They Break but They Bail

They Break but They Bail

March 17, 2023

So, you may have heard this week that there is a bit of distress in the financial markets, particularly with the banks. And the talk of banks collapsing and / or being bailed out has become rideshare-driver talk. There are definitely stresses, and we can point to a few specific examples of banks in the same situation we recall so well from the great financial crisis of 2008-2009. But the circumstances of today are very different. That said, the Federal Reserve is again at the heart of it, as would be expected.


There are a good number of financial commentators that are making the argument that the Fed has created this crisis by raising interest rates at the fastest rate since the 80s. And in essence, that argument is probably not wrong. The Fed’s attempt to rein in inflation is, by design, an effort to make financial conditions tighter. When the overall money supply contracts because of higher rates, you can expect something eventually is going to break. And this week things got broken. But was it only because of higher interest rates?


We can’t discuss individual names here, but there are three distinctly different types of banks that have come up floating or semi-swimming on the surface of this shrinking liquidity pond. Consider these examples.


First, we have a bank that was very concentrated on providing service to the crypto world. As that environment has become embroiled in scandal and the failures of a number of individual firms, it would make sense that a bank focused on that market would have serious problems.


Second was a bank that again concentrated on a very distinct market, that of venture capital and the start-up world. In this case, there would seem to have been very poor, or even a complete lack of, risk management with respect to their balance sheet and their investments in long-dated bonds. As interest rates rose and they needed to sell those bonds at significant losses, their future came into doubt. Add in the fact that the majority of their customers had balances that far exceeded the FDIC insurance limits, and you give rise to bank run conditions.


Third is the case of a giant international bank, whose problems stem from years of operating in a zero, and even negative, interest rate environment. The pressure on profits that built up over the years for this bank has caused it to move into a reorganization phase where it finds itself navigating the sale of major components of its operation in a stressed global economy. When those stresses begin to boil over, it makes a difficult proposition that much tougher.


Things are moving quickly and there is probably a lot more to learn related to each of these examples. And there are other institutions out there that are likely facing similar difficulties.


Is the Fed bailing out any of these banks? That’s the second argument we are hearing and the voices come in loud from both sides. The answer really depends on your perspective. As a bank depositor that holds accounts far in excess of the FDIC insurance limit of $250,000, you are probably very happy to learn that the Fed has made arrangements to “backstop” your deposits in excess. Taxpayers have been assured they won’t be on the hook as any funds that might be needed for this are coming from a bank insurance fund. We’ll see how that works.


But as a shareholder in this case, you have been wiped out and the bank management has been fired. Neither one of those groups feel they have been bailed out.


But what about for the sector as a whole? What the Fed has done is open up a new facility at the discount window. This is a lending facility that banks have access to at the Fed. And banks have been using it at a record rate.



According to a Bloomberg article from today, almost $153 billion was taken in the week ending March 15th, which is a new record. These are loans backed by bank collateral, like those portfolios of long-dated bonds, that can provide for short-term liquidity. We believe many banks are taking advantage of the window, just in case. After all, financing is always better if you line it up before you actually need it.


Bottom line is this is not a systemic crisis like 08-09. The epicenter of that episode was sub-prime lending and securitization gone wild. Today’s lending standards have been reasonable, and in some estimations too strict. The pressures that higher interest rates have caused are exposing weaknesses that already existed in the economy. In part, that is the point in an inflation fight.


For us, the most important point is to watch your FDIC limits on cash balances, control your asset allocation and risk exposure, and stay the course. Recessionary forces are building but that is part of the cycle.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.


The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.


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