by Franklin J. Parker, CFA
The Summary
- What a fast-moving weekend! On Friday, the FDIC put Silicon Valley Bank into receivership, which is the largest bank failure since 2008 (and the second largest in US history). On Sunday, New York Signature Bank was also shuddered by regulators. In an effort to mitigate the risks of contagion among regional banks (more on that in this week’s Details), the Federal Reserve and the US Treasury created a special vehicle to guarantee all deposits at these banks — even those above the $250,000 FDIC limits.
- The turmoil in the regional banking sector has pushed investors to completely re-think the Fed’s potential rate moves later this month. Pretty much overnight, investors shifted their expectations on rates from an almost-certain 0.50% hike to a 0.25% hike, or even the possibility of no hike at all. In short, investors believe the events of this past week were enough to make the Fed second-guess their current path of rate hikes.
- Despite the drama of the past week, I have still not gotten the “recession is almost here” signals. This week we see some important data, including inflation, retail sales, and industrial production, and all of that could easily push markets around. That said, risk of contagion in the financial system is not gone and there is little that could suck the life out of an economy faster (it reminds me of 2008). In short, this could be a watershed moment in this economic cycle, and I am watching everything very closely. My opinions here may change in an moment.
- In any event, the events of this week highlight the importance of diversified exposure to banks for people with significant cash holdings. Through our partner programs, we can help you get FDIC insurance for balances up to $25 million.* If you find yourself concerned about recent events, let’s talk through what is worrying you and we can find a solution that fits your situation.
The Details
This week we saw an old fashioned bank run end the life of two major US banks. How does this happen? What are the risks it spreads?
Banks, of course, take in customer deposits and then use most of that cash to make loans and buy securities. There are strict limits on what banks are allowed to invest in, but for every $1 in customer deposits a bank will only have around $0.14 in actual cash. The rest will be invested in loans, US Treasury bonds, mortgage-backed securities, etc.
Most of the time, this is perfectly okay because only a few people are withdrawing money on any given day. If more withdrawals than usual are needed the bank can simply sell some of their more liquid investments (such as US Treasuries).
Recently, however, US Treasuries and mortgage-backed securities have lost considerable value relative to a few years ago. For a bank needing to raise cash to meet withdrawals, like Silicon Valley Bank, the losses on those investments became so much that they needed more capital to remain compliant.
When word got out that SVB needed to raise capital to remain solvent, the tight-knight startup community rapidly withdrew their cash, and that created the need for more capital which the bank could not fulfill. Thus, the rapid demand withdrawals, combined with the losses on their investments, led SVB to end Friday almost a billion dollars short of cash.
Normally, this means the FDIC steps in and freezes all deposits over the insured threshold. They would then spend the next few months selling the assets of the bank (the loan portfolio, the remaining investments, etc), in an attempt to raise the cash to make depositors whole. That, however, leaves depositors without access to their cash during that time, and for a business needing to make payroll, that time is destructive.
However, over the weekend, the Federal Reserve partnered with the US Treasury to create a special fund that will guarantee all deposits at these banks and that is very likely to stem the tide of panic, at least for the moment. More than anything, the backstop of the Federal Government gives depositors enough confidence to keep their cash in place, ending the bank run.
Yet this is a highly fluid situation, with news breaking hourly, and there are probably some more dominoes to fall. Investors (and business-owners) would do well to have some conversations with people they trust and do some risk management exercises.
Chart of the Week
Of all the outcomes of this weekend, the most directly impactful to investors has been the complete turnaround in expectations for the Federal Reserve’s rate hike at their March 22nd meeting. At the end of last week, investors saw a 0.50% rate hike as a near certainty. Now, however, investors see a 0.25% rate hike as most likely, with no rate hike as also a real possibility. That hasn’t been the case in a very long time, and sets up markets for some dramatic news when the rate announcement finally does occur.
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