Is America Heading for a New Banking Crisis?
No doubt you heard late last week that Silicon Valley Bank collapsed, and that crypto-focused Silvergate Bank is no more. On Sunday, a third bank failed: Signature Bank in New York. Now, a number of others are reportedly teetering.
All are victims of the Federal Reserve, but I’ll return to that in a moment.
First, I want to address the big question so many people are wondering: What does this mean for my bank and my deposits?
To assuage any concerns you may have… your deposits are fine. They are insured up to $250,000 per account by the Federal Deposit Insurance Corp. (FDIC). And amounts above that are also protected if you bank at JPMorgan Chase, Wells Fargo, Bank of America, or Citigroup.
Regarding the wider banking system, in normal times, I’d say “everything is fine.” Bank failures are more common than you might think, and they do not generally cause a crisis across the banking industry.
Since the end of the global financial crisis—let’s call that 2010—the FDIC has taken control of 215 failed U.S. banks, and I’m betting most people probably never heard about that. In the last dozen years, only 2018, 2021, and 2022 managed to avoid a single bank failure.
But this time feels different. I cannot rule out a broader banking crisis. Silicon Valley Bank, or SVB as it’s known, and Signature Bank could very well be canaries in the coalmine.
In fact, news emerged Sunday that the FDIC was already on-site at a fourth bank, San Francisco-based First Republic Bank, trying to determine the best path forward to protect depositors amid what was reportedly an accelerating bank run.
Beyond First Republic, nine other banks are allegedly at risk now: Customers Bancorp (Pennsylvania), Sandy Spring Bancorp (Maryland), New York Community Bancorp, First Foundation (Texas), Ally Financial (Detroit), Dime Community Bancshares (New York), Pacific Premier Bancorp (California), Prosperity Bancshares (Texas), and Columbia Financial (New Jersey).
I am not saying any of those are going under. I am only telling you where the concerns are rising up.
More broadly, however, it’s clear the banking industry is facing its most urgent and perilous moment since the global financial crisis.
So, I wanted to send you this special alert today to explain clearly what’s happening… and what comes next.
Let’s begin with SVB…
What Happened to SVB?
In short, the Fed’s aggressive rate hikes doomed the bank.
Over the last year, the Fed has pushed interest rates to 4.75% from 0.25% in an effort to tackle inflation.
For banks and investors that own government bonds, rising interest rates drive down the value of existing bonds because the rates those older bonds pay are less than what the new bonds offer. In short, the old bonds are worth less because they generate less income than the new bonds.
If rates rise from 0.25% to 0.5%, the system adjusts easily because the move is mild and there’s no rush to grab a marginally higher rate.
But if investors can collect 4.75% instead of a measly 0.25%… well, you can reflexively understand why investors would rush to dump older bonds, driving their prices down sharply.
SVB had huge amounts of older government bonds on its books.
The bank also had another problem… it had a lot of tech startups and venture capital firms as customers. During the pandemic, those clients generated a ton of cash that they deposited at the bank. But amid the market downturn over the past year, money for fundraising and public offerings dried up. So, these clients were using their deposits at SVB to cover their operating costs.
With more money flowing out of SVB than was coming in, the bank was forced to sell bonds at a loss to replenish capital. This was unsustainable. Word got out and suddenly depositors were fleeing what they perceived as a failing bank.
Thus, SVB becomes the second-largest bank failure in U.S. history… followed by Signature Bank, now the third-largest failure ever.
What Does This Mean for My Bank?
As I mentioned above, if you’re banking at JPMorgan Chase, Wells Fargo, Bank of America, or Citigroup… you’re fine.
Back in the aftermath of the global financial crisis, those banks were deemed “systemically important banks,” or SIBs. This designation indicates that they are so big and important that the federal government will not allow them to fail because that would have a massive impact on the domestic and global economy.
In practical terms, that means the current FDIC limit of $250,000 of insurance per account simply doesn’t apply to an SIB. The banks’ entire deposit base is effectively insured.
That’s not the case with non-SIB banks, and most banks in America are not SIBs.
Silicon Valley Bank did not have this designation. And news accounts noted that between 80% and 90% of SVB’s more than $200 billion in deposits were not insured because those accounts exceeded the $250,000 FDIC limit.
Late Sunday, the FDIC, the Fed, and the Treasury stepped in and promised to cover all the deposits at SVB.
The regulators’ actions have SVB customers breathing a sigh of relief, for sure, but it raises a bigger question: Can and will regulators step in and make whole every bank that now fails? If so, then the FDIC’s $250,000 limit means nothing anymore.
The bigger potential problem here is that across the U.S., more than $1 trillion sits in deposit accounts that exceed the $250,000 limit.
My bet: Consumers and business owners are not going to take the risk. They’re rightly going to assume that regulators cannot and will not backstop every bank. As such, we’re very likely to see a flood of cash flee smaller community and regional banks in coming weeks, with that money diving into SIB banks, just for peace of mind.
Job losses and bank closures will mount.
Why Has the Collapse of SVB and Silvergate Impacted the Crypto Market?
If you’re a crypto investor, you’ll no doubt be aware that the crypto market has taken a big hit from the collapse of SVB and Silvergate.
While crypto had nothing to do with the collapse of SVB, it was at the heart of the failure of Silvergate Bank, in San Diego. Silvergate serviced a lot of crypto companies. And the crypto bear market over the last year saw huge amounts of cash pulled out of Silvergate.
Silvergate’s losses, however, were absorbed by its owners (as should be the case), who announced that they would make depositors whole and shut down the bank. So, the FDIC did not have to step in and take over that bank, as it did with SVB.
However, the collapse of SVB did have impacts in the cryptosphere. Most notably, it caused the USDC stablecoin to lose its peg with the U.S. dollar.
USDC is designed to track the dollar 1:1. However, the company behind USDC, Circle, had $3.3 billion on deposit at SVB. That news freaked out the market on fears that Circle could lose some or all of that money in the SVB failure.
As selling pressure on USDC mounted, it lost its dollar peg, falling at one point to about $0.82.
The stablecoin regained its peg at $1 on Sunday when news emerged that regulators will fully backstop SVB’s deposit base. (Personally, I am not worried about USDC long term. This moment will cause Circle to make changes that ensure this doesn’t happen again.)
Nevertheless, that incident exemplifies how deeply intertwined the traditional and digital financial systems are, and why the Fed is such a menace to the economy. Which brings us to…
What Comes Next?
I’ve been saying for a long while now that the Fed was on the wrong path with its aggressive rate hikes.
Today’s Fed is haunted by the ghost of 1970s stagflation (a period of high inflation and stagnating economic growth). Fearing a repeat of that economically limp decade, Fed Chair Jerome Powell has attacked inflation with all the subtlety of a bull goring a matador.
Alas, today’s America is not the America of 40 years ago. Back then, consumers, companies, and the U.S. government did not have excessive debt. Today, consumer, corporate, and government debt levels are at record highs.
In that debt-soaked environment, pushing interest rates up at warp speed was always going to cause a backlash.
Now, we’re seeing the dominoes begin to tumble.
When the Fed, Treasury Department, and FDIC announced on Sunday that they would make all SVB investors whole, it marked a monumental change from the past… and it speaks directly to the Frankenstein that the Fed has created.
Regulators felt forced to step in with a full backstop plan to halt any contagion.
Indeed, over the weekend businesses all over the world were in panic that they might not make payroll this week. SVB is a leading lender to startups and has branches in Canada, the U.K., China, Sweden, Denmark, and elsewhere. Thus, a single bank failure in California could have rippled across the globe with a vast effect on small businesses, technology, and employment.
Regulators say the costs for these bailouts won’t be borne by the taxpayer, but then where does the money come from?
Brrrrr goes the printing press…
That creates yet another moral hazard in America’s hazard-ridden banking industry. Now, bankers will know they can be loosey-goosey with their banking practices and feel confident that their failures will be covered by the taxpayer.
All of this because the Fed went all street-rat crazy raising interest rates… after spending decades saving Wall Street and the economy from every hiccup by keeping interest rates at illogically low levels.
Now, the rapid rise in interest rates without an adequate transition period has broken the banking system.
If there’s any good news in all of this, it’s that the Fed is now likely done with its rate hikes, which should lead to a pop in stock and crypto prices.
The Fed simply cannot continue hiking interest rates into a crisis that has seen three banks fail in a single weekend… with more failures likely. This story is still developing, however. There’s more fallout to come. Stay tuned… and I’ll keep you informed on the key developments.
