Friday, November 12, 2010

A personal banking nightmare

The story I'm about to tell you happened about two years ago, just as the first rumblings of the housing crisis were beginning to be heard. I distinctly remember listening to a story about the problem, then largely speculative, on Marketplace. One line from that show still echoes in my mind: the host, Kai Ryssdal, asked his guest, "So how bad is it really?" The guest responded, "No one knows." Later that day I called my broker and had him sell a bunch of stock. But I digress.

About that time I was on the receiving end of a wire transfer of a pretty substantial sum, well into six figures. I was having the money wired into a brokerage account, which is more complicated than wiring money into a checking or savings account. To wire money into a brokerage account, the money is wired into a bank account owned by the brokerage firm with a notation that the money should then be credited to a particular client. It's called an FBO (For Benefit Of) transaction.

The bank from which the money was being sent shall remain nameless, but it was (and still is) one of the biggest banks in the country, with a universally recognized brand. This bank had a reputation for being conservative. Some banks will accept wire instructions via phone or email, but this one required that the client present themselves in person so they can fill out and sign a form. I had provided the person sending me the money with a copy of the wire instructions that were provided to me by my broker.

Wire transfers are supposed to be same-day transactions, but by close of business the money still had not arrived in my account. I was told that this happens some times and not to worry. Two days later, the money was still MIA. Forensics revealed that the wire form had been filled out incorrectly. Instead of being filled out as an FBO transaction, it had instead been filled out as if it were a regular wire transfer using an intermediary bank. Moreover, it was immediately obvious that this was the case because an essentially random number had been filled in as the intermediary bank's ABA routing number. It didn't even have the right number of digits. Nonetheless, the wire transfer proceeded. The money left the sender's account and went... somewhere. Where it was, no one could say.

Yes, I know it is hard to believe, but it's true. The money was missing for two weeks, during which time no one at the sending bank knew where it was, or even, apparently, had any way of finding out. The only reason that the money was found was that I got a call from a befuddled accountant from the bank where my brokerage firm held its accounts saying that they suddenly had a few hundred thousand dollars in one of their accounts that they didn't know where it came from. The money had apparently been wired to the correct institution somehow, but to a completely random account. Even after the mess got straightened out no one could figure out how the money ended up where it did. Or if they did, they wouldn't tell me.

The shocking thing about this to me at the time was how fragile the system was, and how difficult it was to recover from errors. I thought then that this was surely a six-sigma event, but now I'm not so sure. If the person who received the money had not been so diligent in tracking down its source I'm not sure it would ever have been found. And after reading about how the banks are playing fast and loose with foreclosures and mostly not getting called out on it I can't help but wonder if money doesn't get lost on a regular basis and we just don't hear about it. I used to think that there was someone minding the store, and that the system had checks and balances in it to make sure that this kind of thing couldn't happen. I'm not so sure any more.

Since then I've been trying to get more information about how our financial system really works in terms of the mechanics of moving money around between financial institutions but it turns out to be incredibly difficult to find anyone who really understands it. Bankers in particular don't seem to have a clue. I've spoken to CEOs and CTOs of banks and they have no idea how the system works. I know it sounds crazy, but it's true. Maybe the bigger banks have their own IT departments, but the smaller banks get their software from third-party providers, and the people procuring and operating it have no idea how it works under the hood. Or if they do, they won't tell me.


Don Geddis said...

I once had a similar experience. My funds were low one Christmas during college, so I deposited a credit card check. Except that the check was old, and the card number had changed, so it turned out to be an invalid check. The bank thought I might be trying to cheat them, so they changed my account from a "checks clear in 2-3 days", to "checks clear in 2 weeks".

Before I realized that, I deposited my payroll check. Now I didn't have any cash in my account, I no longer had my payroll check, it was Christmas, and the bank said it would take up to two weeks to credit the payroll to my account.

I spent hours on the phone, trying to figure out what it meant for a deposited check to "clear". Surely, the cash was either still with my employer (in which case I could ask them to cancel the existing check, and immediately cut me a new one); or else the cash was already at my bank. Surely the cash had to be somewhere!

I eventually reached the conclusion that "check clearing" doesn't mean anything at all. What there really is, is a web of trust among large financial institutions. They take actions which work 99% of the time, and then they have correction procedures for the 1% that fail. It's like when a store gives you a money-back guarantee, for a low price, or for a product not breaking. That doesn't enforce the price actually being the lowest, or the product actually not breaking. What it is instead is just a promise: if we're wrong, here's how we'll compensate you. The promise actually has almost nothing to do with guaranteeing that the promise will be kept.

So with check clearing, their primary concern is that I'm not a con man who is going to take money out of the system. As long as the cash is EITHER at their bank, OR at the original bank, they can afford to not be completely sure just where it is, and to work that accounting out over time.

This system is totally unlike how computer scientists would design it. They would want guarantees that the money really was only in one place, and there would be a thing which is a "transaction", where the money reliably went from one place to another. A wire transfer is something like that, but it's really bootstrapped on old-time banking, which is a trust relationship with repair procedures, not a guarantee of freedom from error.

Dan Maas said...

While you're at it, can you find out why it takes days for "electronic" fund transfers to complete in an age when a credit card company can process a similar transaction in a fraction of a second?

Danston said...

It sounds like it's Schrödinger's money during the check clearing interval.

Tony Mach said...

With this I understand how PayPal could have arisen – and why they can charge their insane fees…