Given the gravity of the situation in our global banking system, I am going to expound a little bit more on Friday’s note. To say that the last few weeks have been action-packed in finance land would be a gross understatement.
Right when we were absorbed and preoccupied with the subtle balance between inflation, interest rate hikes, and recession, Wham-O!…here we are with bank failures both internationally and domestically.
In retrospect, this clearly should be no surprise. Rates had been at essentially zero for an extended period and then within months, they are at 5%. The repercussions were not to be good ones.
Since we have entered a new chapter, where these dislocations are now being recognized, a total of four (4) notable events took place just since Friday with the intent to contain the ripple effects of the Silicon Valley Bank failure.
- Will the UBS acquisition of Credit Suisse contain the crisis and ripples across the Atlantic? This is very important as it shows that the global banking system seems to be respecting other countries’ situations. The Credit Suisse situation has been brewing for some time, and this was more of a last straw to break the camel’s back.
- Six national banks (global); the Federal Reserve, Bank of England, Bank of China, Bank of Japan, European Central Bank, and Swiss National Bank, introduced additional swaps to provide US Dollar funding. And they are going to do this daily vs. the normal weekly. Again speaking to the attention being given to the gravity of the situation.
- On Saturday, the "Mid-size Bank Coalition of America (MBCA) sent a letter to the FDIC arguing that extending insurance to all deposits would halt the exodus of deposits from smaller banks. In other words, it wants the FDIC to backstop the massive withdrawal of deposits from their institutions and the pain suffered as a result of their being forced to sell their underwater bond portfolios to fund these withdrawals.
- Fed Chair Powell and Treasury Secretary Yellen released a joint statement in support of the Swiss National Bank's actions to support the mergers in the first one above. Also, the $250,000 FDIC insurance would be backstopped to ALL deposits (announced this week).
Before continuing to read this week's note, I implore you to read my note from last Friday to get a better understanding of what went on with our bank issues in the US in the last week. Beyond reading this and understanding the poor management at these banks I want to bring up another point. The issues we are experiencing today are completely different from the problems we dealt with in the Great Financial Crisis of 08-09. Back then there weren't proper guidelines in place to control who was a credible borrower or how to measure the reserve requirements of banks.
This time, we had a confluence of issues that didn't exist 15 years ago. First, in the digital age deposits are not "sticky" and flee with a keystroke on a phone or a computer. Second, the balances on deposits as a result of the massive infusion of capital from the current administration created a fictitious sense of security as the credit balances made banks like Silicon Valley appear too big to fail even though they were nowhere near the size of the major money center banks.
When too many people came to them too quickly to remove funds, not only were they upside down on their bond holdings (definitely poor risk management) but the losses that ensued from the required sale of these bond holdings threw the bank into an upside-down position. 15 years ago, there simply were not the technology-related access capabilities to remove this much money so fast.
This past weekend, almost the entire issue of Barron's was related to the banking crisis of 2023. More than one article was about what it sees as currently attractive for purchase in the markets. I find this rather premature as there are likely more cockroaches to be scattered. Associate Editor, Randall Forsyth stated, "The hasty and aggressive responses by government, regulators, and the biggest banks staunched the bleeding resulting from the market's loss of confidence in many smaller institutions. That should allow the Federal Reserve to stay on course to raise its key policy interest rate again this Wednesday. But comparisons to the bailouts during the 08-09 financial crisis that culminated in the failure of Lehman Brothers in September of 2008 seem misplaced."
He went on to explain that many feel that what the Fed is doing to address the current issue could be considered another form of QE (Quantitative Easing) but that is not the case. The "difference this time" was that the money that was helicopter dropped onto the US economy went straight into household coffers, not directly to the banks. This time the bank reserves are being backstopped, sort of not giving them money to handle internally but rather guaranteeing their ability to pay out money if the rush for money occurs.
Now that we've reassessed what happened, and how the Fed is addressing it (to hopefully keep the public from panicking and having a massive run on the banking system), let me give you the Big Picture issues we are considering at this point:
- The world has had to deal with so many panic situations from the blow-up of Long-Term Capital Management in 1998, to the bankruptcy of Lehman Brothers and Bear Stearns in 2008, to the COVID pandemic in 2020, to the most recent issue of spiking inflation in 2022. The world is on pins and needles about pretty much anything that appears could affect an entire global financial system.
- The Fed is now stuck between a rock and a hard spot. If they continue to raise too aggressively (I'm not saying what 'too' aggressively means) they run the risk of other bank investment portfolios going upside down and further Silicon Valley Bank-like situations ensuing. Or they don't raise enough and inflation remains rampant and destroys our purchasing power and sovereignty of the US Dollar.
The Fed pays attention to their data-specific labor-related issues and doesn't apply proper attention to other economically sensitive measurements that are telegraphing not only a decline in the rate of inflation but also a slowdown in the economy that could mature into a true recessionary environment. I believe that the spread between the 3-month interest rates and the 10-year interest rates along with the overall decline in rates in the last few weeks is speaking to this concern for a possible recession later in 2023. The subtle balance of "inflation breaking" or "economy breaking."
In closing, the late great Supreme Court Justice Antonin Scalia wrote almost thirty years ago, "Day by day, case by case, the Supreme Court is busy designing a Constitution for a country I do not recognize." Imagine if he were around today! After the awful monetary policy of the 1970s and the Fed's attempt to fight inflation, it surely caused S&L and bank failures across the nation. Then as stated above the required bailout of Long-Term Capital Management in the late 1990s where the "too big to fail" concept was truly understood. Then the complete mismanagement of regulations on lending created the Financial Panic of 08-09. All of these lent themselves to a situation where it is becoming tough for the Fed to administer the sour medicine necessary to rectify the momentous debt problems.
Before 2008 the Fed had total assets of $875 billion, as of last Wednesday the assets are around $8.6 trillion. Our economy is currently on shaky ground, but it is still the safest economy on the earth built on democracy vs. communism. Debts by consumers and companies will continue to be paid down. Deflation due to superior technology will make the majority of companies more profitable and the money saved, and hours saved by allowing many employees to work remotely will have a supreme impact on the profitability of companies and new disposable income for workers.
I guess the hardest thing to deal with is the speed with which these changes are occurring. As a result of the last two weeks, the expectation of the direction of interest rates has changed:
We live in interesting times. But remember the indisputable statistics I've been showing all year of how 2023 markets “should” perform. Please refer again to the previous notes. A bank failure is truly a bank failure, but it is not an entire economic collapse the likes of which our still growing economy with a still growing and healthy GDP and labor market supports us being able to weather even taking into account this new curve ball.
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