Rex Salisbury
Aug 23, 2017 · 2 min read

With the products currently provided by major banks and brokerages, you are correct that the only reasonable thing to do is hold a large balance. Especially since an ACH transfer from a brokerage would have to be triggered manually and may take up to 9 days to complete.

That means we have two problems:

  1. The types of accounts offered are not great
  2. Transfers are slow

Types of Accounts

There is no reason that bank deposits should the preferred form of liquidity. Why not have a checkable brokerage account backed by treasuries, instead of a checkable deposit account backed by the banks creditworthiness and FDIC insurance?

Such checkable brokerage accounts do exist, where the underlying asset is often money market funds, but there is no reason why the underlying asset couldn’t be something that floats in value, like stocks — if the software powering the experience is powerful enough to handle the various tax implications. However, in their current form it is very difficult to wire up such accounts to pay bills or facilitate ACH transfers.

This starts to get into a different subject which is why do deposit account exist in the first place. Some would argue, such as John Cochrane, they are an outdated product that should be replaced, since consumers are giving away money to free for banks, regardless with how risky that banks balance sheet is, which creates a principal agent problem. If banks borrowing costs are divorced from the cost of the risks they are taking, why bother being prudent?

Worse, short term debt is always the contagion of financial crises. Generally, consumer deposits are not a contagion because of FDIC insurance, but other forms of overnight lending are.

So for now there is little choice, but there’s not reason there couldn’t be better alternatives in the future.

More from John Cochrane.

In this vision, demand deposits, fixed- value money- market funds, or overnight debt must be backed entirely by short- term Treasuries. Investors who want higher returns must bear price risk. Intermediaries must raise the vast bulk of their funds for risky investments from run- proof securities. For banks, that means mostly common equity, though some long- term or other non- runnable debt can exist as well. For funds, or in the absence of substantial equity, that means shares whose values float and, ideally, are tradable.

Speed of Transfers

Transfers are artificially slow, because Banks like keeping money locked up in deposit accounts so they have a cheap source of funding. Eugeme Fama argues that banks aready have a way to do instant transfers for free. They’re called wires. They just aren’t interested in doing so.

From Eugene Fama

In a wire transfer, which is basically the way everything settles, the costs are zero. It’s just accounting. It’s an entry on a computer, the cost is zero.

In conclusion

Right now you are stuck holding that $25,000 in a deposit account because banks want you to have no other choice. But that could change.

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Rex Salisbury

Written by

software dev, yimby, econ nerd, fintech enthusiast, lover of mountains

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