March 2023: The month of bank failure

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Malibu City Council candidate Doug Stewart

California’s Silicon Valley Bank one of four worldwide to suffer huge failures

By Doug Stewart

Guest Columnist 

The month of March has seen four of the largest bank failures on record, including a global Swiss bank. To many people, their confidence in the U.S. banking system has been shaken. 

This is not a new issue as troubled banks and difficult economic times have often gone hand in hand. Ask anyone who remembers the holiday movie classic “It’s a Wonderful Life.” This is the story about depositors all wanting to take their money out of their local bank at the same time. This was the typical “run on the bank.”  

Keep in mind that, unlike the movie, today most bank customers’ money is safe as there is federal insurance of $250,000 on deposits at all banks and credit unions. Your own bank may even assist you to have an even higher amount that is covered by insurance. 

For the City of Malibu, state law requires banks that hold government deposits to backstop/guarantee those deposits with U.S. bonds valued greater than the amount on deposit. The city treasurer has recently verified this in place and the city’s funds are protected.

But what just happened? Silicon Valley Bank (SVB) in California and Signature Bank in New York have been taken over by their bank regulators and two other regional banks in the US and a major bank in Germany are often mentioned as being “troubled.”

In the case of SVB, the story takes a twist probably never seen before. SVB did not have the typical bad loans that cause bank failure. Instead of loans, SVB was holding a huge portfolio of what is probably the safest and lowest-risk debt security in the world, U.S. government and related bonds and notes. They did not go bad; they just lost part of their value for accounting purposes. For SVB, this was a loss mostly on paper. 

The run on the bank was not typical either. Instead of standing in front of the locked door wanting cash as in the movie, the money flowed out digitally via cell phones and laptops. What no doubt made this even more disappointing from the bank’s point of view was that these exiting deposits were from many of their best clients with the largest but uninsured deposits. The day before the bank closed, $42 billion was withdrawn, nearly a quarter of the bank’s deposits. This was preceded by ever-increasing withdrawals in the days beforehand. On Friday the 10th, when SVB was closed by the regulators, they were out of cash.

How quickly the loss of depositor confidence took place is evidenced by only a week earlier Goldman Sachs being confident they could support a proposed new stock offering for SVB. In a matter of days, SVB went bankrupt.  

We may never really know the match that lit the fuse for the run on the bank, but it was likely the concern that SVB had taken major paper losses (not cash losses) on these government bonds. As interest rates rose starting in 2022, the market value of the 2021 and earlier bonds dropped considerably. The two-year Treasury note in 2021 paid 0.25 percent. At the time SVB failed, this same note paid nearly 5 percent. The difference in value, only on paper, had a theoretically significant impact on the reported bank shareholder equity. When the major depositors decided the bank had the potential to become a failed bank due to these potential paper losses they hit the fund transfer button on their computers. Then social media spread the concerns to clients, partners, investors, and fund managers to do the same. The run was on.

What went wrong will be the subject of many autopsies and pundits, but here is my quick take. In 2021 when the federal government stimulated the economy with major stimulus programs, the high-tech world was suddenly awash in cash. This money flowed into SVB and quickly nearly doubled the size of the bank to over $200 billion. Loan demand could not keep up with the inflow, so the SVB deployed the money to the safest place they could, U.S. government bonds and agencies. Historically, the U.S. banking system has used “stress testing” models for changes in interest rates to help prevent risk management failures such as what just happened at SVB. The typical benchmark in the models was rate movements up or down by 2 percent annually for one year and then two years. No one ever envisioned a nearly 5 percent movement of rates by our government in just one year. The war on inflation does cause casualties.

The Federal Reserve and the U.S. Treasury are now faced with what to do to protect banks and depositors both in the U.S. and even globally. From these March bank failures comes the question of how to maintain the depositors’ confidence in the over 4,200 community and regional banks that are not designated as too big to fail (B of A, Wells, Citi, and Chase). The banks other than these big four are truly the backbone of the nation’s banking system providing local consumers, businesses, farmers, and industry the banking system they need for our economy to operate. To meet this critical need, the full guarantee of all deposits by the FDIC, at least in the short run, is highly likely. Higher CD and savings rates for depositors are likely, too, as banks seek to hold onto the deposits they already have.

While the depositors are protected in this expansion of bank deposit insurance the concern will quickly move to those who need financing to run their business each day, plant crops, finance business expansion, or manage their consumer needs. Borrowed money will continue to cost more with the Prime Lending Rate already at 8 percent today which is far above the 3.5 percent it was just 12 months ago. Problem loans will likely increase at banks as the higher cost of borrowing negatively affects borrowers of all types and their cash flows. Financing will also become harder to obtain as banks will tighten lending standards to keep more cash reserves and deal with the increase in problem loans.

The American economy will make it through all this. History shows we always do, but expect at least a bumpy road ahead.