Is The Banking System Safe?

I'm returning to the blogosphere after a five-month hiatus to write this post, and it's out of necessity. Because there are too many self-proclaimed "experts" on social media and in the Fourth Estate who would have you believe that we're on the precipice of a systemic banking crisis in light of recent events. Rather than offer up a spoiler alert with regard to that claim, I'm going to make you read on to the conclusion. But here's a hint: those social media "experts" and media pundits don't know baby poop from apple butter about the banking system, from what I've seen.

So what are my qualifications to weigh in on the topic? I have an MBA with a concentration in Economics and Finance, and hold a Chartered Financial Analyst (CFA) charter. I've worked with or for financial institutions for 37 years. I started my career as a savings and loan examiner during the S&L crisis of the 1980s, when over 1,000 S&Ls failed. I've written a published white paper about the crisis. I then worked for an $11 billion S&L that was taken over by the regulators, and I was sufficiently deeply involved that I wound up being deposed in the subsequent court proceedings. (Many years later, the U.S. Treasury admitted that the regulators had wrongfully taken over my former employer, an admission almost unheard of in its rarity, but that's another story in itself.)

Since that time, I have worked as an investment advisor to, then as CEO of a broker/dealer and investment advisory firm serving credit unions, for a total of 21 years. During that span, I also served a stint as Chief Economist of a $30 billion wholesale financial institution that was the investment advisory firm's parent organization. For the past ten years I've been a risk management consultant to credit unions. I witnessed first-hand not only the S&L crisis, but the Federal Reserve bailout of the Long-Term Capital Management hedge fund (which led to the dot-com bubble of 2000); the housing bubble and subsequent crash, which led to the Great Recession (which I predicted in early 2007); and, of course, the short-lived recession and sharp, rapid recovery from the ill-advised economic shutdown in response to COVID (both of which I also predicted, in this blog).

To borrow a line from Farmers' Insurance, I know a thing or two, because I've seen a thing or two.

So I'm going to lay out the facts. First, I'll recap the situation over the last week. Then, we need to lay some foundation for exactly how and why all this happened, and define some terms. Next, I'll look at each event, involving each bank in question, in turn, so that you can see whether they appear to be related. If they're unrelated, the problem isn't systemic. We'll also examine whether this is anything like 2008 (a connection the media seems hell-bent on making), and along the way, we'll look at the anatomy of a bank takeover - a subject that I know intimately and painfully, because I lived it. (I've also seen it, both from the perspective of a regulator and an industry advisor/consultant.) We'll also talk a bit about ratings agencies, specifically Moody's.

I'm going to use plain English. This will not be a technical treatment. If you don't understand banking or finance, I don't believe you'll get lost here. I've had to explain some pretty arcane subjects to credit union board members, who were laypersons like anyone who might be reading this, and I've gotten rather adept at doing so in a manner that they can understand it. So I think you'll be able to follow just fine.

Here we go.

The Sitrep

(I read a lot of spy and military fiction, and I've always wanted to use that term - it means "situation report.")

• Last Friday, March 10, Silicon Valley Bank (SVB) of Santa Clara, CA, with $209 billion in assets, was taken over by its state regulator, the California Department of Financial Protection and Innovation (DFPI). (The "Innovation" part of their name is pretty funny. Regulators tend not to be a very innovative bunch.) The DFPI immediately handed the reins to the Federal Deposit Insurance Corporation (FDIC), the federal bank regulator and overseer of the banking industry's deposit insurance fund. The takeover occurred during business hours (more on that later).
• On Sunday, Signature Bank of New York, NY, with $110 billion in assets, was seized by the New York State Department of Financial Services (DFS), which also turned the bank over to the FDIC. This takeover happened on a Sunday (more on that later also).
• As the ensuing week progressed, attention turned to Credit Suisse, a $574 billion Swiss bank, although the bank's problems had been known for quite some time. (By this time, media and social media hysteria over a "systemic banking crisis" had led business "journalists" to beat the rushes looking for any bank that might have problems - whether related to those of SVB or Signature or not - in order to reinforce the siren call of impending doom.)
• By Thursday, it was announced that First Republic Bank of San Francisco, a $181 billion institution, had received $30 billion in funding from a group of other large banks to ensure that it had enough liquidity (funds to meet deposit withdrawal demand, loan demand, and repayment of borrowings) in the wake of the SVB failure (and, of course, the media frenzy).
• On Wednesday, Moody's downgraded the entire U.S. banking system, and placed a number of banks on watch for further downgrades, including UMB Bank, a Kansas City bank with about $33 billion in assets. (We'll address the whole Moody's downgrade, and talk about UMB, separately from the "Big 4" mentioned above.)

The reporting of all of this noted - actually, noted is not nearly a strong enough word; it screamed from the rooftops - that the SVB failure was THE LARGEST SINCE 2008 and that the failures of SVB and Signature combined were NEARLY AS LARGE AS THE 25 BANKS THAT FAILED IN 2008. We'll address that later.

Setting the Stage

Now, we need to look at some of the things that have taken place in the economy and the financial system over the last year or two that have laid the foundation for what befell SVB and Signature, and what threatened Credit Suisse (at least in part) and First Republic. Don't misconstrue my use of the word "befell," SVB and Signature died by their own hand, but they got an assist from these macro factors. 

• Foremost among these contributing factors is that the Federal Reserve (Fed) has raised interest rates by 450 basis points (bp) over the last 12 months. A basis point is 1/100th of one percent, so the Fed has raised rates by 4.5%. Let's put this cycle of tightening, or rate-raising, in its proper perspective: the Fed has been using interest rates, instead of the money supply, to effect monetary policy since 1980 ("the Monetarist Era"). During that entire 43 years, they have only raised rates by 75bp on a total of five occasions. Four of those occurred in 2022, and were consecutive. That is unprecedented in its aggressiveness, in terms of raising rates.
• At the same time, the Fed was reducing the program of buying bonds that it began in response to COVID. That program, called "Quantitative Easing," was also used in the aftermath of the Great Recession of 2008-09, and was intended to assist in reducing market interest rates. So discontinuing the program has the opposite effect: it allows rates to rise. But it also has another effect: it pulls liquidity out of the markets, and the banking system. During 2022, the Fed reduced the amount of bonds it held by $310 billion.
• During that same span, the U.S. money supply shrank by about a trillion dollars. Besides the Fed pulling liquidity out of the system, another contributing factor was that people started withdrawing their savings and spending money again, as COVID fears waned and confidence returned (although recent consumer confidence figures are down). People started traveling again, and holiday spending hit record levels. Remember all that COVID stimulus? It's gone. As a result of it, the U.S. Personal Saving Rate was a whopping 33.8% (of disposable income) in April 2020, far and away a record. The second round of stimulus spiked the saving rate to 26.3% in March 2021. By June 2022, it had fallen to 2.7%, the lowest level since 2005.
• Now imagine you're a bank, and think about all those savings deposits being sucked out out of your bank in a matter of about 15 months. Most of my clients have seen quarter-on-quarter deposit declines throughout 2022. And yet loan growth in 2022 was the strongest since the early 1990s, more than 15% year-over-year. So most banks and credit unions found themselves in a liquidity crunch: the ratio of loans to deposits approached 100%, or in some cases was above that threshold. (How can loans be more than deposits, you ask? Borrowings. Institutions can borrow money on lines of credit, and use that money to make loans, thus their loans-to-deposits ratio may exceed 100%.)
• All of that isn't an insurmountable problem, as long as three things hold true. First, rates don't go up so much that the cost of deposits, borrowing, or other funding sources becomes so high that it gets too expensive to raise additional liquidity. In that case, you have to increase pricing on loans to discourage borrowers; in other words, turn off the lending spigot. Second, you still have ample contingent sources of liquidity: lines of credit, assets you can sell (but that can be a problem when rates are rising, as we'll see) or pledge as collateral for borrowing, or access to brokered deposits outside your core customer base. And third - there isn't a run on deposits.
• A couple of final things that were going on in 2022 that are pertinent to the SVB and Signature failures: the tech sector was experiencing a downturn, the likes of which hadn't really been seen since the dot-com bubble, and Sam Bankman-Fried's FTX crypto exchange infamously collapsed. In the case of the tech sector, tech firms had liquidity issues of their own, as their ability to raise capital was impaired due to their weakening condition. And the FTX melt-down had a ripple effect across other crypto exchanges. (It's still lost on me why anybody invests in that crap.)

Before we go any further, we need to define a few terms. Again, I'm going to keep it non-technical, although the terms I'm defining are anything but.

• First let's establish that, in general, banks don't invest in stocks, they invest in bonds. Next, let's set forth a simple truth about bonds: in nearly all cases, the price of a bond moves in the opposite direction of interest rates. So when rates go up, bond prices go down.
• Now let's define a term that relates to bonds: duration. Here's where I promise not to get technical, because to explain duration would require calculus, and I'm not going to do that to you. Just accept that the duration of a bond is, in general, both a measure of time and a measure of price sensitivity. More specifically, the longer the duration of a bond, the longer you (the investor) have to wait to get your cash flows back from the bond (interest and principal payments). A ten-year bond will have a longer duration than a two-year bond. Pretty simple. Also, remember that we said bond prices go down when rates go up? Well, the longer the bond's duration, the more its price will go down for a given increase in rates. So if rates go up, say 450bp in a year (wink, wink), a ten-year bond will go down in value by much more than a two-year bond, because the ten-year bond has a longer duration. That wasn't so hard, right?
• Next, let's take that same concept and apply it to a bank's entire bond portfolio. We can calculate the weighted average duration of the entire portfolio, but what's important is that the same principle applies: the longer the duration of the portfolio, the more it will decline in value for a given increase in rates. What's the lesson here? In a rising rate environment, you want to keep your portfolio duration short.
• You can manage the risk that your portfolio value will fall as rates rise through hedging. This is most commonly done using instruments called interest rate swaps.
• There are different accounting treatments for bank investments. One is called Held-to-Maturity, or HTM. If you use this treatment, you can carry the investments on the books at their historical cost, rather than "marking them to market," or writing down the value as it declines in a rising rate environment. That allows you to effectively overstate the value if rates fall. (It would be like looking at your IRA balance as the price you paid for the investments in it, rather than the current value.) The caveat is that you have to be able to actually hold the bonds until they mature. If you sell just one bond that's classified HTM, you "taint" the entire portfolio, and have to immediately adjust the value of all your investments to the market value, which is an immediate hit to the value on the books. The alternative is to classify investments as Available-for-Sale, or AFS. Under this treatment, you have to mark the bonds' value down to the market value as prices fall, but you can sell any bond at any time, for any reason - say, to raise liquidity. Most institutions - in fact, all of my clients, as far as I know - classify their investments as AFS, both for liquidity purposes and to afford them maximum flexibility in managing the portfolio, in the event they ever want to reposition it to, say, adjust portfolio duration as rates change. (Imagine not being able to sell any of the stocks or funds in your IRA without some kind of onerous penalty that would affect the entire portfolio.)
• One final thing: under either treatment, the difference between what you paid for a bond and what it's worth now (assuming the value has fallen) is called the "unrealized loss" (actually, that's true for any investment). The loss is "unrealized" because it's only on the books; it wouldn't become realized unless you actually sold the investment at that loss. Banks have to report their unrealized losses.

Okay, I believe we've set the stage sufficiently to be able to talk about exactly what happened with SVB and Signature, and what's going on with Credit Suisse and First Republic. Let's look at each in turn.

SVB

Here were the problems with SVB, in no particular order:

• For roughly the two years prior to the time SVB was taken over, the bank had no Chief Risk Officer. This is unfathomable - it's beyond comprehension. For one thing, they had had a CRO prior to that - why they didn't have one subsequently, I have no idea. Most banks with at least a couple billion in assets have a CRO. And some of the responsibility is on their regulator, because regulators are usually on the backs of large financial institutions to have a CRO and a strong risk management program in place.
• They were heavily concentrated in loans to the tech sector, which, as mentioned above, ran into difficulty in 2021. Moreover ...
• Their deposits were also heavily concentrated in the tech sector. Big global tech firms accounted for a lot of their deposits, as opposed to individual depositors like you and me. In fact ...
• 94% of their deposits were uninsured. Let me repeat that: 94% of their deposits were uninsured. This means the deposit amounts were above the FDIC's $250,000 insurance limit. These deposits were held by huge tech firms like Roku, among others, which had $487 million on deposit with SVB. That's more than 25% of Roku's total cash.
• It gets better. They were hedging their interest rate risk with swaps in 2021, but ... they stopped hedging in 2022 - the same year that rates went up 450 basis points. In other words, when they didn't need to hedge against rising rates, they were, and when they desperately needed to, they stopped.
• Why did they "desperately" need to hedge, besides the fact that rates went up 450bp? After all, not all financial institutions hedge against interest rate risk. Well, SVB's average investment portfolio duration was .. SIX YEARS. I'm not sure I've seen a depository institution with an average duration of six years, at least not since the S&L crisis. I'd guess my clients' average duration is a third of that. Given that SVB's loans-to-deposits were less than 50%, most of its balance sheet was in investments, and those investments were highly sensitive to interest rate risk, and interest rates went up by almost 5%, and they had stopped hedging, so they had massive unrealized losses, and ...
• Nearly the entire portfolio was classified Held-to-Maturity. So that's fine if they don't ever have to sell a bond to raise liquidity. But ...
• During the week leading up to March 10, SVB's big depositors started withdrawing funds, and the bank faced a liquidity crisis. They had no alternative but to sell their $21 billion in AFS investments at a massive loss. Unable to sell bonds out of the HTM portfolio without tainting the entire portfolio, which would have resulted in having to realize the full decline in market value on the portfolio, they tried - and failed - to raise over $2 billion in capital. Word got out that the capital raise failed, which led to more withdrawals, which led to the DFPI coming in and taking over.
  

It's almost as if SVB's executive team had a crystal ball and in 2021 could see the coming trifecta of sharply rising rates, a liquidity crunch, and a decline in the tech sector, and they gathered in the board room and said, "Let's write a Harvard Business School case study on how, in the face of all that, to completely destroy a bank." Then they set about doing it.

Signature Bank

This one's pretty simple:

• They had exposure to FTX.
• They made loans to other crypto exchanges, which were hurt when FTX imploded.
• They also had somewhat of a concentration in taxi medallion loans. Those loans were solid gold for a long time, as NY taxi medallions only went up in value forever. Then along came Uber, and in two short years, the value of taxi medallions collapsed. Several large NY banks and credit unions specialized in taxi medallion loans, and had large concentrations in them. All of those institutions have been seized by their regulators. I was scheduled to do a risk management program implementation for one of them. I had all of my travel booked, and was set to go. About a week out, on a Friday afternoon (that's when most takeovers happen), the news hit the trade press that they'd been seized by the regulator. So much for that trip. I've had two other clients that bought portfolios of taxi medallion loans from that or other credit unions, and they ultimately had to write them off entirely.
• All financial institutions are trying to make it easier and easier for customers to access their money. As I like to say, money is a tool, and they want to make it easy for you to access the toolbox. (Of course, that opens the toolbox to fraudsters as well.) But that also means that you don't have to wait until Monday morning to withdraw all your money if you want to; you can do it on the weekend, from your couch, using your phone. You just open an account somewhere else, and transfer it there.

And that's what happened. Signature's depositors, knowing of the bank's crypto exposure and taxi medallion loan concentration, and having heard of the SVB failure, started pulling money out of the bank on Friday after the SVB news broke. The hemorrhage continued through the weekend until the NY regulator said, "No mas!" and stepped in on Sunday.

Credit Suisse

This one's simpler still: Credit Suisse's problems were almost entirely compliance-related, have been going on for some time now, and were relatively well-known. In fact, there were articles about them in the press in the days prior to the SVB takeover. Specifically, their issues were around improprieties in their financial reporting and disclosures. Now, that has led to liquidity issues, as they've been bleeding deposits for quite a while. And their largest investor, Saudi National Bank, recently declined to provide more capital, although that was due in part to the fact that it already owns 9.9% of Credit Suisse, and if its ownership stake goes above 10%, some pretty onerous regulatory requirements kick in.

However, Credit Suisse has secured funding from the Swiss central bank. To be sure, it remains a poorly managed crap-show of a bank, but its problems, as you can see, are entirely unrelated to those of SVB or Signature, other than the fact that it's just another poorly-run bank. (I can think of at least three or four poorly-run restaurants, but I don't run around saying there's a "systemic crisis" in the food service industry.)

First Republic

Also a simple case; First Republic's woes are due primarily to its geographic proximity to SVB. It also has a number of large tech customers, and 68% of its deposits are uninsured. So as the week progressed and the media/social media hysteria spread like wildfire, depositors started pulling money out of First Republic. In response, they secured funding from a number of their peers. That alone should tell you something: those other banks wouldn't touch First Republic with a ten-foot pole if they thought it was in the same league as SVB and Signature. But they gave it a vote of confidence.

***************

Thanks for sticking with me so far (assuming you have). By now, it should be readily apparent that these four situations bear no resemblance to one another, and thus this is not anything close to a "systemic banking crisis." Anyone who suggests otherwise is ... well, I'm going to be nice and refrain from using disparaging terms like "moron" and "idiot," and just say that anyone who suggests otherwise doesn't know baby poop from apple butter about the banking system. I'll come back to them at the end, bless their hearts.

Let's talk about Moody's, and the other ratings agencies. So Moody's downgraded the banking industry last week? Okay, fine. But Moody's also gave SVB an "A" rating - its highest bank rating - prior to the takeover. So how much faith can we really place in Moody's, and the other ratings agencies (Fitch and S&P)?

None. Moody's downgraded the banking system to save face because it had rated SVB "A" prior to the takeover. We learned in 2008 that Moody's, Fitch and S&P are nothing more than three very high-priced call girls, offering their wares to the highest bidder.

I "made my bones" in the world of mortgage finance, and I probably understand what precipitated the meltdown in 2008-09 as well as anyone. I've written and spoken about it extensively. And a huge part of the problem is that Wall Street firms would buy up subprime mortgages - loans that were almost certainly going to default - and package them into crappy mortgage-backed securities (MBS), collateralized mortgage obligations (CMOs), and collateralized debt obligations (CDOs), that were just as certainly going to default. Then they'd go to, say, Moody's, and tell them, "We need a Aaa rating on this bond issue (Moody's highest bond rating) in order to sell it. If you don't give it to us, we'll go to Fitch or S&P." And Moody's, which gets paid to rate bonds, would give it to them, often without even reading the details of the bond issue.

As for Kansas City-based UMB Bank, Moody's based its decision to place them on ratings watch on the fact that the bank has a "concentration of uninsured deposits" (it's nowhere near the levels of First Republic or certainly SVB), and that it has "an elevated level of unrealized losses." News flash, people: in this rate environment, every financial institution has an elevated level of unrealized losses. Remember, bond prices go down when rates go up. And rates have gone way up. So bond prices have gone way down. And banks buy bonds. So they have unrealized losses. UMB's unrealized losses are about 41% of its unadjusted equity. I've seen a lot higher in this environment. They'd have to face a massive liquidity crisis before they ever had to even think about selling bonds at a loss, and realizing those losses.

So what about this looking like 2008? Fox Business News apparently cited SVB's holdings of MBS, and on that basis said this looks just like 2008. (This isn't first-hand; I've been avoiding watching business news, because there isn't anybody on Fox Business News who knows an MBS from an MBA.)

There's nothing going on in the mortgage market that would make this look remotely like 2008. Yes, home prices have fallen for about the last six months. That was an inevitable correction, because home prices rose at an unsustainable pace for the 20 months prior to that, in virtually every market in the country. It was a housing bubble that was more widespread than the bubble of the early 2000s, which was largely concentrated in the "Sand States:" California, Arizona, Vegas, and Florida.

But the more recent bubble was very different. There was hardly any unsold speculative construction by homebuilders. All the new construction was sold before it was completed. There was no subprime lending; borrowers had to have sufficient equity to qualify for a conventional mortgage - in most cases, 10-20%. Appraisers weren't fudging values to match the amount needed to buy the home; if the price was above the true market value (which in many cases it was), the buyer had to put up more equity.

And even though prices have fallen and the bubble has burst, mortgage delinquencies are actually down, according to the most recent data. Foreclosures are below pre-pandemic levels.

CNN Business ran a graphic showing that SVB and Signature alone had a combined $319 billion in assets, which was almost as much as the $374 billion in assets held by the 25 banks that failed in 2008. What the morons at CNN failed to mention (sorry, I wasn't going to use that word) was how much bank assets have grown since 2008. Comparing 2023 assets to 2008 assets isn't apples-to-apples; it's apple seeds to apples.

You know how much SVB and Signature had in assets in 2008? Neither do I. My research only took me as far back as 2010. But in 2010, SVB had $15.66 billion in assets (vs. $209 billion in 2023), and Signature had $10.93 billion (vs. $110 billion in 2023). So in 2008, the two banks combined had less than $25 billion in assets. That's less than 7% of the total assets held by the 25 banks that failed in 2008. Two divided by 25 is 8%, so their asset size was less than the average bank failure in 2008.

(To address a couple of other media myths, Signature Bank's failure had nothing to do with the stupid videos its management made years ago. The videos were embarrassingly ridiculous, and probably a waste of money, but they didn't tank the bank. And no, this is neither Trump's nor Biden's fault. I won't even dignify that nonsense. The blame falls squarely on the shoulders of the banks' management teams, and to some degree on their regulators, who appear to have been asleep at the switch.)

One other note. One of my Facebook connections tried to claim that a bank takeover during business hours is unusual - his assertion was that it typically happens after hours. He also claimed that it's normal for the regulator to already have another bank lined up to acquire the failed bank, and that it's rare that the regulator has to act as receiver for the failed bank. He cited both of these "anomalies" as an indication that the SVB failure was an indication of a looming banking crisis.

He has no idea what he's talking about. A takeover after hours (or on a weekend, like the Signature seizure) is highly unusual. The regulators typically come in during the day on a Friday, so that they can inform management and the board that their services are no longer required, and so that they can inform personnel that their services will be needed, but that they will now be working under government leadership. Then, those personnel are required to spend the rest of the day working on various tasks like communications to depositors, valuation of assets, etc.

I know this from experience. The S&L I worked for that was taken over was seized on a Friday morning. I was at my desk when a colleague said that he'd heard a rumor that we'd been taken over. I went to a Bloomberg terminal and looked up "Franklin Savings Association," and found that the rumor was true (the regulator had issued a press release after meeting with the board). Just then, our receptionist came back to our area and told us that the regulators were in the office, and all staff were requested to meet with them. My group spent the rest of that day working on valuing the portfolio. If the regulator had come in after hours, none of us would probably have shown up for work on Monday, and the regulators would have had to do all the work themselves.

As for the notion that another bank would be waiting in the wings - imagine the regulators going to a group of banks and saying, "Hey, we're going to take over SVB on Friday. Anybody want to buy them?" You think that wouldn't get leaked? It's preposterously silly. I've never heard of a regulator having another bank lined up to buy a failed bank. A troubled bank, yes. A failed bank, no. Hell, during the S&L crisis, the regulators created a special agency just to act as conservator or receiver for failed S&Ls.

This is part of the problem. People who think they know more than they do get on social media and proclaim their expertise, and unfortunately some of their friends think that they do know more than they do, and believe them. Then people start pulling money out of their banks, and those banks start to face liquidity issues. And that can turn into a real problem, and it becomes a self-fulfilling prophecy. So if you're one of the people doing that, stop it, right now. It's bad enough that you don't know baby poop from apple butter; you're screwing around with other people's livelihoods. That's worse than being a mere moron or idiot.

So that's what going on in the banking system. In a word, the answer to the question in the title of the post is "Yes." Deposits in financial institutions are insured up to $250,000 per account. A married couple can actually have up to $1 million in insured deposits with one institution, by structuring ownership of those accounts between the two individuals, and jointly. (If you have more money to deposit than that, you can put it in more than one institution, and it'll be fully insured, as long as each account's balance is no more than $250,000.) And it is very, very unlikely that your bank is going to fail, because there is no systemic banking crisis on the horizon.

In fact, the FDIC made the decision to cover the deposits of even the uninsured depositors of SVB and Signature Bank. Of course, that sets a dangerous precedent, creates a moral hazard, and represents a massive inappropriate transference of risk. But that's another topic for another day. Probably tomorrow, or the next day. Stay tuned.