can provide 3% return and still get covered under FDIC, but maybe they can find a way to get on the right side of SIPC.

> Iceland refused to make depositors whole

As I recall it, the 340,000 people of Iceland had no chance in hell of covering the enormous amounts even if they wanted to.

Edited: Iceland isn't a member of the EU, so my comment didn't make any sense.

Iceland is not a member of the EU

So confusing:

Iceland is in the Schengen Area, and the EEA, but not the EU or Eurozone

This helps: https://upload.wikimedia.org/wikipedia/commons/3/3c/Supranat...

needs ECJ jurisdiction, and ECHR. literally unplayable.

but for real, country names would be helpful too

ECJ jurisdiction is the EU, and the ECHR applies to all Council of Europe members.

Whats that one flag outside of the council which can mint Euros

Vatican City

I figured it was one of the microstates

A bit outdated it as Latvia and Lithuania are in the Eurozone.

Probably other changes too.

Iceland is not a member-state in the EU but they have close economic and political ties. They are a part of the European Economic Area (EEA) and the European Free Trade Association (EFTA).

They once applied for membership after the financial crisis but it didn't go through; currently most citizens are opposed to the idea.

Becoming a full EU member would require them to accept the EU's fishing limitations, potentially hurting their economy. There are also other factors involved:

https://en.wikipedia.org/wiki/Iceland%E2%80%93European_Union...

That’s what I thought was funny. How did Iceland’s financial laws allow a local bank to take deposits so big the entire country can’t insure it. Not to mention the criminal element.

> How did Iceland’s financial laws allow a local bank to take deposits so big the entire country can’t insure it.

Why not? Shouldn't Icelandic law protect Icelandic residents?

Icelandic law should apply equally to people regardless of of nationality. In my country, it’s illegal to murder someone regardless of the perpetrator or victim’s nationality. And bank insurance applies regardless of nationality. Restrictions apply to prevent such systemic problems.

So it’s good to protect Icelandic residents. But the law is inefficient if it allows too much capital that it can’t be managed and insured.

You're right that what happened in Iceland hurt Iceland. But I was addressing the more general point of why the Icelandic taxpayer should insure depositors from other countries.

> it’s illegal to murder someone regardless of the perpetrator or victim’s nationality

You're mixing up two things: whether the law as it exists was violated (in which case Icesave should of course be punished) and whether the law SHOULD protect foreign depositors. I'm discussing the latter.

> bank insurance applies regardless of nationality

I'm not well-versed in cross-border banking to say the least, but isn't that an opinion? One could just as well argue that Icelandic taxpayers shouldn't have to subsidise the British (as an example) public, by providing free insurance. If Britishers want insurance, it's up to their government to incur the costs, since it's the Britishers who'll be benefiting.

> When it all went belly up those savers realized these Icelandic banks were not quite the same thing as UK banks and Iceland refused to make depositors whole.

That's a very inaccurate recalling of history which you can see from reading the intro to the relevant Wikipedia article[1] and a summary of the EFTA Court's decision on the matter[2].

The case centered around a dispute between mainly Britain, The Netherlands and Iceland about how to interpret certain EFTA regulations. Iceland's position ultimately prevailed in court.

1. https://en.wikipedia.org/wiki/Icesave_dispute

2. https://en.wikipedia.org/wiki/EFTA_Surveillance_Authority_v_...

I read both your links, and I don't think my characterization is an inaccurate recalling of history at all. From the second and third paragraphs of that wikipedia page:

----

When Landsbanki was placed into receivership by the Icelandic Financial Supervisory Authority (FME), 343,306 retail depositors in the UK and Netherlands that held accounts in the "Icesave" branch of Landsbanki lost a total of €6.7bn of savings. Because no immediate repayment was expected by any Icelandic institutions, the Dutch and British national deposit guarantee schemes covered repayment up to the maximum limit for the national deposit guarantees – and the Dutch and British states covered the rest.[1]

The Icelandic state refused to take on this liability on behalf of the guarantee fund. Originally this was because the state lost funding access at credit markets due to the Icelandic financial crisis, but later proposed bilateral loan guarantees for repayment were rejected by Icelandic voters.

----

At the end of the day there were a ton of foreign depositors who felt like these were just normal savings accounts with higher rates, but when the financial crisis came they were in a much more difficult position than people who used domestic banks.

I took issue with the abrupt ending of "refused to make depositors whole[...]".

That sounds like unilateral action, whereas what happened was that there was a dispute about how deposit guarantees should be treated within the EFTA agreement, and all parties involved ultimately didn't insist on what they individually felt like doing, but followed the rulings of the EFTA Court.

But yes, it was a big learning experience for everyone involved. But that's exactly the reason it's important to make the distinction.

It's not that Iceland was unilaterally callous and pursuing those relatively small amounts was deemed small potatoes. Rather, EFTA rules were clarified in a way that would also apply to e.g. French depositors in Danish banks should a similar Danish default occur in the future.

What happened with domestic depositors is that the Icelandic state was free to selectively grant benefits to whomever it pleased once it became clear that its banks weren't subject to the EFTA deposit guarantees for anyone.

That's also an important distinction, and is why the action didn't violate the rules of the trade area.

I remember (but cannot find a citation) in ~2005/6 AIG was offering 4% saving accounts. I'm having deja vu all over again.

In Germany 5% was common at that time for savings.

yeah i had a 4% account from HSBC around that time. This immediately brought up an uneasy feeling for me, like this is the "pump" side of a pump and dump or the books are so ugly they need cash deposits at any cost to make it look sane.

That wasn't an unreasonable rate at that time[1], I don't recall the exact timing, but my credit union was at 4% on savings for a while, before fed set interest rates to near zero for many years.

[1] https://www.depositaccounts.com/blog/archive/2005.html

CDs were in the 5.10% range in 2006-2008, I had a ladder of them.

Many of the institutions I had CDs with were dissolved and I was refunded the principal (without interest) by the FDIC. Compared to the losses everyone else was seeing I was more than happy with my 0% "return".

That's extremely reasonable for a savings account. The fed rate at the time was around 5% [1]. Today's is much lower which raises questions about where this rate is coming from.

1: https://en.wikipedia.org/wiki/Federal_funds_rate#Historical_...

Long term bonds are just above 3% now.

That’s because interest rates were around that level at the time and the bank was also getting paid that much to hold your money. It wasn’t a conspiracy.

Consumer savings accounts had absolutely nothing to do with the crisis.

Like, on the list of “things that caused the crisis,” they would literally be dead last.

Did you know your parents had savings accounts that delivered 10% interest at one time? Look up historical interest rates in the US. 4% is like average.

IIRC, high interest rates are caused by an economic boom, as raising interest rates is caused by both an increase in demand for cash flows to finance investments and also as a monetary policy to put economic pressure to control inflation.

Currently the world in general is very far from an economic boom, and central banks are actually implementing desperate monetary policies to jump start inflation. Thus, we are very far from those times to the point that nowadays a 3% interest rate is considered huge, as the norm is for interest rates to remain below the inflation rate

3% is not huge for the US right now (we have been the most aggressive of the developed markets in normalizing). 3% is only a bit above the federal funds rate right now.

When you account for the investor cash that will subsidize this service as a loss leader offering, it’s not unreasonable.

The only risk is we enter a severe recession and the fed has to drop interest rates to 0 again. In that scenario, robinhood simply has to lower the rate of their offering as well. This isn’t some big existential risk.

> Consumer savings accounts had absolutely nothing to do with the crisis.

That's just not true. A significant contributor to the mortgage crisis is that banks loan out savings that are backed by the government. Savers deposit their money with banks even if those banks are underwriting risky mortgages

That’s like saying a significant contributor to the mortgage crisis was restaurants, because restaurants pay interest on their loans to banks which the banks then used to underwrite risky mortgages.

Not sure I follow your argument. How did savings accounts that offered 4% cause the crisis?

That was a real bank. Historically savings accounts are in the 2.5-5 range.

Investment banks were leveraged 40:1

The consumer banking side of the story has almost nothing to do with it

Short term investment grade debt has a default rate of near-zero and pays more than 3%. See for yourself:

https://investor.vanguard.com/etf/profile/VCSH

It is entirely possible for them to safely promise a 3% account under these conditions. This is not at all like the financial crisis. It's just wrapping an investment grade bond fund in a bank account interface.

Yeah. But MMFAs can default in ways that aren't guaranteed by the government. The distinction between zero and near zero matters.

This is an important distinction. When the money marketeer redeems a dollar for less than a dollar it "Breaks the Buck" [0]. Cowen's MM account IIRC was the first one to do that back during the 01 crash.

[0] https://www.investopedia.com/terms/b/breaking-the-buck.asp

The rules around breaking the buck were significantly changed after 08. Funds can suspend transactions instead now.

As if not letting people out is better than letting them out at a haircut. Need to maintain the illusion of safety I suppose.

Yeah. And the haircut is usually quite small. If I sold my money market for 98 cents on the dollar in a financial crisis I really wouldn't be that upset.

When you buy a bond and the interest rate goes up, the nominal value of the debt goes down when the interest rate goes up, while with bank accounts they stay the same.

Ex: You buy a $100 bond at %3, then the prime rate goes up %1 so the typical market price of bonds of your class are now %4. Now your bond is worth less than $100 if you were to liquidate it.

Big difference.

that's a good point.

However, in this case, won't it be more like a bond-fund, where the fund essentially has a ladder of bonds that are constantly expiring and getting reinvested (and also investing new investments from retail investors), and so the overall value of the fund may still remain close to $100.

I could well be wrong, so please feel free to correct me! Trying to learn.

Yes bond funds do that to even out interest rate changes kindof, but those fund prices can still go up and down in price as a result of interest rate changes and other market dynamics.

If they called this the 'bond fund account' with easy liquidation and buying to make it bank account-ish, then I don't think people would be as upset about this, but it would be a fairly niche financial product.

One risk is that the other investors might suddenly decide for some reason (say a sudden wave of panic) to cash out their holdings in the fund. This would force the fund manager to immediately sell some of the bonds, perhaps at an unfavorable price. Bonds (safe ones) eventually pay out at their full value, but their market price fluctuates before maturity, and a sale forced by other investors could stick you with a loss.

There is a strong difference between Yield to Maturity and effective yield. Yes, If they hold bonds until they mature, specifically government bonds, there will be no loss in principle.

What people seem to be misunderstanding is that a yield curve exists. If they were to go the safe route of short maturities, the interest rates will be must lower than long dated securities. If they reach for yield in longer term securities, they will have to mark to market when interest rates rise (which they most likely will due to the fed signaling that they'll be tightening in 2019).

You can't have your cake and eat it too

I clicked 'performance' on that page and it says 1.5% over the last five years. Am I reading it wrong?

does 'performance' include dividends?

Yes. This is a marketing website for Vanguard, so of course they want to list the highest return possible, and dividends definitely do count in performance.

That's the average annual performance. Interest rates only started climbing over the last couple of years.

Look at the "SEC yield." That's what it pays going forward. Returns were lower over the past five years because the Fed had lowered rates to stimulate the economy.

The yield is only part of the return, one has to consider also the change in price. If interest rates go up prices will go down and the actual return will be lower than the yield.

Over the last 12 months, the price of the VCSH fund is down more than 2%. This offsets the dividends paid with the coupons received and results in flat performance.

It may be fairly safe, but it's not risk-free (and certainly not guaranteed by the government). Even if companies don't default, their borrowing rates can still increase, reducing the value of the bond and causing you to lose money.

The 3% return is compensation for the added risk. The financial markets are pretty efficient for liquid stuff like this.

Banks also provide services that consumers are willing pay for through lower rates on their checking accounts, and need to cover their administrative costs or have some other way of making money with the deposits.

No, it's much worse than the financial crisis.

It's very unlikely that regulators and smart money would smile upon "wrapping" VCSH or similar corporate bond fund and trying to transform it thereby into a demand deposit account.

A bond fund like that, even with a relatively short duration of 2.65, is going to have significant price movement in the principal amount due to interest rate risk. (Not counting credit risk etc -- credit spreads could move significantly too in a financial crisis.)

A big rate move coupled with a big jump in credit spreads could easily move the price of the underlying by several percent in a matter of days.

Not so cool when your deposit of $100 can only be cashed out for $97 a few days later.

Well, we're in a strong economy so of course the default rate will be near-zero. What happens if there is a financial or economic crisis and companies start defaulting?

You're assuming they are just holding onto all the deposits and buying these bonds... that strikes me as extremely unlikely.

For what it's worth, the point of deposit insurance is not to mitigate against typical situations where bonds behave "like normal" and stick to their typical default rate. The FDIC and SIPC were founded in response to what happens when everyone just turns a blind eye and says "oh, that's totally safe, risk is _near_ zero!"

This is extremely misleading and no one should be using bond funds as a checking/savings account replacement. You have mark to market and liquidity risk here which in normal circumstances you do not have with a savings/checking account.

Additionally, Robinhood is reportedly investing proceeds in US Treasuries. US Treasuries have a completely different risk profile than corporate investment grade bonds.

> no one should be using bond funds as a checking/savings account replacement

Literally all money market accounts are bond funds under the hood, actually.

Under the hood vs how they function in everyday situations are completely different things.

If I sock away $100 a month for the next 12 months to pay for something, which one is more likely to have >=$1200?

That depends on what you mean by "sock away".

Thought was implied but money market funds vs corporate bond funds.

With the important difference that money market accounts should never lose principle (aka "breaking the buck"). It has happened, but its fairly uncommon.

Bond funds, however, frequently can and do lose value - if interest goes up, price goes down (the reverse should also be true, though).

But it carries more risk. It may not continue to pay 3%. In a financial crisis the money may not be there any more, the companies may go bankrupt en masse for example, or companies that were previously thought to be safe may not be able to meet their obligations. There is no sort of guarantee here, and the SIPC guarantees are supposed to be about making sure investors end up with the securities they purchased, not making investors whole if their investments turn out to be worthless.

It is precisely this kind of bundled 'derisked' derivatives which caused the last financial crisis (those were sold as very low risk mortgage debt , these are corporate debt).

You get your dividend, but the actual price may (and did) decline. Actual performance over the past year is under 0.1%.

If you want a guaranteed return you do not buy bonds or stocks. You buy a money market fund like VMMXX. See https://investor.vanguard.com/mutual-funds/profile/performan...

Very important distinction between money market funds and checking accounts is that they aren't FDIC insured.

True, true. But with a megacorp like Vanguard backing it, I'm personally not too concerned...

Vanguard is not a corporation. It is structured as a mutual company; it is owned by funds managed by the company, and is therefore owned by its customers.

See: https://en.wikipedia.org/wiki/The_Vanguard_Group

Vanguard has many pieces and parts, many of which are, indeed, corporations. It says so on the bottom of its website: "Vanguard funds not held in a brokerage account are held by The Vanguard Group, Inc., and are not protected by SIPC. Brokerage assets are held by Vanguard Brokerage Services, a division of Vanguard Marketing Corporation, member FINRA and SIPC."

Regardless of its legal structure, I meant "megacorp" in the generic sense of "large company."

It is a large company.

good point.

Vanguard has a pretty good reputation regardless of it's company structure. I'm not so trusting of some other financial firms.

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