Is Your Bank Safe Now?

Commentary One week ago Sunday, the Federal Reserve Board, alongside the FDIC and the U.S. Treasury, announced plans—in the wake of the failure of Silicon Valley Bank (SVB)—to provide liquidity to U.S. banks in an attempt to “bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy.” Can we, therefore, trust that the U.S. banking system is now safe? Following the bailout of SVB’s uninsured depositors, and with additional lines of government emergency funding now available to U.S. banks, President Biden said on Monday, March 13, that “Americans can have confidence that the banking system is safe.” The Federal Reserve Board said that “The capital and liquidity positions of the U.S. banking system are strong and the U.S. financial system is resilient.” And, even though deposit flight continued throughout the week, the eleven too-big-to-fail banks which stepped in to rescue First Republic Bank on Friday, March 17 said, “The banking system has strong credit, plenty of liquidity, strong capital, and strong profitability. Recent events did nothing to change this.” But is any of this really true? The financial markets certainly don’t think so. And perhaps neither should you. In spite of massive government intervention and encouraging words from both government and banking sector leaders, an estimated $550 billion of deposits left the U.S. banking system this week. Banks were forced to tap the Federal Reserve’s emergency funding lines for $165 billion. The Federal Home Loan Banks, a government-sponsored entity, just raised $88.7 billion in new bonds to lend to a banking system otherwise unable to fund itself. U.S. bank stocks ended the week down five percent on Friday, and the NASDAQ Bank Index remains 25 percent below levels at the beginning of March. The banking system is tottering, and the shriller the voices become insisting that everything is fine, the more we know we’re in trouble. A sign in front of a First Republic Bank office in Oakland, Calif., on March 16, 2023. (Justin Sullivan/Getty Images) Take the case of First Republic Bank, which as the fourteenth largest bank in the United States is larger than SVB was when it collapsed. Following the failure of SVB, depositors and investors reasonably asked what other banks might be at risk of a similar deposit run. First Republic was vulnerable, and over the course of just a few days, several billion dollars of demand deposits fled the bank. First Republic tried to find a buyer, but none emerged. Early on Friday, a consortium of eleven of the largest banks in the United States agreed to collectively inject $30 billion of deposits into First Republic to keep it afloat and to prevent financial contagion. Despite these actions, markets were not convinced. First Republic’s share price ended Friday’s extended trading day down 31 percent, and down 84 percent since the beginning of March. Late on Friday, Moody’s downgraded First Republic’s credit rating to junk status, an action which followed S&P and Fitch earlier in the week. Lack of an investment-grade credit rating places First Republic (or any bank trying to access the capital markets) in an untenable position. The cost of borrowing becomes prohibitively expensive, and the losses begin to mount, worsening the bank’s profit and capital condition. First Republic appears to be a dead man walking. Moving on from First Republic, both investors and depositors will look for the next weakest link in the chain. And when the deposit run at that next bank begins, perhaps on Monday, perhaps next month, will those same Big Banks step in once more with additional tens of billions of liquidity support? And even if so, what about after that? Where does it end? There is not enough private sector funding to go around to solve a systemic deposit run once contagion kicks in. We saw this in the global financial crisis of 2008. So that leaves the U.S. government to step in further. Neither the $25 billion U.S. Treasury backstop of the Fed’s lending program nor the FDIC’s $128 billion Depositor Insurance Fund is anywhere near enough to protect $18 trillion of U.S. deposits. The Federal Reserve, the lender of last resort, is itself constrained. Inflation fighting through quantitative tightening and raising interest raises is now effectively over. The Fed’s $8.6 trillion balance sheet is now good for one thing only, and that is printing more money, which means inflation will resume its upward path later this year. The logo of Swiss bank Credit Suisse and a Swiss flag in Zurich, Switzerland, on Aug. 1, 2014. (Keystone, Steffen Schmidt/AP Photo) Contagion is spreading to Europe. Credit Suisse, one of the world’s largest investment banks, is teetering on the edge. So much so that on Wednesday, March 15, the SNB, Switzerland’s central bank, was forced to come to Credit Suisse’s rescue with a $50 billion liquidity package. The SNB announcement followed the

Is Your Bank Safe Now?

Commentary

One week ago Sunday, the Federal Reserve Board, alongside the FDIC and the U.S. Treasury, announced plans—in the wake of the failure of Silicon Valley Bank (SVB)—to provide liquidity to U.S. banks in an attempt to “bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy.” Can we, therefore, trust that the U.S. banking system is now safe?

Following the bailout of SVB’s uninsured depositors, and with additional lines of government emergency funding now available to U.S. banks, President Biden said on Monday, March 13, that “Americans can have confidence that the banking system is safe.” The Federal Reserve Board said that “The capital and liquidity positions of the U.S. banking system are strong and the U.S. financial system is resilient.” And, even though deposit flight continued throughout the week, the eleven too-big-to-fail banks which stepped in to rescue First Republic Bank on Friday, March 17 said, “The banking system has strong credit, plenty of liquidity, strong capital, and strong profitability. Recent events did nothing to change this.”

But is any of this really true? The financial markets certainly don’t think so. And perhaps neither should you.

In spite of massive government intervention and encouraging words from both government and banking sector leaders, an estimated $550 billion of deposits left the U.S. banking system this week. Banks were forced to tap the Federal Reserve’s emergency funding lines for $165 billion. The Federal Home Loan Banks, a government-sponsored entity, just raised $88.7 billion in new bonds to lend to a banking system otherwise unable to fund itself. U.S. bank stocks ended the week down five percent on Friday, and the NASDAQ Bank Index remains 25 percent below levels at the beginning of March.

The banking system is tottering, and the shriller the voices become insisting that everything is fine, the more we know we’re in trouble.

Epoch Times Photo
Epoch Times Photo
A sign in front of a First Republic Bank office in Oakland, Calif., on March 16, 2023. (Justin Sullivan/Getty Images)

Take the case of First Republic Bank, which as the fourteenth largest bank in the United States is larger than SVB was when it collapsed. Following the failure of SVB, depositors and investors reasonably asked what other banks might be at risk of a similar deposit run. First Republic was vulnerable, and over the course of just a few days, several billion dollars of demand deposits fled the bank. First Republic tried to find a buyer, but none emerged. Early on Friday, a consortium of eleven of the largest banks in the United States agreed to collectively inject $30 billion of deposits into First Republic to keep it afloat and to prevent financial contagion.

Despite these actions, markets were not convinced. First Republic’s share price ended Friday’s extended trading day down 31 percent, and down 84 percent since the beginning of March. Late on Friday, Moody’s downgraded First Republic’s credit rating to junk status, an action which followed S&P and Fitch earlier in the week. Lack of an investment-grade credit rating places First Republic (or any bank trying to access the capital markets) in an untenable position. The cost of borrowing becomes prohibitively expensive, and the losses begin to mount, worsening the bank’s profit and capital condition. First Republic appears to be a dead man walking.

Moving on from First Republic, both investors and depositors will look for the next weakest link in the chain. And when the deposit run at that next bank begins, perhaps on Monday, perhaps next month, will those same Big Banks step in once more with additional tens of billions of liquidity support? And even if so, what about after that? Where does it end? There is not enough private sector funding to go around to solve a systemic deposit run once contagion kicks in. We saw this in the global financial crisis of 2008.

So that leaves the U.S. government to step in further. Neither the $25 billion U.S. Treasury backstop of the Fed’s lending program nor the FDIC’s $128 billion Depositor Insurance Fund is anywhere near enough to protect $18 trillion of U.S. deposits. The Federal Reserve, the lender of last resort, is itself constrained. Inflation fighting through quantitative tightening and raising interest raises is now effectively over. The Fed’s $8.6 trillion balance sheet is now good for one thing only, and that is printing more money, which means inflation will resume its upward path later this year.

Epoch Times Photo
Epoch Times Photo
The logo of Swiss bank Credit Suisse and a Swiss flag in Zurich, Switzerland, on Aug. 1, 2014. (Keystone, Steffen Schmidt/AP Photo)

Contagion is spreading to Europe. Credit Suisse, one of the world’s largest investment banks, is teetering on the edge. So much so that on Wednesday, March 15, the SNB, Switzerland’s central bank, was forced to come to Credit Suisse’s rescue with a $50 billion liquidity package. The SNB announcement followed the script that there was nothing to see here: “the problems of certain banks in the USA do not pose a direct risk of contagion for the Swiss financial markets.” And yet SNB felt the need to announce it was providing a lifeline. Credit Suisse’s largest investor, a Saudi sovereign wealth fund, on that same day essentially walked away from its investment after declining to put more money in the beleaguered investment bank. Credit Suisse’s counterparties are now demanding to be paid upfront before executing transactions that are normally settled later. This breakdown of trust between transacting parties is exactly what caused the financial system to seize up fifteen years ago nearly to the day, leading to the demise of Bear Stearns.

At that time, the global financial crisis started amongst the largest investment and commercial banks from the securitization of overvalued or worthless residential mortgages. In this current crisis, it’s the regional and smaller community banks that could blow up first, and it’s the collapse of the commercial real estate (CRE) market that may be the match that lights the fuse.

Here is one way the contagion could spread. The CRE sector, which is sitting on millions of square feet of un—or under-utilized (and thus unprofitable) office space, is under pressure, and delinquencies and defaults are rising. Small and medium-sized banks play a substantial role in CRE lending. If the recession in the CRE sector worsens, so too does the financial position of these banks, which do not have the liquidity or capital buffers to absorb the losses. Any holders of loans or CMBS (commercial mortgage-backed securities), which include the Big Banks, will similarly incur losses.

Last week we wrote  that if the market concluded that the issues at SVB were bank specific, i.e., not systemic, which was the narrative being told at the time, the storm might pass. Otherwise, financial contagion might set in. Based on this week’s events, it appears that the banking crisis is going to get worse before it gets better. While bank deposits may be safe under the FDIC’s new precedent, the banks themselves are not. When one sees the storm approaching rapidly, only the foolish refuse to take shelter.