Economic DiscussionEconomySHJ Blog

Inside the Economy: The Bank Circus

By March 22, 2023No Comments

This week on “Inside the Economy”, we discuss the headline news of two bank failures as well as other economic data. Silicon Valley Bank (SVB) was taken into conservatorship by the regulators and forced the FDIC and Fed to act. How will this impact monetary policy in the coming months? Unemployment was mixed and other data points to inflation continuing to trend downward in the right direction. Tune in to learn about this and more!

Key Takeaways:

      • 2-year Treasury falls to around 4%
      • Unemployment up at 3.6%
      • Mortgages rates still around 6.6%

Full Transcript:

Welcome to another edition of inside the economy. I’m Larry Howes, thanks for joining me. I’m going to spend some time on the current banking circus that’s going on the media right now, or as I like to call it, big things versus little things. Quick look at the numbers and I’m not going to dwell on this.

We’re making progress on inflation. Headline is down, core is down. Unemployment is creeping up a little bit, we’re at 3.6 up from 3.4. But if you look down at the bond yields, they’re all lower than they were a couple of weeks ago. That is what we call a rally in the bond market. Unfortunately, a lot of media publications, magazines, broadcasters or saying things like government bond yields are plunging like that inherently is bad news.

It’s kind of a result of some bad news, but when yields go down, what they call plunging, when yields go down in a bond, that means the price has gone up. Kind of a rally on the stock market, you’d call that a good day. It was a bond rally, and I’ll get into that a little more. I know the media has really been grim and brutal in how they’re communicating what’s going on in the banking industry right now. It’s even worse than it was before 2008, even though we had a real banking crisis back then.

We’re not having a banking crisis right now. When Joel came in the office this morning, the janitor rode up in the elevator with him, and asked Joel, is my money safe? I think that’s a result of some real bad hammering from the media, based on nothing that resembles data or factuality. There are a couple of banks, Silicon Valley Bank, Signature Bank, these guys, that are having some troubles. Mystery to no one, I’ll get to that in a minute. But the banking industry is having a rough time, because of the spotlight that’s coming in their direction.
2018, we had an adjustment of what’s known as the Dodd-Frank bill, and some regulation was pulled out of that, right or wrong back then. Lowering some regulation and some stress testing on the smaller regional banks. SBV and Signature Bank, those are regional banks. Well, you’re going to hear a lot more about that, probably more than you ever wanted. The stress testing that was taken out of that system had to do with banks under 50 billion dollars, and as it turns out, the particular process for the stressing has no impact on the issues that these banks are dealing with right now.

It’s called interest rate risk. Historically, you take your hundred dollars into a bank, that bank turns around lends the hundred dollars out, makes an asset. They charge the guy that borrowed the money seven percent, paid to depositor three, that four percent is their spread and their profit. That’s intermediation, that’s how banking works, that is the foundation of actually the Global Financial system is that process. There are some banks that don’t do a lot of lending, Silicon Valley Bank is one of them.

People out there and their depositors don’t need to borrow money, they just need a place to park their money. So you come into Silicon Valley Bank and you give them your million dollars, and they don’t lend that million dollars out and create an asset like a loan, they go buy a treasury or mortgage-backed security or some other bond. And a year ago, they were getting three and a half percent on these bonds whatever they were, and paying depositors a quarter of a point. Okay, that was all right.

The risk is when rates start going up, when rates start going up, the value of a bond goes down. That’s the classic inverse relationship. When rates go up, value of a bond goes down. When rates come down, the value of the bond goes up. Everything in the mathematics of a bond is that ratio. So depositors put all their money in Silicon Valley Bank, and in the last year when rates start going up, it’s harder to get more operating money for their technologically oriented businesses.

In the last year since rates have been going up, the markets have adjusted, it’s been harder for a lot of companies to raise new money. So they’ve been having to pull on their cash and their other assets. So depositors go into Silicon Valley bank and they say yes, I need 10 million out of my 85 and whatever it is. And then the bank has got to sell those assets.
Well, that million dollar bond they bought nine months ago, isn’t worth a million dollars anymore, it’s worth less than it was, because rates have gone up so the value has gone down. The bond itself is of fine quality. It just doesn’t have the same place in the market that it did, because they have to sell it. They’re not holding it to maturity.

More depositors come in, yes, I want my money, Silicon bank has got to sell their assets, pretty soon gee. I’m selling assets that are costing me more and more, and the depositors want their money back, big problem. So FDIC closes them down, they got a run going. Small number of depositors, real good social media, they talk to each other, that’s a great recipe to have a run on a small bank. Signature Bank in New York is kind of similar, I’ll just touch on them in a minute.

So FDIC comes in, Friday closes them down. This is no surprise to anyone in the regulatory industry. The San Francisco Federal Reserve has been dealing with Silicon Valley Bank for a year. They’ve been sending them MNAs, matters that need your attention, MNIAs, matters that need your immediate attention for a year. Greg Becker, I think that is his name, right? And you’re going to be hearing that guy’s name a lot more here in the near future, the CEO of Silicon Valley Bank, is also on the board of directors of the San Francisco fed.

So whatever problems he might have had, one audit team got replaced and reassigned, and the new audit team had similar problems until the whole thing collapsed. The San Francisco fed is going to have to air a lot of dirty laundry about him, and a number of other things. And they’re going to hear more about it than you ever wanted to.

Signature Bank had similar problems, even narrower world depositors, that was mostly cryptocurrency and they wanted their money back, same kind of deal. Signature Bank is the only bank that I’m aware of in New York, that’s willing to finance the rent assisted buildings in New York City and Rochester and all those other places. No one else is willing to touch those properties. And since they really don’t exist anymore, and I don’t know how valuable those loans are, that might be a problem for New York. Fundamentally, this is not a banking crisis, banks are doing great.
Very quick history lesson, because it’s important to what’s going on right now. Here we are 2008, we did have some problem loans then and some problem real estate issues. But banks were given a whole bunch of money highly capitalized in case people needed to borrow money. There was all kinds of money thrown into the system, a couple trillion dollars. This is indicative of people keeping their money in cash in the bank, but the bank had a lot of money to lend, they just weren’t lending out much.

So everything else is what’s known as an excess reserve. And back in those days, the Federal Reserve said yes, we’ll pay you interest on these excess reserves because we want you to have them. Well, it was a quarter of a point then, a 25 basis points not that much money. Well today, the FED funds rate is about four and a half, 4.58 this morning as a matter of fact. So the Federal Reserve is paying all these Banks well it’s 150 billion dollars a year, that’s just interest on their excess reserves. It’s going to be very bad news for the banking industry when a politician stands up there and says why are we paying all these Banks 150 billion dollars a year? And they’re not going to tell you why, because it was a good reason in 2008, it’s just not so good right now.

When there was more money put into the system for COVID, that was another 4 trillion, it was the same kind of thing. The banking system is strong, the banking system is very liquid. You can do what you want with it. But now they’ve got Congress looking at them, in fact, Congress is going to have the targets on their back here, it’s probably already started. I know the class action suits have already started against great Becker and the board and a bunch of other people at Silicon Valley Bank, that’s going to go on for decades.

But don’t worry about your bank, they don’t have a problem. They have lots of cash. I think it’s First Republic Bank in San Francisco got 30 billion dollars in a hurry because Jamie Diamond called Janet Yellen Treasury and said let’s give him some money to make sure the problem doesn’t turn into a contagion. It doesn’t spread, people don’t lose all their confidence in the banks. Well Jamie, it’s the right idea, but you got an image problem now, it’s going to take you a little while to fix it.

And unfortunately, Congress is probably going to help them do it. You’re going to hear a lot about how they modified the Dodd-Frank Bill back in 2018. There’s going to be some politicians pointed out, it doesn’t matter. It was a fairly pointless piece of legislation, they’re taking some regulation out saying we’re freeing up American Banks from excess regulation. Well, they didn’t know. But you’re going to hear a lot more about it, but it’s just fascinating that SVB started really growing their assets back then.

They knew how to work the system very well. They bought this little bank and turned it into a big asset manager, which is kind of what Dodd-Frank was trying to avoid. But you’re going to hear a lot more about that than you ever wanted to. And banks that do a good job with new assets and growth are probably going to find that harder. And the FDIC is just going to have to look at all of these other regulators, the other Federal Reserve banks and say well, what aren’t you doing that’s good? It’s your own fault, they’re just going to have to deal with it.

The issue is here, this is not a what’s going on in the back room kind of thing. But in a lot of ways, what’s out in front, is the media circus. What’s going on the bank, and going on here and is your money safe? All that stuff. It’s not like it’s a conspiracy to keep you occupied, but it’s keeping everybody occupied. The important things going on the back, and that is the Federal Reserve selling the assets it’s accumulated when we put that last four or five trillion dollars in because of COVID.

It was a good move at the time, very important but the money has got to come out of the system. And now if you look at the very top of this chart, money is starting to come out. The money supply, M2 is starting to get a little smaller. It’s going to have to get smaller, it’s going to take a decade, but it has to get smaller.

This excess money in the system is a core in our inflation issue, and to really get at it, you’ve got to pull that money out. This is a huge part of what the Federal Reserve is doing to slow inflation. They’re not going to explain to the media that the Congress oh we’re taking money out of the system, that just won’t go over well at all. They’re having to do in the back, and they have to do it and it’s a good thing. There’s going to be a lot of good things out of this banking crisis.

It’s going to be a little uncomfortable for the banks a while, but it also, it’s going to help the FED decide how much they need to crank rates more. They got a meeting here in a couple of days. It’s a safe bet, they’ll do a quarter of a point, 25 basis points, that’ll put us at five, put the customer at five, it’s probably a good point. And as you know, as soon as the markets think the FED is pausing, there will be great rebounding in the stock market, and yields will start coming down, remember when they come down, prices go up.

The bear market we’ve been in the last year was probably coming to a close. Inflation is easy, it’s clearly easy. The mortgage side of things, the green here is new mortgage applications and the little lineup there’s where mortgages are. Well, there’s a relationship housing. Housing is going to stay down here, and the housing is going to grind slower regardless of how long it takes.

There’s still some good properties in good locations that are in great shape, that are getting a premium price. It’s probably not going to be the case by the end of the year, they’re going to slow, they’re just going to have to slow. And rates are actually, artificially low seven. Actually mortgage rates right now, if there were really let to run like in the marketplace, they’d be in the eights. I think they’re just taking a little more time to get that housing market, but we’ve been through it.

You’ve got to go through housing, you’ve got to go through employment, you got to go through more debt and foreclosures, and then things come out. And frankly, you’ve seen this number before, the mortgages have been recovering since COCID and they’ve just started turning around. We’re starting to get more 30-day, 90-day foreclosure notices, late notices, that kind of stuff. Nothing dramatic yet, it’s going to have to get worse.

Okay, unemployment can’t stay at 3.6. A lot of the good news, a lot of the strength in the economy is going to have to be work through, if it’s going to take money out of the system to help that. They’re going to have to work through to slow everything down, and they are going to do it. But I think most of what the FED is going to do here in the near term on the surface meaning raising rates, probably close to being done.

The back office, taking money out of the system, slowing the Bank income down, taking that 150 billion dollars a year down, boy they’re going to want to do that and a few other things, that’s going to continue to go on for another decade. It’s going to be a headwind for a while, we’re just going to have to live with it. Well, that’s enough. I’m sorry the media is beating everybody up.

As usual, if you have any questions, there were a lot about banking as you might imagine. Send them along to will be happy to deal with it. And I appreciate you joining me.

Leave a Reply