“The U.S. banking system is strong and resilient,” Jerome Powell boasted days after he took over First Republic Bank, marking the second-largest bank failure in U.S. history. In our Fed Chair world, First Republic is just another one-off, like Signature and Silicon Valley banks before it.
Sorry, one-off (as Powell is trying to create a First Republic) if you are UBS by the Swiss. Counting the forced merger of Credit Suisse with , rarely comes three or four.
Shortly after Powell’s assurance, regional-bank stocks began to crash. Eleanor Tarrett and Charlie Brady of Fox Business reported that in the past week, the sector is down 10%. For the year, regional-bank stocks are down 34.6% — compared to an 8.1% gain in the S&P 500.
The latest problem child appears to be LA-based PacWest Bancorp, which has $40 billion in assets. That’s smaller than First Republic’s $200-plus-billion, but not insignificant, and its stock fell shortly after Powell’s comments. Shares recovered a bit on Friday but not enough. They are still 82% below their 52-week high and its management continues to look for a white-knight savior.
The main culprit is, of course, high interest rates. There is also a lack of leadership. The Fed is the nation’s front-line bank regulator. But Wall Street appears to have less faith in Powell’s ability to avert the latest systemic threat to the US economy — a looming crisis threatening the scores of mid-sized banks — than in his ability to forecast “temporary” inflation.
Ditto for Treasury Secretary Janet Yellen, another player in the bank regulatory apparatus. For weeks now, she has also been telling the markets that things are fine with our banks. Logic suggested quite the opposite, particularly at the regional-bank level where management seemed to have collectively drunk from the same cup of Kool-Aid.
Regional people took opportunities so that they could compete with the big banks. They were sure the good times would never end when Powell & Co. printed money and Yellen spent like crazy even after the economy opened up from Covid. They made loans on terms that did not take into account that the economy would someday slow down as it is doing now. They load on capital purchased at the height of the market.
The Fed’s money printing came at a high cost, of course – this fraudulent tax on the working class known as inflation. Over the past year, Powell has jacked up rates eight times to slow the fast-burning economy.
Inflation could fall even if it remains sticky, which means rates are likely to rise further despite talk of a “pause”. That means speculative assets will “normalize,” a Wall Street term for the continued compression of prices in things like crypto, meme stocks, tech, and the now-risky assets on regional-bank balance sheets.
Banking is a trust game. Remember Jimmy Stewart’s character George Bailey in “It’s a Wonderful Life” trying to convince depositors to take their money from the Bailey Building and loan. “You’re thinking all wrong about this place like I have the money back in a safe. The money is not here. . . Your money is in Joe’s house. . . And a hundred more.”
George Bailey kept his “magnificent old building and loan” from collapsing, but barely. He dipped into his own pocket, using his honeymoon savings as a short-term loan to pay off some depositors. He was also able to convince enough people to believe in his ability to keep the bank afloat.
Yes, times were hard (it was the Great Depression). But depositors’ money, he argued, was in people’s homes—tangible assets that would pay off over time. Their savings were safe until they panicked.
The depositors are absconding
We could use some George Baileys now. As word of risk-taking spreads, regional depositors are rushing for the exits. They are draining banks of their capital and sending them into bankruptcy because they don’t know what they are backing, such as increasingly depressed commercial real estate. Their crews hide behind Pollynish flexes that can’t be trusted for truth. First Republic avoided crucial questions during its last analyst call that almost guaranteed its demise.
Powell and Yellen also offer bromides, and a patchwork of short-term corrections. A shotgun marriage orchestrated by the feds allowed JP Morgan to buy First Republic into receivership with government guarantees. This has done nothing to allay concerns about the system, as the events of the past week have shown.
My banking sources tell me they hope policymakers will come up with another half-baked solution to prevent depositors from moving their money out of regional areas: Increase deposit insurance well beyond the current $250,000 limit. Possibly make it infinite, either explicitly or by declaring it all. Regional banks are “systemically important” so they get the same “too big to fail” designation as places like JPMorgan.
Sounds good, but the interest rates offered on bank deposits suck. Extended deposit insurance won’t stop the drain as you can earn around 4% to 5% in a super-safe money market fund offered by money managers like Vanguard.
Another solution: just let regional banks fail and be taken over by larger, possibly better capitalized megabanks. But the bulk of the nation’s lending equipment cannot be replaced by the big guys — JPM, Citi, BofA, and Wells Fargo. More bank lending is necessary to prevent a full-scale recession.
And how many bad banks like First Republic can digest Jamie Dimon and JPM’s balance sheet? JPM now controls about 17% of the country’s deposits. Talk about too big to fail!
Sorry, there are no quick fixes to the pickle we’re in, other than trying as hard as we can to avoid the sins of the past.
We need Jerome Powell to become George Bailey and start telling the country some hard truths. The Fed printed money when it was not necessary. The hyperlow interest rates of the last three years lasted far longer than the threat posed by those Covid lockdowns to the economy. And now the bill is coming due.
