I hope you are all well and enjoying the early spring. The extra hour of daylight that began yesterday makes me look forward to warmer days ahead.

Unfolding events over the weekend may remind us of the ghost of Christmas past – a haunting straight out of the 2008/09 financial crisis. In three short days, we’ve witnessed a bank failure (Silicon Valley Bank), another bank being taken over and closed by the FDIC (Signature Bank), and the Federal Reserve rolling out a new bank lending program (Bank Term Funding Program). The natural question for many investors is whether this is the beginning of a new financial crisis like 2008/09.

While all of this is very recent, my initial answer to that question is no, this is not the beginning of another financial crisis. Without getting too deep into the weeds, here is my rationale.

  • Silicon Valley Bank (SVB) failed because of a colossal error in judgement. Several weeks ago, SVB became aware that Moody’s (the credit rating agency) was likely to downgrade the bank because of its bond portfolio. Much of that portfolio was comprised of Treasury bonds – very safe but very low-yielding Treasuries. The bonds’ values were also down a lot because of recent increases in interest rates. It’s certainly not unreasonable for SVB to want to rework the portfolio, take some losses on the existing bonds, and reinvest at higher rates.  However, the bank took a backwards approach to try to reach their goals. They sold the bonds and realized the losses FIRST. They were required to disclose this information to the public and further told the public that they would be selling stock to raise money to cover those losses. This sequence of events essentially led to a run on the bank – everyone wanted their deposits out of the bank AND no one wanted to buy their stock to provide the necessary funding.  SVB was stuck and the FDIC stepped in and closed the bank.  If the bank had reversed the sequence of events – raising funds first, then selling the bonds – the bank may not have failed at all.  It failed because everyone wanted their money at the same time.
  • Over the weekend, the Federal Reserve worked to ensure that the failure of SVB would not lead to similar problems at other banks.  The FDIC took over Signature Bank – a bank that was very closely tied to the cryptocurrency industry.  If any other bank was likely to be a target of concern, one tied to crypto was it, especially after the implosion of FTX and the closing of Silvergate Capital.
  • In addition, the Federal Reserve said that it would guarantee all of the deposits at these two banks, even deposits over the current $250,000 per account limit. There’s no reason for bank customers to pull cash from accounts if the Fed is guaranteeing all of it.  This hopefully stops further runs on banks.
  • Lastly, the Federal Reserve rolled out the new Bank Term Funding Program that is designed for banks that are holding a lot of Treasuries like the ones held by SVB (low yield and underwater) to use those Treasuries as collateral for cash to meet the needs of all their depositors.
  • Taken together, I think these actions should be sufficient to calm the markets and provide support to the banking system.

Since the 2008/09 financial crisis, most banks have significantly more capital than in the past. However, no bank has enough cash on hand on any given day to pay out all its deposits. That’s not how banks work. Banks take deposits, then make loans with that cash. Those loans return interest to the bank as income and the loans are ultimately paid back. If a bank always had to have all their depositors’ cash ready to hand back to their customers, there would be no mortgages, no business loans, no auto loans, no nothing – not even a bank.  It’s a balancing act and a run on a bank throws everything out of balance.

Some people may complain that the government is again bailing out the banks. I do not think this is the case. The shareholders of SVB and Signature Bank will lose all or most of their investments – the stock will likely be worthless when all is said and done. Only the depositors are being protected, which ultimately protects people who rely on those deposits – families, employees, vendors, and so on.

Hopefully we can leave the ghost of Christmas past to the next showing of A Christmas Carol. For now, it’s time to get back to the business of bringing down inflation, keeping the economy humming along, and seeing corporate profits rise.  I’m ready for this market downturn that began in early 2022 to be over!

If you have questions or would like to chat, please let me know.