Posted on 03/26/2023 10:12:54 AM PDT by Mount Athos
After the rapid collapse of Silicon Valley Bank and Signature Bank earlier this month, along with Credit Suisse’s untimely demise last week, regulators and business leaders have made it a point to publicly assure consumers that banks are safe. The potential for “contagion” throughout the financial system is now slim after the Federal Deposit Insurance Corp. (FDIC), Federal Reserve, and Treasury came together to backstop all depositors, both uninsured and insured, at SVB and Signature, they say.
Treasury Secretary Janet Yellen, for example, told lawmakers on the Senate Finance Committee last week after the second- and third-largest bank failures in history that Americans “can feel confident” about the safety of their deposits. And Citigroup CEO Jane Fraser told the Economic Club of Washington D.C. on Wednesday that the banking system is “sound,” and both large and regional banks are “well-capitalized,” adding “this is not a credit crisis,” Reuters reported.
When Credit Suisse went under shortly after Silicon Valley Bank, analysts argued that it was a scandal-plagued institution that had racked up billions in losses from high profile issues—including the Archegos hedge fund implosion of 2021—and its clients and depositors merely lost confidence. And they note that Silicon Valley Bank made fatal, and easily avoidable, errors in risk management that aren’t indicative of the health of the overall financial system.
But SVB also suffered from heavy unrealized losses caused by rising interest rates that helped to trigger a bank run from its large base of uninsured depositors. And a new paper by researchers at New York University on March 13 found that they aren’t the only ones with these issues—U.S. banks had unrealized losses of $1.7 trillion at the end of 2022. The losses were nearly equal to banks’ total equity of $2.1 trillion, professors Philip Schnabel and Alexi Savov and the University of Pennsylvania’s Itamar Drechsler explained.
Rising interest rates have slashed the value of the U.S. Treasuries and mortgage-backed securities that make up a large portion of many banks’ assets. In another paper, also from March 13, university researchers found that U.S. banks’ assets have lost 10% of their value over the past year alone.
Additionally, of the $17 trillion in total U.S. bank deposits, nearly $7 trillion are currently not insured by the FDIC, according to that paper. The authors of the study—including University of Southern California’s Erica Xuewei Jiang, Northwestern University’s Gregor Matvos, Columbia University’s Tomasz Piskorski, and Stanford University’s Amit Seru—explained that if half of these uninsured depositors decide to withdraw their funds after the recent bank instability, it could put hundreds of billions of dollars of deposits in jeopardy.
“If uninsured deposit withdrawals cause even small fire sales [of assets], substantially more banks are at risk,” they wrote. “Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the U.S. banking system.”
No fire without a spark Unrealized losses aren’t reflected on banks’ balance sheets due to an accounting practice where assets are held on banks’ books at the value at which they are bought, instead of their current market value. And Stephan Weiler, an economics professor at Colorado State University and co-director of the Regional Economic Development Institute, explained that these losses will only be realized by banks if they are forced to sell their holdings amid a bank run where depositors withdraw their funds en masse. That’s what happened with SVB, depositors asked for the money back in droves, forcing the bank to sell its holdings of mortgage-backed securities at a $2.4 billion pre-tax loss.
“As long as people aren’t all coming in at the same time and demanding that their deposits back, you’re okay,” Weiler told Fortune Thursday.
The problem, JPMorgan’s analysts led by Nikolaos Panigirtzoglou noted this week, is that $1 trillion in deposits were pulled from the “most vulnerable” U.S. banks after SVB’s collapse.
“So the chances of facing those unrealized losses are going up,” Weiler warned, and that could lead to more bank runs.
As a result of this potential problem for U.S. banks, multiple politicians, including Massachusetts Sen. Elizabeth Warren and California Rep. Ro Khanna, have argued the Fed should backstop every type of depositor at all banks to prevent further bank runs from the public. And those calls intensified this week after Treasury Secretary Janet Yellen told the Senate Appropriations subcommittee Wednesday that she is not considering “blanket insurance” for all U.S. bank deposits, unless “systemic risk” becomes an issue, Reuters reported.
Even the billionaire hedge fund manager Bill Ackman said this week that the FDIC “stop the bleeding” and “explicitly guarantee all deposits now.”
“We have gone from implicit support for depositors to [Secretary Yellen’s] explicit statement today that no guarantee is being considered,” Ackman, who founded Pershing Square Capital Management tweeted on Wednesday, adding that he “would be surprised if deposit outflows don’t accelerate, effective immediately.”
Why don’t banks hedge interest rates? Interest rate risk management seems obvious if running a bank. This is the problem.
Just for the record in 1929...a lot of what occurred then was the unrealized (non-existent) funds in the bank vaults and on the books...where the bank executives/clerks had taken a ‘cut’ of cash weekly/monthly/yearly, and the books had never been audited to show this problem.
When the customers felt that the bank might fail....they went to the banks to ask for their money, and rapidly emptied out the true cash reserves sitting at the bank.
A lot of smaller banks in the US didn’t fail...mostly because of honest intentions over the years prior. Bigger banks had simply hidden the lost reserves, in some cases, for decades.
Presently, one gets the impression that management has carried losses for years (even before 2008), and just trying to figure out a path to escape this approaching problem.
The banks could offer lower payoffs of loans but higher than the unrealized loss if they have to sell the loan to cover outflows. Nah. That would make everyone know the banking issue is quantified to the average person.
Not. Good.
The idiot fed dumped trillions into the system, and banks bought bonds and securities for the interest rate.
Then the idiot fed jacked up rates too fast, and these bonds and securities were under water.
Now what??? All it takes is a black swan spark.
US banks are much healthier than they were in 2008. They’re also much healthier than European banks which never realized anywhere near as many of their toxic assets nor took nearly as many write downs.
I still contend that CRYPTO is also involved.
FTX started the trip wires.
Avalanches cannot be predicted with any degree of accuracy, they cannot be stopped, and there is no way to get out ahead of one that has already gathered momentum.
What is called “contagion” is just another name for this same phenomenon as it applies to economics.
The fecal matter has hit the air recirculation system.
Here is how the unrealized losses have affected me personally. Each of the seven homes I’ve bought had been abandoned and taken over by the bank. I’d say, on average, these homes had been empty for seven years. Why did it take so long for the bank that had repossessed them to finally put them up for sale? As long as they don’t sell the home, then it’s on the books as an asset at X value. Once they sell it at, say, one half X then they book a loss. I’m pretty sure the only reason some of these homes were put up for sale is because the bank was being sold or offered for sale. The buying bank will not accept the bookkeeping shenanigans intended to keep the sale target looking good. To sell the bank and claim the repossessed house is valued at X would be a clear case of fraud.
Even if banks have unrealized losses on the books, can’t they start to “write down” these amounts on their balance sheets, so that we get a true picture of their financial situation?
As I recall from Accounting 101, the balance sheet must balance; it’s not optional. And if the liabilities( bank customer deposits) exceed the assets, the bank has negative net worth as an ongoing business.
So could some of this be resolved, if they actually reported the asset holdings at the actual value? As I understand it, some bank assets in the form of loans, are written down if those loans are not being repaid. Why don’t they do the same with these bonds and securities held by banks in their asset base?
In any event, it seems the financial records do not show the true financial health of these banks.
Very interesting post, thank you
Anyone who invests understands the difference between realized and unrealized losses. Losses in the value of a stock price occur all the time, but if the fundamentals of the company and forward guidance are sound, nobody but the idiot day trader’s that show up on CNBC get panicked.
With bonds its even less a problem. If bonds are held to maturity, the principal and interest payments are paid exactly as stated on the bond. Nobody loses a dime, guaranteed.
If interest rates increase, investors evaluate whether it makes sense to sell the bonds at a loss and raise cash to take advantage of a better opportunity. The other reason SVP and other small banks had to sell long term bonds at a loss was because they had to raise cash to pay all their panicked depositors who stampeded into a run on the bank. They should have understood the first rule in the Hitchhiker’s Guide To The Galaxy. Don’t panic.
Makes sense. Crisis created by the Fed. Facilitated by inept regulators and bank officers.
Factor in that the clowns just realized the depositors use this new-fangled internet thing for banking, and all we need is a slightly off-white swan for the meltdown to start.
“The speed of the run – it’s very different from what we’ve seen in the past..” -- JPOW about SVB
The only way for banks to generate enough revenue to even cover payroll was to invest in longer term government backed securities.
As interest rates go up, the cash value of these securities goes down.
As depositors get scared and withdraw their savings, the banks are forced to sell these securities at a loss.
Perhaps the Fed should have started raising interest rates a year or two earlier, which would have enabled them to raise the rates in smaller increments.
Comments welcome.
My grandfather was a finish carpenter & cabinetmaker back in the 1920s.
He employed two other men in the trade as well. It was a thriving business in its day.
My dad was just a very young boy back then, but he would help out in the shop by sweeping up sawdust, picking up debris, tools, etc....whatever a little fella could do to help and not get in the way to earn a nickel/week.
My grandfather had almost $5000 cash in the bank (everything was done with cash back then) that he used to further his business: payroll, materials, additional tools, etc....whatever was needed to keep the business going.
When the “crash” hit in ‘29, the bank permanently closed its doors overnight and posted armed guards to hold the people back. It never reopened, and he never got a single red penny of his money back...not a penny. It emotionally and financially destroyed him, not to mention the two families that depended on that business for income.
My dad NEVER trusted a bank from that day forward....ever. The whole time I was growing up, he’d literally stash paper money in a mattress and coin money would be sealed up in mason jars that he’d actually bury in the backyard. He kept a little hand-drawn pencil map as to where each jar was buried. My poor mother had an awful time with him in that regard. I can remember when she finally convinced him to dig em all up because they wanted to buy a nicer house. Our backyard looked like a prairie dog town when he was done digging em all up....I’ll never forget it...LOL
He told me the whole time I was growing up to NEVER trust a bank, not even trust their clock on the outside of the building, even if the whole U.S. government treasury stood behind it. He’d always say that anybody that would trust a bank with their life savings was outright utter fool. He went to his grave with that mindset.....I always thought he was just crazy.
Maybe he wasn’t so crazy after all.
One analyst said that’s exactly why he will never buy bank stocks.
Banks typically have low equity relative to their assets. So if assets decline by a “regular” amount for a “typical” American financial crisis, they are quickly technically bankrupt.
In 2008 Congress changed the rules for bank accounting—short version is they banned them from showing the true market value of their holdings—didn’t want to cause another panic ya know...
Bank audits are of, by and for liars.
Good story about your grandfather and dad. Back then, it was an easy thing to stash cash in or around your home. $5000 in high denomination bills was easy.
Unfortunately, if you have $500,000 or more, it's very tough to store that much cash. Highest denomination to carry are $100 bills. And government entities seize your cash if you carry around $10,000 on you (and often times less because they think you're trying to evade the $10G rules). So most of us suckers are forced to trust putting money in banks - for our security they say.
If I have large amounts of cash I stick it into property, safer than banks. While stashing lesser amounts in the house.
1. Federal Government funds Gain of Function research in Wuhan. Result: Covid-19 pandemic.
2. Covid 19 pandemic gives government an excuse to shut down business, run roughshod over liberty.
3. To address their destruction of business, government offers all sort of handouts to “help”. Huge federal borrowing, huge transfers to States to waste, huge corruption.
4. Biden/Democrats double down on deficit spending.
5. Biden/Democrats kill domestic energy production causing ncreases in energy costs. At the same time, wage hikes unconnected to productivity gains occur due to artifically created worker shortages and minimum wage increases.
6. Inflation predictably skyrockets.
7. In response to the hyper-inflation the Dems have caused, the Fed raises interest rates sharply.
8. Higher interest rates gut the value of bonds held by banks, diminishing their core capital, and making them extremely vulnerable to bank runs.
The banking problem is caused by government ineptitude (and lots of political cronyism, woke investment, etc. —all of which is not far removed from being government too).
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