Question:  

Did we just have a run on the banks, and will banking failures be contained?

Answer: 

 In the financial world, contagion refers to the spreading of a harmful idea or practice. Problems were discovered at Silicon Valley Bank (SVB), Signature Bank and Credit Suisse were evident prior to March 8, 2023, but caused extreme action on that day. The belief is that these incidents are narrow in nature and caused by venture capital funding at SVB, leverage tied to the bitcoin industry at Signature, and years of poor management at Credit Suisse.

Before we go further, this is being written on the morning of Sunday, March 19, 2023, to be reviewed by our compliance team prior to publication. Much may have changed since that date.

A Run on the Banks

News of liquidity concerns at SVB, Signature and Silvergate Capital hit social media causing mania to break out. Investor psychology and rapid-fire response of outward money-flows drove capital out the door. On Thursday, March 9, 2023, a staggering $42  billion of deposits fled from SVB forcing the FDIC to take over on Friday morning. 

“It’s A Wonderful Life” with Jimmy Stewart as George Bailey, is a classic movie for many reasons. Today we’ll focus on how it helps illustrate the concept of a run on the bank. The scene where George finds depositors lined up outside to withdraw their life savings from Bailey Building and Loan (BBL) in response to news of demand repayment of their mortgage loans caused a run on the bank. George lets the depositors inside and learns that his nemesis, Harry F. Potter, acquired the town’s other bank and demands repayment of all loans made to BBL. Potter sneakily offers his misplaced assistance suggesting that he’ll buy BBL for pennies on the dollar to keep them afloat. Sound familiar?

The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by Congress and signed on June 16, 1933, by President Franklin D. Roosevelt to maintain stability and confidence in the nation’s financial system. FDIC’s first insurance level was $2,500 and has grown to $250,000. In today’s world, tech companies and start-ups scrambled to meet payroll as they worried about their uninsured deposits in excess of the $250,000 threshold.

To prevent further contagion and provide liquidity, the Fed, Treasury, and FDIC introduced a new loan facility called the Bank Term Lending Program (BTLP) on Sunday, March 12, 2023. BTLP will provide loans up to 12 months to help banks access capital as needed. Banks can pledge long-term bonds as collateral (that otherwise would have been sold in the open market at a loss to provide liquidity to depositors) and receive face value for loan purposes. BTLP, the Fed, and Treasury will continue to assess risks and provide resources as needed. 

Don’t Fight the Fed 

Unprecedented policies run the risk of unintended consequences. Therefore, the Fed may want to tread lightly. Stabilization and normalization after a global economic shutdown aren’t easy or smooth. The recent pressures and difficulties are a byproduct of rapid interest rate increases and tightening of credit by central banks. The effect of Fed tightening is not immediate and takes time to work its way through the economy to ultimately slow inflation. Record interest rate hikes exposed weak hands, or as Warren Buffet said, “only when the tide goes out do you discover who’s been swimming naked.”

The banking crisis will likely cause the Fed to rethink continuing to accelerate the rate of change with moving interest rates from zero to sixty mph in one year. The rapid rise in interest rates to combat inflation was one causal factor of the recent bank failures.

The unseen benefit may be that the Fed moves more slowly raising rates. An earlier end to the tightening cycle should be a positive for the economy. In the aftermath of these bank failings, bank lending is likely to tighten even further. This increases the already high likelihood of economic recession to come. Despite the likelihood of increased volatility and potentially more downside, it’s worth reminding investors to not lose focus on long-term goals. We believe that equities will once again print new highs at some point when the dust settles, as they have followed every recession through time. Stay focused and plan accordingly.