Good Bank, Bad Bank
I am worried that my previous post may have been too favorable to bankers. Bankers are not universally loved. They have a reputation for foreclosing on decent people having a hard time financially, for not lending to anyone except those who don’t need a loan, and so on. Two movies that illustrate this are “It’s a Wonderful Life” and “The Best Years of Our Lives.” In “It’s a Wonderful Life” Jimmy Stewart’s Bailey Brothers Building and Loan mortgage business is threatened by the bank which finances it when a bank payment is misplaced. In “The Best Years of Our Lives” bankers who have stayed home during World War II refuse to make loans to GIs returning home, because they are not creditworthy enough. Despite later being named the “greatest generation” soldiers returning home after World War II faced many of the same problems that soldiers returning from other wars have faced, from the Civil War to the Iraq War.
In an ideal world, banks and their communities would work together. Bankers would lend to deserving people in the community and the depositors would not run to get their money out at the whiff of a problem. But it’s not an ideal world. Early on, many bankers were simply rich men who would loan out their own money and could impose whatever terms they wanted. Many bankers today are too concerned about themselves and their money than about their community. On the other hand, SVB illustrates what can happen if customers lose confidence in their bankers.
Again, ideally when a bank gets in trouble, community leaders would work cooperatively with the bankers to fix the problem. When this doesn’t happen or is too difficult, the government has to step in to try to work out a solution.
The US faces this problem now of loss of confidence. To prevent a run on the bank, should all depositors, including the very rich, be made whole or should a just the smaller ones, who have less than $250,000 deposited? It’s basically a political judgement of how much the government has to do to restore confidence in the banks. Currently it looks like the government has decided ad hoc to protect all depositors now, but without promising to protect all depositors in the future.
How strongly the government must respond depends on how bad a shape the bank is in. The American banks that have failed — SVB and Signature — and First Republic, which has been on the brink of failure, do not necessarily indicate a generalized failure of the US banking system.
SVB was in somewhat of a unique position. It had quadrupled its assets in four years. About 97% of its depositors were very rich who had more than $250,000 deposited. It locked itself into backing its deposits with long-term low interest bonds, in part because its rich depositors did not need the type of traditional loans (mortgages, business loans, credit cards) that most banks make and that tend to be more varied than fixed interest bonds. Signature bank had recently expanded widely into the cryptocurrency business, but then was hit by the problems in the crypto area, such as the FTX failure.
This chart from S&P shows that both SVB and Signature were near the top of American banks had uninsured deposits, making them different from most mid-sized banks which have diversified customer bases that include many smaller, poorer clients, who would be covered by the $250,000 FDIC insurance.
This article from the Economist magazine describes how the Fed’s reverse repo facility has made it easier and more profitable for money market funds to use it rather than traditional investments. Deposit withdrawals from banks like SVB often went into money market funds, which ended up transferring some of these funds into the Fed, rather than into other banks, leading to an overall decrease in assets held by banks. This article does not mention it, but the rise in interest rates has led to a decrease in the value of bonds held by banks, which was a key element in SVB’s failure.
The overall decrease in bank assets looks bad, and it is, but it should be survivable. The relatively small decrease should leave the banks able to meet normal demands for payment. If there are abnormal demands for payment, as in a bank run, the underfunded banks, like SVB may fail. In the absence of runs, the banks can readjust their asset holdings and be back on a completely sound basis when the economy stabilizes. The government just has to prevent more bank runs until then. But the Fed, the Treasury, the FDIC, and Congress will have to decide on the best way to do this. Yesterday and today Yellen and Powell did not seem to be on the same page, but hopefully they will work it out in a way that will satisfy bank customers and Wall Street.