Market Update: The entire banking system changed overnight

Clients & Friends

You might have noticed news headlines that dominated the media throughout the weekend regarding the second, and third, largest bank failures in U.S. history.  The media is notorious for inflicting fear, but this was an event that could have escalated very quickly and could’ve been catastrophic to the banking system; luckily our government threw us (another) lifeline.

What Happened?

On Wednesday last week, Silicon Valley Bank (SVB) announced a liquidity problem, and by Friday the Federal Depository Insurance Corporation (FDIC) had seized the assets of the bank.    By Sunday, another bank, Signature Bank, was also seized by FDIC.

As a result, any individual or company that held more than the FDIC protected amount ($250,000) at SVB or Signature Bank going into the weekend faced a high probability those funds were lost due to the bank failure.

However, by Sunday evening our government announced that all deposits will be protected regardless of size, which brought much needed relief to the entire banking system.

What we expect going forward is that all deposits will be covered by the FDIC regardless of amount, which is a major change to the entire banking system and how your cash is protected at a bank.

These bank failures happened very quickly and could’ve rippled throughout the entire banking system if the government had not intervened, causing markets to sell off quickly.  This was a potential crisis that was diverted, thankfully.

In my opinion, government involvement here came directly from their playbook during the 2008 financial crisis, and it worked.  This was not a bail out, and it is not an ideal outcome, but it was necessary, and it changed the banking system going forward to protect those who deposit cash into a bank, including you.

Why did this happen? 

For many months, investors have been pulling cash from their bank and investing in places where interest rates are higher, mainly because banks have yet to offer higher interest to their depositors as market interest rates moved higher; I have personally assisted many clients with this over the past year.

In SVB’s case, they needed to free up cash due to depositors pulling funds out of the bank.  When a bank needs to free up cash it is forced to sell off assets, in SVB’s case it was heavily invested into long-dated government bonds.  As a result, those bonds were sold at large losses and the bank was forced to absorb those losses.

As word spread about the losses, depositors were spooked and began pulling their money out of the bank; within 24 hours over $40 billion was withdrawn from SVB bank accounts, leaving the bank insolent.  Unfortunately, this was not something anyone could’ve seen coming in advance, this was a systemic risk that is near impossible to identify when it escalates so quickly.

In my opinion, in defense to SVB, you can’t get much more conservative than owning long-dated government bonds, but this backfired when interest rates spiked last year causing the value of those bonds to plummet.  Holding these bonds was a risk that could have been avoided by the bank, but maybe not entirely, and is mostly the result of a decade of (near) zero interest rates.

This time is much different than the financial crisis, mainly because banks owned toxic assets that couldn’t be sold, creating a much scarier environment.  However, this does bring back memories of a time when the banking system was in jeopardy, especially during a time (like now) when bank accounts can easily (and quickly) be moved via a cell phone app.

What can we expect now?

It’s possible (and likely) that other banks will fail, but they were just thrown a massive lifeline.  If they do fail it will be because of mismanagement, and investors in those banks will be the biggest losers, not the depositors.  Most important, these events do not seem to be contagious so worries regarding escalating problems from these bank failures will soon diminish.  However, the world is watching and unfortunately this event brings another layer of uncertainty in an already fragile market.

As for current Fed policy, prior to these events the Fed announced plans for a few more (smaller) rate hikes.  However, the market is now pricing in a probability that the Fed will not raise rates in their next meeting due to market vulnerability, delaying their (ongoing) fight against inflation; we will know more in the coming days.

As always, we stay committed to our investment strategies and continue to monitor risks & identify opportunities within individual holdings in the current economic environment.  If you have any questions about your investments, please contact us directly.



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