What’s the Deal with Banks?

When you wake up to news of banks failing, stocks tumbling and the Federal Deposit Insurance Corporation (FDIC) swooping in to “save” the 16th largest bank in the country, you have to ask yourself: What is the deal with banks?

Simply put, the deal here is that last Friday, venture-focused Silicon Valley Bank (SVB) failed, marking the largest bank failure in the U.S. since Washington Mutual during the financial crisis. Then, on Sunday, Signature Bank of New York (SBNY) also failed, and was taken over by the FDIC. Like the also-failed Silvergate Capital (SI) and SVB, Signature Bank had a lot of crypto exposure. In sum, three large banks failed in less than a week!

In response, the Federal Reserve and the Treasury Department aggressively stepped in and announced that all depositors at SVB and SBNY, including FDIC insured and non-insured, will be made whole and have access to their deposits.

Then, in a flashback to the financial crisis, the Fed also created a new lending facility, the Bank Term Funding Program (BTFP). This new institution will provide one-year loans to banks, accept Treasuries and agency mortgage-backed securities (Fannie/Freddie MBSs) as collateral and the lending facility will value the bonds at par (not current market values).

But did this situation just appear out of nowhere? Of course not, no effects happen with prior causes.

The underlying reason for the bank dislocations is in very large part due to the Fed’s monetary policies over the past couple of years. You see, after keeping the cheap-money fire hose on full blast for years, this past year, we reaped what we sowed and got inflation.

Now, the Fed is determined to reverse the easy-money policies of the past to try to tame inflation, and that’s resulted in a contracting money supply and the price of money (interest rates) going up very fast. We also now are suffering the pernicious effects of a negative yield curve, where short-term interest rates are higher than long-term rates. And while bond yields have gyrated wildly of late, sharply compressing that negative yield curve, the result of that prior huge inversion has been horrible for banks, and as a result, bank fundamentals are very negative.

Of course, the SVB, SBNY and SI situations all have issues specific to their situations. Those respective specific problems resulted in old-fashioned “bank runs” in the space, meaning more people went to get their money out of the bank than the bank could handle — and that’s always an extremely scary situation.

Now, the fear is “contagion,” i.e., that other banks will suffer the same fate as SVB, SBNY and SI. And seemingly right on cue, this morning, we woke to similar issues with Credit Suisse (CS), one of Europe’s most storied financial institutions.

 So, what’s the bottom line here for markets? Well, this could be a silver lining in one sense, and that is we are very likely to see the Fed get much more “dovish” from here when it comes to future interest rate hikes.

We know that, because the introduction of contagion risk has significantly altered the market’s outlook on what the Fed is going to do. Prior to the failure of Silvergate, Silicon Valley Bank and Signature Bank, fed fund futures were pricing in a greater-than-50% chance of a 50-basis-point rate hike next week at the March 22 Federal Open Market Committee (FOMC) meeting, and a terminal fed funds rate (level where rates finally peak) of 5.625%.

Now, in just three trading days, Fed fund futures are pricing in a 25-basis-points hike next week (and the possibility of no rate hike), and a terminal fed funds rate of 4.625% – 4.875% (meaning next week’s hike could be the last of this cycle).

That change helped stocks rally big on Tuesday despite the bank failures, but of course, that Credit Suisse news overnight soured yesterday’s bullish mood.

Unfortunately, there’s likely to be more negative bank news before this whole tragicomedy is over, and that means we are likely in for more equity and bond market drama in the days and weeks to come.

So, hold on tight, as there is one thing you can bank on here, and that is this rollercoaster ride ain’t over yet.

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J. Paul Said It Best

“If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”

— J. Paul Getty

The richest men in history often have a way of putting into perspective what the rest of us have trouble conceiving. The reason why is because the more money we have, the more our perceptions of the world change. Think about that in your own life.

Indeed, as much as we might try to deny it, the wealthier we become, the more our world view changes. Those changes can be both good and bad, depending on one’s perspective. However, just like a man can’t step into the same river twice, neither can he look at the world the same as his net-worth increases.

Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.

P.S. Join me for a MoneyShow virtual event where I’ll be on a panel moderated by Roger Michalski and will be joined by my colleagues Bryan Perry and Mark Skousen. In addition, the entire event focuses on investing for income — real estate, Master Limited Partnerships, dividend-paying stocks, bonds and more.

In the name of the best within us,

Jim Woods