By: Dr. M. Ray Perryman
Published in syndication March 15, 2023
The recent shenanigans in several banks stoked fears of another financial crisis similar to the Great Recession in 2008 or the meltdown of the 1980s (I wrote a book about that one). Not to worry! The basic problems for each of the affected banks boiled down to inadequate risk management and issues specific to their situations rather than any systemwide weakness.
Quick action by the Federal Reserve, Treasury Department, and FDIC have calmed markets and depositors sufficiently to contain the fallout. There will no doubt be some jitters and gyrations around the globe for a while, but the system is sound.
Banks are the arteries of modern economies, taking in deposits from some customers and lending them to others. Usually, when numerous banks have problems on a broad scale, it's due to high-risk practices (such as the subpar mortgage origination and securitization prior to the Great Recession), changes in the regulatory environment (such as the schizophrenic tax and financial policies which first incentivized syndications and then tanked them in the 1980s), or similar systematic issues.
Silicon Valley Bank (SVB) customers were highly concentrated in technology sectors (start-ups, in particular), As these firms came under pressure, they needed additional cash to fund operations. However, SVB had invested its assets into US Treasury and similar bonds with values sensitive to interest rates. These vehicles are risk-free if held to maturity, but subject to fluctuations when they are liquidated unexpectedly. As rates rose, the value of SVB's portfolio fell. The bank raced to sell them at a loss or raise equity in other ways to manage the spate of withdrawals, but social media musings created and amplified a major run on deposits.
Clearly, SVB's risk management was inadequate. Excess funds were too concentrated, and a hedge against interest rate risk should have been implemented. Greater diversification of its loan portfolio would have also been wise. In essence, bad choices took down SVB. The other two failures were basically generated by bets on the cryptocurrency market that did not pan out.
Fear can be contagious, and it will take a bit of time and a bit of data to fully restore confidence. The response by regulators (which does not reward shareholders, management, or bondholders) was appropriate given the situation and the need to maintain smooth functioning of the economy.
One result of this debacle is that the Federal Reserve now has yet another concern to deal with in its ongoing quest to promote both economic growth and modest inflation. The important point, however, is that neither tech dominance nor crypto concentration is the norm among US banks. This is neither 2008 nor the 1980s, and our financial infrastructure is fundamentally strong. Stay safe!