Spanning 2008 – 2012 (during the Great Financial Crisis), 465 banks went under. They totaled $687B in deposits. No customer lost their savings accounts. So far in 2023, 3 banks (Silicon Valley, Signature and First Republic) have failed, totaling $367B in deposits. I fear there are more shoes to drop and we are only a few months into this.
During 2007 – 2008, the Federal Reserve was cutting rates quickly; well before bank failures started. Fed Funds went from 4.75% to 0% in just 16 months. Today, we have raised rates from 0% to 5.25% in just 15 months. Did the Fed make another mistake? Bank stocks think so. So do Fed Fund futures, which are now expecting three rate cuts before the end of this year. Long-term bond yields are down 100bps in short order, pricing in a much slower economy and inflation coming back to stable levels. The Fed does not want to repeat the failures of the 70s where money supply kept spiking and helping inflation last a decade, but at what cost? Time will tell, but a fragile banking system is not one to be messed with.
Putting moral hazard aside for the time being, short-term fixes are available. The FDIC can raise insurance limits. Ideally, this would help corporate operations such as payrolls. A big issue with Silicon Valley Bank is that a lot of their customers were newly formed technology companies that have great ideas and products but not much in the form of revenues or profits. They rely upon funding from private equity, IPO’s or debt in order to keep talented employees. They were depleting their cash reserves but also moving them out of a single bank and spreading that cash around in order to maintain insurance levels. If cash held in bank deposits is “stickier” then banks could stabilize a bit. Ditto for high-net worth individuals who have been taking cash out of their local branches where they have over $250k and putting it JPMorgan or other large banking institutions. We do not think consumers losing deposits are at risk, but 50% of Americans still do. Raising the limit might help. There exists an implicit guarantee of deposits but officials are reluctant explicitly say this.
Another option, from the 2008 playbook, is for the SEC to ban short selling on financial stocks. While this is not the American way, it would help stabilize the stock market and banks. Multiple smaller regional banks published updates to their business operations the past few days. Most of them are seeing deposits actually rise, contrary to what is being reported in some media outlets. Cash is coming back but hedge funds keep pressing their short bets. In essence, there is no real-life bank run but if their stock keeps collapsing 25%+ a day, it creates a run. When you see a bank stock going from $200 to near zero, fear takes over and withdrawals accelerate. By that time, the bank is insolvent (more liabilities than assets). Stopping this now would be a quick fix for many. However, the SEC has publicly stated they are “not currently contemplating” a ban.
The end result is we need a stable banking system. Raising rates into the storm makes little sense and exacerbates the problems. Imagine if Amazon could not make payroll in their beginning years because banks would not lend them any short-term funds. Ditto for those families who need a loan to keep a roof over their head. Watching regional banks collapse while assisting the larger banks cleaning up the mess is not conducive to a fully functional financial system. The longer they wait for a fix, the worse this issue becomes. There are plenty of other options than I just listed. Hopefully one comes to fruition soon. Inflation will come down in either scenario, but deflation and massive job losses could occur under the current game plan. Granted, this is a near-term patch. Banks will suffer loan losses if/when a recession comes, as is typical for an economic cycle. They will have to pay more on their deposits, creating profitability headwinds. Earnings are coming down, but that does not mean we should sit idly by and let banks continue to fail at this rate.
Unusual Yield Curve:
Readers of this newsletter are well aware of what happens when yield curves invert. Borrowers are pinched, lending criteria tightens and (eventually) the economy slows. However, this takes time to filter through a system as big as the United States. Consumers still have plenty of cash in their savings accounts. Normal economic cycles have been thrown for a loop since Covid shut down the global economy. Some pockets of the economy have already progressed through a mini-recession (covid winners turned losers).
Going forward, we are nearing an inflection point where Covid comparisons are eliminated and trendlines off of the 2019 “normal” economy start to make sense. With respect to our massively inverted yield curve, the next indicator investors should pay attention to is the re-steepening of the yield curve as interest rates get back to “normal” as well. So far, this inversion just keeps getting worse. Short-term rates are still rising, especially June & July maturities where fears for a US Government default are forcing those T-Bills to have yields 40bps – 50bps higher than slightly longer maturities. Check out the highly unusual shape of our current yield curve:
10-year Treasuries seem to be pricing in a much slower economy, if not a bad recession as they approach 3.3%, a full 100bps below where they were towards the end of 2022. Currently, the spread between a 10-year Treasury and a 3-month T-Bill is up to a negative ~190bps. The long-term average is a positive 120bps. This chart below goes back to 1985, showing the extreme nature and rarity for such a wide spread. Unprecedented times indeed and outside of a brief Volker spike, this is the most inverted yield curve in history.
As mentioned, the next step is getting back to a normal yield curve where short-term interest rates are lower than long-term. One would think this re-steepening is a positive event, getting back to normal. However, looking back at the last 7 inversions, this re-steepening event happens 6 months before a recession even starts. The Fed does not alter course until something breaks. Even though we have had 3 banks go into bankruptcy, the Fed is still tightening! After such a solid start to the year for the major averages, risk continues to point to the downside as the re-steepening will likely lead to more pressure on stocks.
As crazy as things seem at the moment, the stock market is basically flat for the past year. If we went back in time and said 3 huge banks would fail, the Fed would raise rates higher than anyone expected, inflation was still elevated, oil prices collapsed (I thought we were supposed to be refilling the SPR, not still draining it!?), gold made new highs and the Russian invasion of Ukraine would all happen, many would think the stock market would be down (or down a lot). The fact that the S&P 500 is holding steady and up 7% in 2023 is bullish on its face. The other side of the coin though, the average stock is down 8% over the past year and flat this year tells a more realistic story. Those mega caps hide a lot of issues with the average stock today. Patience is still recommended as we await Government/Fed officials to get their act together and recognize the perils of letting this situation worsen. Again, chaotic times like these are usually at the tail end of a correction. Opportunities are being created.
Happy Cinco de Mayo to all my amigos!
Will Arnett turns 54 today. Golfer, Rory McIlroy is now 35. Richard Jenkins turns 77.
James Vogt, 610-260-2214