For those of you sitting at home wondering when there will be a new bank failure, you are not alone. If history has taught us anything, it is that most often, banks and wall street do not learn from their past mistakes.
Step into your Delorian time machine and go back to say some fifteen years ago when the Global Financial Crisis took hold of the world, and we can compare and contrast some financial models to both types of markets. Back then (makes us all sound old doesn’t it) a mere couple of percentage point loss in the value of MBS or Mortgaged Backed Securities, and the loss of value of those assets were greater than the market capitalization or total market value of some of the banks that held them. For those who aren’t following, that means the losses that Bear Stearns had from CDOs involving mortgages were greater than the value of Bear Stearns. Scary thought indeed, but it does not seem that our banking system is equipped to handle a crisis here in 2023 either.
Change the date back to the present in your time machine and you have arrived back in 2023, where the Federal Reserve has made it possible for banks to leverage assets and/or securities that already have an impaired value. Putting this into terms everyone can understand, let’s say you own a home. That home was worth $1,000,000 a year or two ago. Today based on its mark to market it is only worth $750,000.00. We would all agree that it has lost approximately twenty-five percent (25%) of its value. But if you were a bank, you can go to the Fed and utilize the prior value of $1,000,000.00. This adds insult to injury as you as the bank have now levered an asset over its current value.
Now you are asking why would anyone do such a thing? Well, ladies and gents this happens all day, every day, and the reason why is so that the bank can get access to more capital, as depositors and others move money in and out of banks like the rest of us go to Starbucks for a latte. If you look through the financials of the recent bank failures, the inevitable situation was all predictable. There were ill-fated investment decisions into securities that have an inverse relationship to interest rates. So as rates were changing the value of those securities was going down, which means you need more of them to borrow the same amount of money in theory right? Or you need more capital to cover the money due to depositors should there be a run on said deposit accounts. Now take into account that these institutions had more accounts that were beyond the normal bread-and-butter coverage of deposit accounts. This adds more risk to the overall financial condition of the institution.
Fast forward now slightly to the run on these institutions by depositors and now what happened in the Global Financial Crisis to hedge funds and other investment partnerships that had no back-stop from the Fed, can now happen to a bank. The depositors decide the bank is “toast” and within 72 hours they withdraw over $40 billion in capital. The bank’s business is the same, besides the multitude of depositors it just lost, and the value of its assets has not gotten better.
So, what does that mean? That means that only the larger money center banks can survive and have larger pockets to withstand a greater liquidity crunch. It also means by saving each of these banks in the form of having them purchased by larger banks while the Fed guarantees the bad assets and loans out there, we are changing the focus of the free market system. If we are going to have an economy based on capitalism, we have to be ok with economic highs and lows. True capitalism is a society based on an economic system in which trade and industry are controlled by private businesses that are in business to make a profit. So, in this scenario, there is a part of capitalism that is based on the survival of the fittest. A free-market system has to allow there to be failure or bankruptcy among businesses. Regarding the current banking situation, we have stopped that from happening by artificially matching the failing bank with a suitor in the name of “consumer protection” and to keep the banking system liquid. This derails the free-market system by a factor of control for the business that is having issues. The point everyone seems to be missing is that our banks are not healthy enough not to be helped by the government. This is something that should alarm everyone.
Instead of letting the free-market system correct and do what it must with those that cannot survive we are once again toying with economics for our own benefit. Every time we change the parameters of the economy in the name of fighting off “insolvency(bankruptcy)” or “disastrous failure” we are playing a dangerous game that will not end well for the shareholders of any entity slated to fail.
Make no mistake my friends, there will be more bank failures due to the complexities of the global and regional economy. Gone are the lines that separate the regional banks from the national banks. There are niche markets where banks have jumped in to fill a need, yet they have not planned out the inherent risks associated with trying to run a brick-and-mortar banking conglomerate at the same as servicing venture capital-backed businesses.
There is no possible way for any bank to maintain its business when depositors run for the exits, and there are not enough exits to go around. An in-depth study of the exponential capital flow out of banks as the problems mount should remind you of the water going down the drain in the shower. First, it does not go down so fast, and the water builds up a bit by the drain. Soon enough gravity wins and the water flows down the pipe and will not stop.
What is arbitrary is that there are no safety nets for all sectors of the economy. When was the last time the government got together to save that restaurant you used to eat at, or help that used car dealership not go out of business? While there are greater good arguments that can be made to stop contagion in the banking sector, there still needs to be the ability to have businesses survive on their own in a free market system.
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