Is Your Cash Safe at the Banks?

Last week, Bank of America (BAC) announced it was closing its $12 billion Columbia Strategic Cash Portfolio, one of the largest U.S. enhanced cash funds, after it was overwhelmed with withdrawal requests from panicked investors. (Enhanced cash funds are similar to money-market mutual funds, but cater to institutional investors and tend to invest in riskier securities.) Days later, Citigroup (C) announced it would bring $49 billion of assets from seven structured investment vehicles (known as SIVs) onto its balance sheet in an effort to make sure the SIVs stay afloat. (SIVs are like virtual banks that issue short-term commercial paper, typically bought by mutual funds. They use that money to invest in longer-term securities, including subprime mortgages.) Other banks, including HSBC (HBC) and U.S. Bancorp (USB), had already announced similar moves. Then, there's Countrywide Financial (CFC), which has been releasing a steady stream of bad subprime news for months now.

For consumers who just want to park their savings somewhere, it seems perfectly rational to have a case of the jitters. Not only that, but the whole situation can be extremely confusing. Are the typically safe choices — money-market mutual funds, bond funds and bank savings accounts — really safe? Or are you better off leaving your cash stashed under the mattress?

The good news: Your savings or investments are most likely secure (savings accounts, for example, are FDIC-insured). But that doesn't mean you should blindly stow your money in one of these accounts without taking some precautions first. Here's what you need to know:

Consider what happened when online bank NetBank was shut down earlier this year. Even though the announcement was made on a Friday, by the time business opened Monday, investors' savings accounts were safely taken over by ING Direct. Not a single cash transaction — from payroll or ATM deposits to online payments — was interrupted over the weekend, McBride says. "The regulators close the institution and do a lot of the legwork in terms of assuming deposits or finding another institution to do it before the public gets wind of it," he explains.

Just how much does FDIC insurance cover? For individual accounts, including savings, checking accounts and Certificate of Deposits, or CDs, the limit is $100,000. Joint accounts are covered up to $200,000. (IRA and Keogh accounts are protected up to $250,000.) This means a couple could technically protect up to $400,000 in non-IRA accounts in any FDIC-insured bank by holding two individual and one joint account.

If you keep more than that in cash, consider splitting it up among different banks or taking advantage of so-called CDARS service, or Certificate of Deposit Account Registry Service. This service, offered by some banks, basically administers your deposits to other participating institutions so you stay under FDIC insurance limits. However, you continue depositing your money or making withdrawals from one single account. (To see which banks offer CDARS service, click here.)

The Community Bankers' scenario is unlikely to repeat itself despite the recent worries of subprime-mortgage exposure in money-market funds and the recent troubles of enhanced cash funds. That's because money-market funds, unlike enhanced cash funds, are regulated by the strict Securities and Exchange Commission guidelines regarding the quality, maturity and diversity of their underlying investments. They are prohibited, for example, from investing more than 5% of the fund's asset in any single security, says Peter Crane, president of Crane Data, a research firm specializing in money funds and other short-term investments. So even though your fund may hold some SIVs, chances are they're a fraction of the fund's total holdings. And as new money continues to flow in — in November total assets in money-market funds surpassed $3 trillion, according to Crane Data — the SIV portion will most likely get smaller. (Naturally, most money funds have halted investing in SIVs.)

The Fed's actions can also impact money funds. When the Fed cuts rates, bonds increase in value, which in turn raises the value of money-fund portfolios and acts as a cushion against losses. (The Fed was hiking rates when the Community Bankers fund shut down.)

In addition, "breaking the buck" is such a stigma in the money-fund world that fund advisors take action long before it becomes a threat, Crane says. Citibank's move to put the seven SIVs it sponsors on its books, in fact, is good news for investors. In simple terms, it means Citibank will bail out its SIVs if they lose money, so the losses won't be passed on to investors. Eight other companies have bought back or taken measures to protect their SIVs. Chances are even more will follow, Crane says.

As subprime mortgages suffered, so did the bond funds that invested in them. Ultra-short bond funds, which invest in fixed-income securities with maturities between 91 days and a year, according to Lipper — including corporate debt, government securities, mortgage-backed securities, and other asset-backed securities — have been hit particularly hard. While some are still set to return more than 5% year to date, others have lost 5% or more, according to Morningstar. Case in point: SSgA Yield Plus (SSYPX), the hardest-hit fund in the category, has lost 13.15% so far this year. As of Dec. 20, 2007, another 23 out of the 137 ultra-short bond funds tracked by Morningstar have lost anywhere between 0.11% and 5.56%.

Call your bond fund and ask if it holds any subprime-mortgage securities. (You certainly won't be the first to ask this question, so the firm should have answers at the ready.) If you're not satisfied with the answer, reconsider your investment. Bond funds — particularly those in the ultra-short category — might not be worth the risk. "There's not a lot of incentive out there to take on a lot of risk right now in the bond market," Berry says.