Good Friday Morning! And welcome to March Madness! After the first day, there are only 787 perfect brackets left, according to the official NCAA March Madness Tournament. After only a handful of games, Furman and Princeton single-handedly burned through most of the brackets. My bracket could live with Furman winning – I had that pick. Arizona losing, though. That torched my bracket, leaving ashes everywhere. I had them in the Final Four – ouch.
There’s always next year, right? It’s astounding to me how impossible March Madness is to predict. Every year, tens of millions of people try, and they all fail. Hopefully, your bracket is doing better than mine, and you’re one of the 787.
After writing about banks last week, I never envisioned seeing three banks closed less than 24 hours later. We went from “everything is fine” statements to emergency actions to prevent a full-scale contagion within a day. I will recap some of that and go through where things likely go from here – links to follow.
Where you can find me this week
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[03/13/2023] America bails out Wall Street and BigTech, again – Conservative Institute
[03/17/2023] The Hidden Costs of Government Bailouts for Banks – Conservative Institute
From cracks in the foundation to full-on earthquake: US banking in crisis.
What a week. Last Thursday, as I sat down to write, I watched markets grow concerned over banks faltering. I wrote cautiously that Silicon Valley Bank (SVB) was on the ropes after Silvergate Bank had gone under. Little did anyone know that the FDIC was in SVB’s offices last Thursday preparing to shut them down Friday morning.
By the end of the weekend, three banks were dead: Silvergate, Signature Bank in New York, and Silicon Valley Bank. Regional banks across the United States were reeling, but a specific subset faced extinction, notably First Republic Bank. The Federal Reserve announced it was lifting the FDIC protection of $250,000 for depositors and guaranteeing every dollar in Silicon Valley and Signature banks.
People credibly asked whether the FDIC was practically guaranteeing every deposit in every bank in the United States with that decision. We don’t have a firm answer on that yet.
The Treasury, FDIC, and Federal Reserve bought themselves a day before the next crisis hit: Swiss bank Credit Suisse. The second largest bank in the world was sinking fast and hard as the bank contagion in the United States spread to Europe. When the day started on Wednesday, Credit Suisse told people it had no liquidity problems. By the end of the day, it begged and got assurances from the Swedish National Bank (SNB) to back it up and get a loan of $54 billion to handle its lack of liquidity.
Not to be outdone, the action pivoted back to the United States on Thursday with a fourth bank threatening to go under. First Republic Bank experienced a liquidity crunch. After the first three banks failed in the US, most people saw First Republic Bank as the next domino to fall. The reason is that its depositor base caters to the very wealthy in Silicon Valley (think Mark Zuckerberg’s bank account big). Those folks, burned by Silicon Valley Bank, started pulling all their money out of First Republic and sending it to the four largest banks: JP Morgan, Bank of America, Citigroup, and Wells Fargo.
Thursday ended with the Treasury, Federal Reserve, and FDIC negotiating and convincing eleven banks to infuse First Republic Bank with $30 billion. The goal is to make First Republic bank liquid to continue processing deposits out of it and into larger banks. First Republic Bank, like Silicon Valley Bank, cannot sell off its assets fast enough to cover deposits in it. These loans are supposed to help get it liquid to get ahead of the flight of capital.
What will Friday or the weekend hold? I have no earthly clue. Anyone suggesting they do is a liar. It’s been one of the wildest weeks in US finance history. Investors and depositors took their money out and dumped it into safe places like Treasury Notes so quickly that interest rate yields on those notes plummeted faster than at any point since 1987. The events of 2023 are only comparable to 2008 in recent history.
Along the way, we learned that inflation remains hot (with some caveats). The European Central Bank (ECB) decided to continue raising interest rates, which shocked markets on Thursday (and me). One of the reasons they continued to hike rates? The ECB said that they were afraid if they didn’t raise rates, people would panic because they’d believe something was wrong. The increased rates help boost belief in the system and cut against investor psychology.
Whether that works or not is another story. But it does set the table for the Federal Reserve this next week. I fully expect Nick Timiraos to publish a piece telling the world what the Federal Reserve will do between Friday and Sunday. I’ve bounced all over the place, but I’ve settled on the Fed raising rates by at least 25 basis points next week. I think they’ll follow the ECB’s thinking that if they stop raising rates – or cut rates – that will cause people to panic.
But again, that is sheer conjecture on my part. If you ask me Friday afternoon, I may have a different view. I’ve bounced between rate hikes and pauses every day this past week.
That said, I want to set the stage for where we are and possible ways forward.
First, the Treasury, led by Janet Yellen, has made First Republic Bank the firewall. They want no other bank failure, bank run contagion, or issues beyond the First Republic Bank. Choose your metaphor here: firewall, circling the wagon, etc. First Republic Bank is where the Treasury is making its stand on the banking system. That’s not just my description; it’s in the Wall Street Journal:
She spoke with JPMorgan Chief Executive Jamie Dimon on Tuesday, kicking off the effort to get funds to First Republic, according to a person familiar with the matter. Ms. Yellen also spoke with other bank chief executives and met with Mr. Dimon in her office at the Treasury on Thursday afternoon, the person said.
The pact is an extraordinary effort to protect the entire banking system from widespread panic by turning First Republic into a firewall. After the failures of Silicon Valley Bank and Signature, fears had grown that First Republic could be next.
The big question moving forward is simple: does the firewall stand? Getting the eleven banks involved to put up close to $30 billion was a significant win for Yellen and the Treasury. But it’s unclear if the main issues are solved.
This will be a very different rescue to what happened during the 2008 global financial crisis. Nobody is buying anybody else like JPMorgan bought Bear Stearns and Washington Mutual, or like Wells Fargo bought Wachovia. First Republic also isn’t reported to be getting additional equity capital. Money would simply be moving around the banking system.
But even this novel rescue will raise questions. For one, it may bolster the emerging narrative that the post-2008 regulatory regime has resulted in a two-tier system: Megabanks where it is always safe to deposit and do business, and everyone else.
At the same time, it might not succeed in putting to rest any fears that might arise about other smaller banks still at risk. The biggest lenders might be able to do this for one bank now. But they can hardly play that role systemically, continually sending deposits to whoever is leaking them. It also doesn’t address banks’ longer-term challenges with rising interest rates.
The structure of this deal also highlights that megabanks are hardly in need of another tidal wave of deposits. Already, the biggest banks were in some ways struggling with what to do with the surge of cash that came their way during the pandemic. More deposits lead to bigger size, which can raise capital requirements for global banks, and at times they haven’t seen sufficient loan demand to put that money to work very profitably. Buying more securities doesn’t seem like the right answer, either, in light of recent events.
The overarching issue is this: smaller banks are losing deposits. Seeing what is happening, people are reasonably saying: “I don’t want that to happen to me.” So they’re moving from small and medium-sized banks into the big four: JP Morgan, Bank of America, Citigroup, or Wells Fargo. Those are the “Too Big to Fail” banks where you know your deposits are protected by law.
At one point last week, First Republic said it had borrowed $109 billion from the Federal Reserve to handle outflows. Bank of America reportedly saw $15 billion in new deposits at some point last week. The other banks have yet to reveal what they’ve received, but the big banks are awash in deposits now.
If you’re a smaller bank, this loss of deposit money hurts. First, when a bank holds money, it doesn’t just keep it. It makes loans, buys treasuries, bonds, and more to make a profit while your money sits there. That allows them to provide banking services to you, usually without fees. The fewer deposits you have, the less money you’ll make (the opposite is true at the mega banks, which have more regulations).
In a remarkable segment, Senator Lankford of Oklahoma questioned Janet Yellen about this – watch here. It’s an important segment because I don’t think it’s dawned on her that the Fed is setting up smaller banks to fail. The Feds are guaranteeing the big banks are safe, building a fire line on the most prominent regional bank in First Republic, and doing nothing to stop the money flowing out of small banks into the large.
That doesn’t mean these banks will fail – though that’s possible in an environment like this. But what it does do is make it harder for these smaller institutions to make loans. In short: a credit crunch could occur in the smaller and medium/regional-size banks.
According to a Reuters report, we already see that in the regional banks. To some extent, the Federal Reserve wants tighter credit to clamp down on inflation. But the Federal Reserve wants to control that process of tightening credit. Banks curbing their lending because of deposit flight is an uncontrollable phenomenon.
Moving forward, the central problem is this:
The problem is not the aggregate capitalization of the financial system, but that the distribution of capital is shifting, leaving parts of the banking sector needing equity, which they should raise yesterday, but probably won’t until it’s too late, and too punitive.
Banks and the Treasury are trying to shift money around to cover areas with insufficient liquid cash to cover deposit outflows. It’s a game of musical chairs. Is there a moment when the music stops, and someone is left without a chair when the liquidity gets moved around?
It’s possible. It’s also possible the $30 billion from these banks isn’t enough to help First Republic Bank, and we will hit another crisis point with them.
My solution would be to allow some of these regional banks to take on a Silicon Valley, First Republic, or another bank in trouble and grow into a new big bank. Let more big banks form and ease rules to create new banks on the backside – make more churn in the M&A space. It would break up some of the power of the more prominent players. Letting venture capital firms and hedge funds take apart Silicon Valley is helpful too. But it appears the White House and its appointees to the FDIC are against such a thing.
Instead, we seemed destined to see if Yellen can navigate this through mere rhetoric and elbow grease. It’s hard for me to envision this working long-term. We’re going to get a crash, but what that looks like and when is hard to imagine.
What’s also amazing: all of this is going down 15 years to the day that Bear Stearns crashed in March 2008, signaling the start of the Great Financial Crisis, at least the banking portion. What is happening this time is distinct and different, but the ghosts from that era haunt the primary decision-makers. Sometimes when you fight the old battles, you miss a new one in front of you.
Links of the week
Is SVB the Canary in the Coal Mine? Although Silicon Valley Bank itself was not systemically important to the US financial system, it could signal more widespread problems that are only just coming into view. Many other banks also have large portfolios of long-dated securities and would incur heavy losses if sold before maturity. – Xavier Vives, Project Syndicate
White House leaks on the Fed: “Fed Blocked Mention of Regulatory Flaws in Silicon Valley Bank Rescue: Federal government officials wanted a joint statement to include a reference to regulatory shortcomings that they believe helped lead to the bank’s demise.” – NYTimes
SVB shows that there are few libertarians in a financial foxhole – Financial Times
Barney Frank Pushed to Ease Financial Regulations After Joining Signature Bank Board: Former congressman and co-sponsor of the Dodd-Frank bill says there is no evidence the change enabled bank’s failure – WSJ
Car Dealerships Hit With Profitability Squeeze As Auto Industry Cracks – CarIndustryGuy / Zerohedge
Twitter Thread(s) of the week
Satire of the week
“Where’s The Poetry Quoting Leprechaun?” Disappointed Biden Asks Varadkar – Waterford Whispers
Thanks for reading!