Making Sense of the Recent Bank Failures

Nick Levinson Life with Money

Recent economic and financial news has left many heads spinning and brought back reminders of the 2007-2009 financial crisis.

To help you make sense of the recent bank failures, below we provide an overview of economic events, share our current assessment, and take a look at the bigger picture.

Current Economic Events

Here are a few of the main events from just the past two weeks:

US Bank Failures:

Silicon Valley Bank (SVB) and Signature Bank (SB), mid-sized banks each with $100-200 billion in assets, failed due mainly to many depositors withdrawing their funds at the same time (i.e., a “bank run”), and were taken over by State and Federal authorities. SVB is under investigation for possible financial irregularities by executives. Most of SB’s assets were purchased by New York Community Bancorp, another midsize bank.
money and safe

Ongoing US Bank Weakness:

First Republic Bank (FRB) has also come under extreme pressure from depositor withdrawals, and its stock price has declined 90%. Several large banks and the Federal government arranged a short-term cash infusion, but that hasn’t appeared to allay concerns yet for FRB’s customers and investors. Charles Schwab, which operates a bank and is also one of the largest US custodians for brokerage accounts (including all of PPA’s clients), also appeared to be in financial trouble.

These concerns appear to have subsided (see our recent note to clients). Questions remain about other mid-size and small community banks, despite the Federal Deposit Insurance Corporation (FDIC) promising to cover all deposits at SVB and SB, as opposed to just those under the previous $250K maximum per account.

International Bank Troubles:

Facing possible bankruptcy, Credit Suisse agreed to a buyout by UBS with the encouragement of the Swiss government.

Ongoing Worldwide Fight Against Inflation:

The US Federal Reserve raised interest rates by ¼ of a percent in its ongoing effort to control price increases. Until the bank failures, the expectation was for a ½ percent increase due to stronger economic activity/slower inflation reductions in recent months. But the Fed decided on the smaller increase due largely to the negative impact of interest rate increases on the banking system.

The hope now is that banks will stay in business, but with reduced activity (i.e., fewer loans made to customers) due to higher rates and potentially stricter regulations. This in turn could slow the economy and allow the Fed to pause on further large rate increases.

Park Piedmont’s Assessment

Our assessment is that the US and other governments around the world have responded to these threats to the banking system quickly and forcefully, and that appears to have eased the immediate concerns about system-wide bank failures. Whether additional regulations prevent similar issues in the medium to long-term remains to be seen, of course.

The outlook for reducing inflation seems even less clear than it did two weeks ago, unfortunately. The Fed is caught between its “dual mandate” of controlling inflation (which would argue for larger rate increases over a longer period of time) and maintaining the stability of the US financial system (which would benefit from pausing the rate increases, if not actually cutting rates). This battle seems likely to play out at a minimum over the rest of this year.

The Bigger Picture

We read with interest Ezra Klein’s recent article, “Can We Slow This All Down, Please?”, which provides useful context for some of the larger issues surrounding the bank failures and broader economic/financial concerns going forward.
bank failures
Klein starts out by noting that “everyone involved in the recent bank failures looks terrible. Regulators did nothing, even though Silicon Valley Bank’s woes had been widely noticed. Bank managers failed at the basic work of hedging against the risk of interest rates rising. Midsize banks, including SVB itself, successfully lobbied Congress and the Trump Administration to be exempted from the regulations for too-big-to-fail banks. Venture capitalists sparked a needless panic that annihilated an institution central to their own industry. The Federal Reserve ignored inflation for too long, and the whiplash of its response has become a risk factor all its own … Change makes fools of us all.”

He cites three main factors causing the recent problems.

Low interest rates came to an end:

“Interest rates had, with few exceptions, been on a downward trend for 40 years. Since 2009 [PPA note: when the recovery from the last financial crisis began], they had often been near zero, and negative when adjusted for inflation … Then the Fed embarked on one of its fastest rate-hiking campaigns in history. As it did, all manner of assets that had levitated toward eye-popping valuations in recent years – stocks, cryptocurrencies … Swiss watches [PPA note: and bonds, since bond prices rise when rates fall] – began to tumble.”

The dangers of viral finance made an appearance:

“Digital information and banking mean bank runs can happen – and spread to other institutions – at astonishing speed … Everything from the fast rise and fall of crypto to the weird moment of meme stocks … reflects the digital acceleration of finance … It’s worth wondering whether speed should be seen and addressed as a financial risk factor unto itself.”

Financial regulators turned out to be fighting the last war:

“Lawmakers had tried, in Dodd-Frank [PPA note: the major legislation intended to address the causes of the 2007-2009 financial crisis], to define systemic risk in terms of assets: $50 billion or above, and you posed a systemic risk … The idea here was that we know what a systemically risky bank looks like: … the banks, and assorted other financial institutions, that caused the 2008 crash …

“As galling as it is that SVB got itself exempted from being regulated as systemically important, it’s not clear that regulators would have caught the bank’s problems even if Dodd-Frank had remained untouched since the Fed’s 2022 stress tests didn’t include interest rate risks.”

PPA agrees with much of this analysis, and we have incorporated several of these ideas into the advice we provide clients. For example, in the context of the historically low interest rates that preceded the current increases, we have avoided long-term bonds, which typically decline in price much more than shorter-term bonds when rates rise. We also try to avoid investment fads, focusing on broad-based stock and bond investments as the core of each client’s portfolio. Finally, we encourage long-term perspectives for our clients.

As our colleagues at Dimensional Fund Advisors (DFA) put it in a recent newsletter (03/21/23), “When the unexpected happens, many investors feel like they should be doing something with their portfolios. Often, headlines and pundits stoke these sentiments with predictions of more doom and gloom. For the long-term investor, however, planning for what can happen is far more powerful than trying to predict what will happen.”

Read “Making Sense of Recent Bank Failures” in the Piedmont Exedra.