Mar 20, 2023

Not a George Bailey Moment

Weekly Market Commentary

George Bailey is the fictional character in the 1946 classic It’s a Wonderful Life. Set mostly in the 1920s and 1930s, George runs the Building & Loan, a thrift that’s besieged by worried depositors. George appealed to his customers not to panic, and the Building & Loan survived.

It’s a fictional account. Many banks in the 1930s weren’t so lucky. Neither was Silicon Valley Bank.

Unable to find a buyer last weekend, the government guaranteed all deposits above the FDIC limit.

The same held true for Signature Bank, which was shuttered Sunday, March 12. SB had a large presence in the cryptocurrency space. Like SVB, it had a high percentage of uninsured deposits.

Without a buyer, the government feared a run on other larger regional banks, which likely would have triggered a serious financial crisis and a steep recession.

On top of the deposit guarantee, the Fed launched a program that provides additional funding to banks that are saddled with high-quality bonds that have lost value amid the jump in rates (bond prices move in the opposite direction of yields).

Swiss Cheese

Both programs helped soothe frayed nerves until Swiss-based Credit Suisse (CS) reported that it found “material weaknesses” in its financial reporting. Credit Suisse has been a long-running train wreck, but the timing exacerbated anxieties.

On Thursday, Switzerland’s central bank provided a $50 billion rescue package (Wall Street Journal), alleviating near-term worries.

Standing in the Gap

Swift action by the U.S. Treasury, FDIC, and the Federal Reserve helped contain what could have been a very ugly day on Monday, March 13.

But this isn’t 2008 when borrowers were defaulting on hundreds of billions of dollars in subprime housing loans. It isn’t about souring loans. This isn’t your father’s banking crisis.

The center of today’s problem is roughly $600 billion in high-quality bonds that have lost value in bank portfolios (Wall Street Journal), and anxieties over the flight of uninsured deposits.

Furthermore, SVB failed to hedge against the possibility of higher interest rates—a huge mistake. And where were the bank regulators?

Credit Suisse has its own share of problems, but the troubled bank, which has a large global footprint, pointed out that it “is fully hedged for moves in interest rates.”

Are We Out of the Woods

California-based First Republic Bank (FRC) isn’t under the microscope because it piled into long-term Treasury bonds. Instead, it has a high concentration of residential mortgages.

Unlike the 2000s, when banks freely lent to nearly everyone that wanted a home, these loans met more rigorous standards. But they were originated when rates were much lower.

Roughly 70% of First Republic’s deposits are uninsured, according to S&P Global. Following the run on SVB, fears have risen that First Republic might be next.

On Thursday, eleven banks deposited $30 billion into the lender (WSJ), helping alleviate short-term anxieties. That’s private capital, not government cash, and it was designed to reflect confidence in the bank, even if there might have been some arm-twisting.

Yet, First Republic does not hold many high-quality bonds, which would enable it to borrow from the Fed if the need arises.

Nothing to Fear but Fear Itself

In today’s world, it’s not bad loans that are driving banking woes. It’s fear.

Uninsured deposits, ones that are over the FDIC limit, are nothing new. Yet, some folks are moving cash, and it’s still too soon to say what might be lurking under the surface. Thus far, there have been no other failures.

We might expect the crisis to slow economic growth, as banks tighten lending standards, but a recession is not yet a foregone conclusion.

In fact, the market might be helping the Fed in its quest to slow the economy and slow inflation, which would alleviate rate worries that have plagued investors.

Cash Management

For years, cash management was almost an afterthought, because rates were near zero. Today, investors have choices.

Keeping under the $250,000 FDIC limit is one. Safe options also include very short-term Treasuries.

Final Thoughts

A full understanding of what happened may not be available until regulators comb through the balance sheets of regional banks and review exactly what happened at SVB.

Overall, the banking system in general remains sound. Stronger capital requirements were put in place after the 2008 crisis, with a lending backstop Fed put in place last week by the Fed.

The Federal Reserve was established in 1913 in response to the Panic of 1907. It was initially designed to address bank panics. Its initial purpose was to lend when no one else was willing.

But recent events are a reminder that confidence is the cornerstone of the financial system. We place funds in banks because we expect immediate, unfettered, and full access to those funds.

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