The Truth About the Banking System

If you watch the news, or are on social media (and I know you are, or you probably wouldn't be reading this), you've no doubt by now learned that there is a systemic banking crisis underway in the U.S.

Balderdash.

I know, I know - I said this more than six weeks ago, and now another "big" bank has failed, and you're thinking, "Aha! The Curmudgeon was wrong! The media was right!"

Now, I'm not saying I'm never wrong. But I can confidently say that there will never come a day when the media is right and I'm wrong about anything related to the financial system, because there aren't four people in the media who fully understand the financial system, and the vast majority of them don't know a liability from their ass(et).

I heard one pundit on one of the major cable news outlets say, "I don't believe in one-offs, and I certainly don't believe in three-offs." (Referring to the fact that three U.S. banks have now failed this year.)

Well, for the record, neither do I. However, consider this: there are more than 4,000 banks in the U.S. Some of them are poorly managed. Poorly managed businesses may fail. Heck, there are more than 600,000 restaurants in the U.S. and 30% of them will go out of business in their first year. So is there a systemic food service crisis in the U.S.?

Here are the facts (pesky as they are): since 2000, 564 banks have failed in the U.S. That's an average of about 25 banks per year. But it's heavily skewed by the financial crisis of the mid to late 2000s; 25 banks failed in 2008, 140 in 2009, 157 in 2010, and 92 in 2011. From 2012 through 2014, at least 18 banks per year failed, a residual effect of the crisis.

In 2018, 2021, and 2022, not a single U.S. bank failed. Three have failed thus far in 2023. Let's put that in perspective.

In 2020, four banks failed: one in February, one in April, and two in October. Also in 2019, four banks failed: one in May, two in October, and another in November.

Now, in October 2019, when those two banks failed in the same month, do you recall the media and every self-proclaimed financial expert on Facebook screaming at the top of their lungs about a systemic banking crisis? Then redoubling their squawking when yet another bank failed the following month? Then another just three months later, and another two months after that?

The horror.

The fact of the matter is, banks are businesses, and some businesses fail. Three failures out of an industry of 4,000 institutions is a very good track record. Yes, banks are different in that they hold your money. That's why we have deposit insurance. No depositor lost a dime in any of those failures since 2000. In fact, no depositor has ever lost a penny of insured deposits since the FDIC was created in 1933. (You and I, the taxpayers, have seen to that when there's been a crisis, and fortunately those have been very few and far between.)

"But," you say, "it's not just these three banks. The media is saying that there are more banks that could fail."

First, if you haven't learned by now that the media's job is to scare you, with hype and hyperbole, or that they don't have the first foggy notion of what the financial system is all about - well, I can't help you. Look up; somebody painted "gullible" on the ceiling.

Second, yes, there is a list of "problem banks." Guess what? There always has been. The FDIC maintains a list of banks that are rated 4 or 5 on its five-point "CAMELS" rating scale, 1 being best and 5 being brain-dead. (CAMELS stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity, and interest rate Sensitivity.) I personally saw the list that the savings and loan regulator maintained back in the late '80s when I was an S&L examiner.

Regulators examine the banks, and rate them on those factors. Do they have enough capital to absorb anticipated and unanticipated losses? (In my current job, part of the analysis I perform for my clients is to calculate their capital adequacy in a near-worst-case, 1 in 20 years loss scenario.) Is their asset quality high (meaning, are the loans they make going to repay, or are a large percentage of them likely to default due to poor underwriting and credit management)? Is their management team strong? Do they have sufficient earnings to build additional capital and remain viable? Do they have enough liquidity, including access to contingent liquidity sources (like borrowing from the Fed or other sources, issuing deposits to non-customers through brokers, selling assets, etc.) to ensure they meet ongoing demands for deposit withdrawals and loan growth? And finally, is their balance sheet structured such that they won't incur significant losses - either realized or unrealized - due to interest rate fluctuations?

The C, A, E, L, and S components are largely about risk management, and that's what I advise financial institutions on for a living. And I can tell you that the trends I'm seeing in risk-adjusted capital adequacy and asset quality (loan delinquencies and charge-offs) are sufficiently strong that no one should be losing sleep. And that's across a fairly broad cross-section of clients, from coast to coast and from Texas to northern Ohio. I'll get back to the trends in earnings, liquidity, and interest rate sensitivity momentarily.

The chart below shows the number and combined total assets of banks on the FDIC's "problem bank list." It only goes through 2021, but you get the trend.

We are not spiking back up to 2009 levels this year - not even close. At the end of 2022, there were 49 banks on the list; it actually declined to 46 as of March 31, 2023. Total assets of those institutions on the list were $49 billion. A year ago, there were 54 banks on the list (March 31, 2022).

Now, let's note a few things. First, just because a bank is on this list doesn't mean they're going to fail. They may get new management and come out of the problem situation(s) that landed them on the list to begin with. (That management change may be by their own choice, or forced upon them by the regulator.) Or, they may merge with another, healthier institution that can absorb the problems (the benefits the acquiring institution gets include an expanded customer base, maybe an expanded branch footprint, and possibly additional capital, even if it's meager). There's another way that a bank may come off the list and move up in the CAMELS ratings. I'll address that after we discuss earnings, liquidity, and market sensitivity.

Second, the 46 banks that are on the list today is a number about equal to the 51 that were on the list in 2021, per the graph above. So we're not trending upward in terms of problem banks. In fact, the graph shows that that number has been stable since late 2018, fluctuating between 51 and 60, and much lower than in previous years.

Bank balance sheets today are as strong as they've ever been. Tier 1 capital - core or primary capital that is the foundation of a bank's strength - is higher now than it was a year ago, and since 2020 Q2 it's been above 14% of risk-weighted assets. From mid-2013 through early 2020, Tier 1 capital never got higher than 13.4% of risk-weighted assets. So the banking industry is in a stronger capital position today than it's been in the last ten years. (And note that the denominator is risk-weighted assets, meaning that the value of those assets has been adjusted for their risk according to a formula. So the Tier 1 capital ratio is already adjusted for risk.)

What about asset (loan) quality? The delinquency rate on all loans for all commercial banks in the U.S., aggregated, was 1.19% of total loans at the end of 2022. In other words, 1.19% of borrowers were late on their payments. (That doesn't necessarily mean that those loans will have to be charged off, either. The borrowers may become current on their loans, there could be timing differences in the payments vs. the due date, or the banks may restructure the loans so that the borrower can meet their obligation without default and charge-off. Also, since residential and many commercial loans are collateralized by real estate, the bank can foreclose and sell the collateral. Even with real estate values declining over the last several months, in many cases the lender could make a profit by charging off the loan balance and selling the house, which is probably worth much more at this point than what's owed.)

To put that 1.19% delinquency rate in perspective, it was 7.40% at the height of the 2008-09 financial crisis, and it was 1.60% in late 2020, coming out of the pandemic shutdown. In fact, 1.19% is the lowest delinquency rate for bank loans since the data has been reported, beginning in 1985.

The charge-off rate on bank loans (balances charged off divided by the average balances of loans on the books) was up a bit as of the end of 2022; it was 0.33% of average loans, vs. 0.19% at the end of 2021. That's not a big increase; again, for perspective, the charge-off ratio was 0.55% in mid-2020, and it's currently lower than it's been at any time since 1985, except for the previous seven quarters.

Yes, I know; those are year-end 2022 numbers, and this is 2023, and three banks have failed. So you're thinking there's been some massive spike in bad loans since the end of last year, right? Well, think again. I just finished reviewing the 2023 Q1 financials for all my clients, and the trend I'm seeing is a slight increase in the charge-off ratio (and by "slight," I mean very, very small), but a decline in the delinquency rate.

How can that be, you ask? How can delinquent loans be declining at the same time charge-offs are increasing? Easy - first, there's a lag between a loan becoming delinquent and when it gets charged off. The lender first exhausts all efforts to collect, or restructure the loan so the borrower can become current. Then, if it's a secured loan, they have to repossess and sell the collateral. Only after they've recovered that amount would they charge off the remaining balance, and even then they may send it to a third-party collector to try to recover the funds, in which case at some future date the recovered amounts would offset that period's balances charged off. It takes even longer to foreclose on a house and sell it; in some states the law requires the lender to wait two years before they can foreclose. So today's charge-offs might be the result of loans that went delinquent as much as two years ago.

Finally, there were a number of forbearance programs put in place during the pandemic to prevent lenders from placing borrowers in default status, foreclosing on real estate, and charging off loans. (Brilliant, right? The government shuts down the economy, forcing tens of millions of people out of work. Then, because they can't make the payments on their loans, the lenders have to wait until the forbearance programs expire to collect on the unpaid debt. And you wonder why banks get in trouble.) Those forbearance programs have finally expired, and so some of the charge-offs today represent loans that went delinquent in 2020, but were placed in forbearance.

Okay, it's time to talk about earnings, liquidity, and interest rate sensitivity. Those factors play into the reasons for the failures of the three banks that have been seized in 2023. Earnings are compressed for banks because of rising interest rates. This happens because, as rates rise, they have to raise rates on their deposits, the vast majority of which are demand deposits (savings accounts) vs. term deposits (CDs). So the amount of interest expense they have to pay on those deposits is going up.

At the same time, their loans are longer-term, and mostly fixed-rate. The average auto loan takes about three years to pay off (at which time the borrower either pays off the loan outright, or buys a new vehicle and pays off the loan with the sale of the original vehicle). Mortgages are even longer-term; the average duration of a 30-year mortgage is around ten years. So at the same time their interest expense is going up, most of their interest income is flat.

Let's look at examples. The rate banks pay on 3-month CDs has increased from 0.10% in September 2021 (on average) to 4.91% today. That's a huge increase in interest expense. Meanwhile, the average 30-year mortgage rate in September 2021 was less than 2.90%. So banks are paying nearly 5% on short-term deposits, and they're still earning less than 3% on mortgages booked before rates started going up.

And there are two things preventing them from replacing those 2021 mortgages with higher-earning mortgages (today's 30-year fixed mortgage rate is nearly 6.4%). First, nobody is prepaying those 2021 mortgages. Would you prepay a loan with an interest rate below 2.9%? You certainly can't refinance the loan (unless you desperately need to pull equity from your house, in which case you could just take out a much cheaper home equity loan). And second, there's hardly any demand for mortgage loans today, compared with the last several years. Nobody is refinancing, and home sales have fallen by about 30% since late 2021.

When the interest rates banks must pay on deposits is rising rapidly, and the interest rate they're earning on long-term assets is flat, that's known as a margin squeeze. And the result is a decline in earnings. So banks' earnings, in aggregate, are down compared with the last few years. They can't make it up with fee income, either; the trend in the industry is toward eliminating or drastically reducing most fees. (One of my clients, a large credit union, has eliminated about 70% of its fees over the last two years.) The decline in fees is driven in large part by concerns over actions being taken by the Consumer Financial Protection Bureau (CFPB) (an agency with no oversight, by the way) to assess massive fines against financial institutions for what it deems as unfair fees. And it makes those determinations with impunity.

Liquidity has also been a challenge for banks for the last year or so. From the top down, the Fed has pulled about $300 billion from the market by reducing the size of its balance sheet, after increasing it dramatically to stimulate the economy after the pandemic shutdown. On a more micro level, as rates have risen, depositors have pulled money out of banks and put it into higher-yielding money market funds, or into the stock market. At the same time, demand for loans remained strong through the end of 2022; while mortgage demand began to decline around mid-year, other lending types remained brisk. Many of my clients saw negative deposit growth throughout 2022, and record loan growth. For the credit union industry as a whole, just a small part of the financial institution industry, deposits only grew by 3.3% in 2022, the lowest rate since the 1980s, while loans grew by 19.1%, the highest rate over that same period. In dollars, deposits increased by about $61 billion from 2021, while loans grew by $244 billion. So the industry took in nearly $200 billion less than it lent out. That's a massive liquidity crunch.

Finally, sensitivity to interest rates is always going to be a challenge in an environment in which the Fed increases short-term interest rates by 500 basis points, or five percentage points, in about a year. That hasn't happened since the 1980s, either. The most recent round of Fed tightening (raising rates) has been the most aggressive in nearly half a century.

So those three factors have been a challenge for all financial institutions. Fortunately, the other factors - capital adequacy, asset quality, and management - have been, for the most part, strong enough to counter those challenges, and the industry as a whole is in a very strong position today.

That's not the case for every bank, however. Silicon Valley Bank was poorly managed, and was doomed to fail by its bad decisions, which included a failure to hedge its interest rate risk, which was excessive due to the way it structured its investment portfolio, and a huge concentration of very large uninsured deposits, which are more likely to lead to a liquidity crisis if those depositors start withdrawing their funds. That latter point also plagued Signature Bank. (Here's a recap of those failures: https://theeconomiccurmudgeon.blogspot.com/2023/03/is-banking-system-safe.html).

As for the most recent bank failure, First Republic, it too suffered from severe liquidity stress, and has been on the brink of failure since SVB and Signature Bank went under.

Are there more banks that will fail? Probably, as the trifecta of a margin squeeze, tight liquidity, and interest rate risk will prove to be the undoing of institutions that aren't well-managed (that's four of the six factors of the CAMELS rating system that would be negative, for those institutions). When rates were low and stable and liquidity was ample, those institutions were able to get away with bad management, and took on too much risk. They were incented to do so by the Fed slashing interest rates to zero, which wouldn't have been necessary (and probably wasn't anyway) if the government hadn't shut down the economy due to covid, which definitely wasn't necessary. So, just like the S&L crisis, this situation resulted from government policy.

The good news is that the vast majority of institutions are well-managed. So even though the three factors mentioned above are a challenge for the entire industry, they're not insurmountable.

I promised that I'd mention another way that a bank can move off the FDIC problem bank list after we talked about earnings, liquidity and market risk. And that's to just stay the course until conditions normalize. For many institutions, what put them in the position they're in has been this environment of rapidly rising interest rates and tight liquidity. So when those conditions normalize, those institutions' health will improve.

When will that happen? When we have a recession. The Fed will begin cutting rates, so rates will go down. Combined with home prices reverting to normal, which is already happening, that will make homes affordable again, and mortgage demand will resume. But first, loan demand overall will decline, since people generally avoid borrowing money during an economic downturn, due to uncertainty over their ability to repay if they were to lose their jobs. And savings balances will grow, as people exit the stock market and move their money into safer, insured deposits. So the liquidity crunch, the margin squeeze, and the interest rate risk will be resolved, albeit painfully for the broader economy.

All of this is likely to happen relatively soon, as I'll address in the next post. For now, let me make two final points.

First, many people might say, "Yes, only three banks have failed this year, but their combined assets are more than the total assets of banks that failed in 2008!" And why wouldn't they say that? The media is shouting it from the rooftops: "Recent bank failures eclipse 2008 levels!" (Never forget that the media sells hype, and that business journalists are, by and large, morons.)

As I noted in the post linked above, we need to consider asset growth since 2008. Yes, SVB, Signature Bank and First Republic, when seized, had combined total assets of over $548 billion. And yes, that's more than the $374 billion in assets of the 25 banks that failed in 2008. However, to compare apples to apples, we have to look at how large the three banks that have failed this year were in 2008. The answer: less than a combined $47 billion in assets. That's only about 12.5% of the magnitude of the bank failures in 2008. Not one of those three banks was as large in 2008 as the two largest banks that failed that year - not even close.

My final point is this: if you believe that social media hasn't played a role in this year's bank failures, you're a Pollyanna. With the advent of meme stocks and APE investors (you know, those people who think that companies like GameStop and AMC are great stock buys, and actually think they understand the financial markets), there are a lot of people slinging around opinions on Facebook as if they knew what they were talking about.

Simply put, they don't.

Some of them are my friends, and I just have to shake my head and chuckle at how ill-informed, and just plain wrong, they are when they opine about all things financial. (I'll address another such fallacy in my next post.) That stuff spreads like wildfire, and their equally ill-informed friends gobble it up, because, "Gee, Jim's a smart guy, he must know what he's talking about, he works for a bank, after all." (Never mind that Jim works in HR or IT, and doesn't really understand how interest rates move, or how markets work.) So the friends share those posts with their friends, who ... you know how it works.

Twitter, in fact, is known to have led to the run on deposits at Signature Bank. Not that Signature didn't deserve to fail, but the deposit run wouldn't have happened without social media.

Here's all the proof you need that social media has played a role in spreading fear over an imminent banking crisis, and leading to unnecessary deposit withdrawals that threaten to turn those dire - if wrong - warnings into self-fulfilling prophecies:

The only place I've seen the claim that social media didn't contribute to any of these bank failures, is on social media. Let that sink in.

A New Airport for Kansas City

Having read a number of critical reviews of the new Kansas City International airport by people who had not been to see it, had not been dropped off or picked up there, had not parked there, and had not taken a flight from or to the new airport, I decided to keep my powder dry, and wait to comment on the airport until I’d actually experienced it. See, I prefer to provide an informed opinion vs. an uninformed one (I know that makes me about as rare a commodity on social media as a blue lobster in the ocean).

So having taken my first flight out of the new KCI today, herewith is my review. For context, this comes from a guy who spent about 17 years of his career traveling 100 days or more a year, and has traveled extensively for pleasure, including internationally. I’ve flown in and out of about 100 U.S. airports, from Atlanta and O’Hare to Lihue and Elmira, and 15 international airports, from Heathrow and CDG to Marsh Harbour, Abaco and Blantyre, Malawi.

Warning: this will be a lengthy review, because I want to address the criticisms that have been leveled against the new airport in some detail. Change is hard; I get it – especially for us Midwesterners. Anyway, here goes.

First, the approach to the airport. I drove myself, and parked in the garage. The signage was good – there have been complaints that the signs directing people to the cell phone lot were unclear, and that’s why people didn’t use it, and instead drove to the terminal and parked by the curb to wait for their disembarking passengers.

Hogwash.

The signs directing people to the cell phone lot were clear, and well in advance of the lot. They even named the exit to take (Paris Street). It’s just that we Kansas Citians aren’t used to having a cell phone lot to use to wait for deplaning passengers. Well, welcome to the 21^st  century, Kansas City: other airports have had cell phone lots since at least 2015 (that’s when I first used one, and I figured it out).

I drove straight to the parking garage, and didn’t get lost once. There were numerous entry kiosks, not just the four that the old KCI garages had. The kiosk instructions were clear: I didn’t have an account, so I requested a printed ticket, and got one. There’s signage to tell you which levels are full, and which levels have spaces, and how many. This is where the one glitch popped up.

The sign said Level 5 had 5 spaces. Being fundamentally lazy, I decided to grab one of those spaces, instead of driving on up to Level 6, which had over 160 empty spaces. (I will say that, once you exit the ramp and enter a level, there aren’t good directions for how to get back to the ramp, but if you just remember which end of the garage it was on, it’s easy to find your way back to it – much easier than the garage at the old KCI, which was something of a maze.)

There are red and green lights on the ceiling to indicate where the empty spaces are in each row, which is pretty cool. So I drove down the rows until I spotted a green light, and turned down that row, and drove to the green light. Unfortunately, the “empty” space had an orange cone in it, and a sign saying they were doing some construction. Apparently the sensors that detect a car in a space, thus turning the light from green to red, won’t detect a plastic orange cone. So that needs some work.

So, I drove my lazy self up to Level 6, where I easily found an empty space, and parked in it. I walked to the bank of elevators. The levels were clearly marked – Level 3 for departures, which is what I needed – so I got on the elevator and went to that level.

For what it’s worth, the drop-off lane was operating smoothly. The early criticisms were related to long lines in the drop-off and pick-up lanes, but I saw none of that in the drop-off lane. And besides, those long lines had nothing to do with problems with the airport’s design. They were a function of the simple fact that we Kansas Citians do not know how to drive.

Doubt me? Try to exit I-435 onto Metcalf Avenue and seamlessly merge into traffic. You can’t, because the people in front of you drive to the end of the exit ramp and … stop, waiting until there is no traffic. Or try to execute a “zipper merge” when there’s a lane closure a mile ahead. (Most of you reading this don’t even know what a “zipper merge” is.) The majority of Kansas Citians see a sign that says, “Left lane closed one mile ahead,” and they immediately get in the right lane, causing a mile-long traffic jam.

The new KCI has arrivals on the lower level, where baggage claim is, and departures one level above, where the ticket counters are. This is how nearly all modern airports are designed. Sure, third-world airports are on one level, as are tiny airports in places like Elmira, NY, with its eight gates, or Beef Island, Tortola, where you deplane your prop-jet plane onto the tarmac and walk into the terminal. Or even some larger airports, like Mineta in San Jose, a sprawling one-level terminal. But those are the rare exception. (And Mineta is a hot mess if you’re returning a car, unless you like driving around in circles. Mineta was also built before Silicon Valley exploded into the mega-metropolis it is today.)

So part of the problem with the new KCI is that, right after it opened, people dropping off passengers were driving to the arrivals level, and people picking up passengers were driving to the departures level, and it was a zoo. Plus, a mile before the terminal, everybody was getting into the right lane, even though there’s signage that clearly says you can use two lanes to drop off or pick up your passengers, causing that mile-long traffic jam that Kansas City is as famous for as its barbecue.

You can’t really fault them for thinking everything was on one level; that’s the way the old KCI, with its archaic, third-world design, was laid out. As for getting in the right lane a mile early – well, that’s just Kansas City driving at its worst.

The other problem, especially with picking up passengers, was that people were parking at the curb and waiting for their passengers to exit the terminal, instead of using the aforementioned cell phone lot. Well, what if your passenger’s plane is delayed? What if they forgot what their bag looks like? (Believe me, it happens – a lot.) So they sit there at the curb, and no one else can get to the passenger pick-up area.

A big part of the blame for this lies at the feet of bad management of the old KCI. At virtually every other airport in the U.S. – probably the world – those people would have been chased off by security, and/or ticketed. Because, since 9/11, that’s a significant security risk. Imagine a car full of C4 (that's explosive material) parked outside a busy airport with a suicide bomber behind the wheel. Not a pretty picture. However, here in Cowtown, airport security let people just sit at the curb as long as they pleased, waiting for their passengers to show up.

Well, security at the new airport has finally decided that the grace period is over, and they’re going to start ticketing those folks. That’s a good thing – it’s safer for all of us. And it’s how the real world works.

So, the bottom line is that these dropping off/picking up/parking snafus are largely resolved, and will be completely resolved when we Kansas Citians 1) learn how a real, first-world airport operates and is laid out, 2) get ticketed to the point that our behavior changes (negative reinforcement works – ask your mother if you don’t believe me), and 3) finally learn to drive like the urban dwellers that we are, instead of a bunch of country bumpkins.

I may not live to see that last one.

On to the interior of the airport. In a word, it’s beautiful. Other words would be spacious, clean, and modern. The concourses are wide. No more feeling like you’re in a cattle pen in the 4-H barn, like the old KCI. The restrooms are clean. No more feeling like you need a shower after you use them. There’s actually more than one urinal in the men’s restrooms inside security! And there’s an electronic sign outside the restroom indicating how many stalls are vacant.

There are plenty of check-in kiosks. (I can’t speak to their efficiency; I didn’t use them, as I carried on my bags.) The security lines were efficient, though I have to admit I used TSA Pre-check. There was the usual confusion due to passengers going to the Pre-check line, not understanding that they didn’t have Pre-check, and then having to be redirected to the regular security line, but that happens with people who don’t fly much.

And … the new KCI has Clear, and Global Entry! Just like a real airport! I understand you can even apply for Global Entry at KCI now, which is huge. (Google it if you don’t know what I’m talking about.)

I ate breakfast before I left for the airport, so I didn’t get to sample any of the food offerings, but there was ample choice, and when I return home, I’ll hang around and have dinner there. There is barbecue, local Chinese (Bo Lings – if you know, you know), pizza, a salumeria, Shaq O’Neill’s chicken place, and plenty more. And it didn’t look like there was a lack of staff to serve customers, which had been another complaint. There were no long lines at any of the concessionaires.

One thing that I thought was cool: I stopped into a gift shop to get a bottle of water, and there were two people in line in front of me. The clerk let us know that there were self-pay kiosks we could use to check out with a credit card, and I used that. Very efficient. (For those of you who insist on a live person checking you out when you make a purchase, I can’t help you, other than to advise that you allow a little extra time in case there’s a line. For the rest of us, technology is a beautiful thing.)

I did check out the inclusive play area, and as the grandfather of an autistic child, I have to say it was nothing short of cool, and unlike anything I’ve seen in any of the 100+ airports I’ve been in.

The free wifi didn’t require signing in to a Boingo hotspot or sitting through a 30-second ad, which I appreciated during my layover in St. Louis, where I had to deal with both of those minor inconveniences. (In fact, St. Louis airport felt dated and tired by comparison, and the food was bad.)

Also, FYI, it took me an hour and 20 minutes to get from my home in south Overland Park to my gate, including buying said bottle of water and a nature break, and my gate was about as far from the entrance to the airport as it gets. (And that includes my sojourn through parking Level 5.)

One other thing that was very cool: the jetways are clear glass, so as you’re boarding (or deplaning), you have an open view of the airport around you, and the planes. I didn’t realize what a big deal that was until I boarded my connecting flight in St. Louis, where the closed jetway felt claustrophobic by comparison.

I may post a follow-up on my arrival/deplaning/dining/departing experience. I won’t be able to comment on baggage claim (and I may never be able to do that, since I’ve become an avowed carry-on traveler). I may Uber to the airport on my next trip, which will be in a few weeks, so if there are any snags with ride-share drop-off/pick-up, I’ll note that as well. I’ll probably never be able to comment on long-term parking as I’ve always either parked in the garage, or used Uber or a car service when traveling to the airport.

I had expected that the new KCI would be comparable to maybe Dallas Love Field, or Austin before it got so overcrowded. (I read one comparison, based on no experience actually using the new KCI, with Sea-Tac. Let me just say that the new KCI’s design in no way resembles Sea-Tac, and I’ve flown in and out of that airport more times than I can count.)

The bottom line is that, in all the airports I’ve flown in and out of, I can’t think of a comparable one. The new KCI is truly unique, and in a very good way. Where the old KCI – which I dubbed “the Continental bus depot of airports” – was among my least favorite airports in the world, the new KCI is already among my favorites. Considering that it’s my home airport, that’s a very good thing.

Of Deposit Insurance, Bailouts, Precedent, Unintended Consequences, Moral Hazard, and Risk Transference

Wow, that was a mouthful. Even for me. Now that we're clear on just what happened with SVB and Signature Bank, let's talk about the topics in the title of this post.

First, deposit insurance. Nearly all banks, savings banks, and credit unions have federal deposit insurance, either through the Federal Deposit Insurance Corporation (FDIC), which insures bank and savings bank deposits, or the National Credit Union Association (NCUA), which insures credit union deposits. (Back before the S&L crisis, there was a third insurer, the Federal Savings and Loan Insurance Corporation, or FSLIC, but it's defunct now, and savings banks - the survivors of the S&L industry - are insured by FDIC.) FDIC and NCUA are government agencies. They're also regulators.

I said "nearly all" financial institutions have federal deposit insurance, because a relative handful of institutions have private insurance, but that's becoming increasingly rare. American Share Insurance (ASI), one such private insurer, insures the deposits of about 100 of the nation's 4,000-plus credit unions. ASI is not a regulator, but it is regulated and audited, and is supervised by credit union regulators in the states in which it operates.

(Although I've spent my career serving credit unions, I'm going to use the term "bank" throughout this blog post, because it's less cumbersome than typing "banks and credit unions," and because "bank" has four letters and "credit union" has 12, including the space. Sorry, credit unions, but I'm lazy. I still love you more, and I encourage readers of this blog to do business with a credit union.)

Bank deposits are insured up to $250,000 per account. A married couple can get creative, and hold up to $1 million in deposits with a single bank, fully insured, through structuring the ownership of the accounts between the two of them. Ask your bank for details. Naturally, you could have even more in insured deposits by spreading your money among different banks.

Now, let's talk about the history and purpose of federal deposit insurance, then we'll look at who pays for it. There's probably nobody reading this who lived through the Great Depression. My parents did, and I've heard their stories. And I've studied the economics of that period extensively. The crash of 1929 devastated the financial system. It made 2008 look like a stroll in the park. The suicide rate among bankers and Wall Street executives was high. Millions of people lost millions of dollars, and those were 1929 dollars; a dollar in 1929 would be $18.15 today.

Among the many reforms in response to the collapse of the banking system that took place in 1929 was the creation of the FDIC and federal deposit insurance, which was implemented on January 1, 1934. The initial deposit limit was $2,500.

This is a critically important point, and one that I'm going to be coming back to, so if you weren't paying full attention to the last paragraph, go back and re-read it now.

Deposit insurance is funded by the banks whose deposits are insured, not by the taxpayers. Sort of. Banks pay into the insurance fund, and when a bank fails, the fund covers the insured deposits. It does NOT cover the stockholders or the bondholders. When you buy stock or bonds, you assume the risk of your investment, and nothing insures that you'll get your money back. Everyone is supposed to understand that when they invest in stocks and bonds. The insurance fund is also not supposed to cover the uninsured deposits, for similar reasons. We'll talk more about that.

Why was deposit insurance put in place in the first place, and why was the limit set at $2,500?

Unemployment in 1929 was 3.2%, not too different from where it is today (3.6%). By 1933, it was nearly 25%. Think of it: a quarter of the U.S. labor force was out of work (and not just for a couple of months, as was the case when the COVID shutdown pushed the jobless rate to nearly 15%, but for the entire year). The average household income was $2,300 per year in 1929; by 1932 it had fallen to $1,500. Virtually everyone's savings was wiped out, because there was no deposit insurance, and ...

4,000 banks failed in 1933 alone. A total of 9,000 failed during the decade.

Compare that to the 25 that failed in 2008, and you see why there's no comparing the two crises.

Now, in 1929 the average family probably had less than $1,000 on deposit in a bank (I say "probably" because the data is scarce, but there's enough for me to make an educated estimate; if my Dad were alive, I'd ask him). The wealthiest income decile (what we'd call "the 10%" today), probably had at least ten times that amount, maybe $10,000 or more.

When FDR put together the New Deal, creation of the FDIC and deposit insurance was a part of it. And FDR - a Democrat, and a pretty liberal one at that - was primarily interested in protecting the small depositor, the average American family. He knew, being a very wealthy man himself, from a very wealthy industrial family, that the rich can take care of themselves; they can effectively self-insure. They take their own risks, and are expected to live with the consequences of those risks - and are entitled to reap the rewards.

So it isn't surprising that FDR's administration set the initial deposit insurance limit at $2,500 per account. That probably would have covered more than 100% of the deposit balance held by 90% of the families in the U.S. in 1929, before the crash, and it probably would have covered at least a fourth of the balances of the wealthiest 10% of American families in 1929. (The rest of them would have been assumed to be financially savvy enough to either divide their money into at least four different banks such that their full savings total would be insured, or they'd invest some of the money in riskier assets - at least at some point, after the Great Depression ended. In any event, they'd be expected to be able to weather the consequences of their own risk-taking, given their relative wealth.)

Today, the deposit insurance limit, as noted above, is $250,000 per account. Makes sense, you say; inflation, right? Well, I agree in concept. As inflation has increased, the amount of protection that the average family of average means should be afforded by deposit insurance should increase - by the inflation rate. So let's examine what that would look like.

There are various inflation calculators on the internet. The Federal Reserve Bank of Minneapolis has one; it goes back to 1913, although it only goes as far as 2022. However, we can extrapolate from 2022 to 2023 using the most recent year-over-year inflation data. So if we plug in the $2,500 federal deposit insurance limit that was in place in January 1934 - again, designed to protect average American families' bank deposits - and look at what that amount should be today, given inflation over the ensuing 89 years, today's deposit insurance limit should be ...

$58,195.46-. That's a lot less than $250,000, isn't it?

So who is federal deposit insurance protecting today? Well, let me ask you this: do you have $250,000 deposited in your bank? I sure don't. Do you know anyone who does? If you do, they're pretty well off, right? They're probably in a position where they can take their own risks, and bear the consequences if they take on too much risk - and they also probably reap the rewards for the risks they assume.

I actually know quite a number of investors who regularly deposit $250,000 in banks. They're credit unions. That's right, institutional investors, not individuals. Instead of buying bonds for their investment portfolios, they sometimes buy bank CDs. They'll put a few million dollars in bank CDs, with not more than $250,000 in any one institution so as to ensure that their entire CD portfolio is fully insured.

Now, they're in the business of managing risk. They normally buy bonds, which are subject to market value declines - and, in the extreme case, to default. So why should institutional investors be entitled to deposit insurance? That's not who it was intended for when it was conceived back in 1934.

That excess insured amount - in this case, about $191,805 per account - comes at a cost. To find out who pays the tab, read on.

As mentioned above, banks pay deposit insurance premiums to ensure there's enough in the insurance fund to cover the occasional bank failure. In so doing, they self-insure the industry. (It's not unlike you and me paying homeowner's insurance premiums; I may never need the coverage, but if my neighbor's house burns down, my premiums help provide the coverage needed to pay the claim. If my house burns down, my neighbors' premiums cover my claim. Either of us may pay premiums for the entire time we own our homes, and never have a claim. Likewise, a bank may pay deposit insurance premiums forever, and never fail.)

However, banks are a business. And like any business, they pass along the cost of doing business to their customers. Require restaurants to provide their workers with health insurance? Fine, but they're going to charge you more for a meal. Raise the minimum wage? Okay, but your groceries and other costs are going to go up, because businesses are going to pass along the higher wage and benefits costs to you, the consumer.

Charge banks an insurance premium to offer deposit insurance to protect depositors? All well and good. But they're either going to raise fees, or pay less interest on deposits, to cover the cost of those premiums.

And here's the most important point: increase the deposit insurance limit to offer greater protection for depositors? Okay, but you're going to need a larger balance in the insurance fund, to cover those depositors in the event of a bank failure. To build up that larger balance, you're going to need to increase the premiums you charge banks for deposit insurance. And if you increase banks' deposit insurance premiums, they're going to either increase fees, or take a larger haircut off the rates they pay on deposits.

It's like that children's book, "If You Give a Mouse a Cookie." A higher deposit insurance limit => larger insurance fund balance => higher deposit insurance premiums charged to banks => higher fees or lower interest rates for bank customers.

Fine, you say. If that's the price we as depositors must pay in order to be protected, so be it. Except ...

The proportionate burden of paying for deposit insurance, as borne by bank customers, is regressive. Let me explain.

Banks charge a number of fees. They charge maintenance fees just to have an account open. They charge fees if you overdraw your account. They charge fees for certain transactions.

Now, you can get those fees waived. How do you get them waived?

You carry a larger minimum balance. That's right - the largest depositors (those who receive the greatest benefit of high deposit insurance limits) benefit the most from those fee waivers, and thus the additional cost of that deposit insurance isn't passed along to them. It's borne by those who only need a much smaller amount of deposit insurance - say, about $58,000 or so; what the limit would be had it just been adjusted for inflation since deposit insurance was put in place in 1934.

In other words, the people who only need a relatively small amount of deposit insurance are paying the excess premiums for those who are enjoying the benefits of excess deposit insurance up to an amount that the smaller depositors will probably never accumulate.

Banks also pay interest. But they don't pay the same interest rates to all depositors. Some depositors get higher rates. Who gets the higher rates?

Depositors with larger balances.

Are you beginning to see the picture? Whether the banks pay for the excess insurance premiums through higher fees or lower interest rates, smaller depositors carry a disproportionate share of the burden, while large depositors enjoy all of the benefit by receiving all of the excess protection.

At the risk of channeling Jen Psaki, whom I'm sure we'd all just as soon forget, I'll "circle back" to deposit insurance and the limit toward the end of this post. But first, let's address how deposit insurance limits got so far ahead of where they should be given inflation.

The deposit insurance limit was doubled to $5,000 in June of 1934, just six months after deposit insurance was put in place. In 1950, it was doubled again, to $10,000, as part of the Federal Deposit Insurance Act. It was increased further to $15,000 in 1966, to $20,000 in 1969, and to $40,000 in 1974, as the U.S. economy faced multiple recessions in the 1960s and 1970s.

In 1980, it was increased to $100,000. According to the FDIC, "The increase to $100,000 was not designed to keep pace with inflation. Rather, it was in recognition that many banks and savings and loan associations, facing disintermediation in a high interest rate climate, had sizable amounts of large certificates of deposits (CDs) outstanding. The new limit facilitated retention of those deposits or replaced outflows from other deposit accounts with ceiling-free CDs."

In other words, the insurance limit was more than doubled, from $40,000 to $100,000, simply because there were a lot of depositors that carried large deposit balances due to high interest rates, and the FDIC wanted to help banks keep those deposits, rather than face disintermediation - withdrawal of funds in favor of other alternatives, like money market funds - and allow them to pay very high interest rates, which may have encouraged them to take excessive interest rate risk (and, in fact, was a contributing factor to the S&L crisis after the Depository Institutions Deregulation and Monetary Control Act of 1980 was passed).

Who held those $100,000 deposits in 1980? Well, the median family income that year was about $21,000, and the personal saving rate was about 11%, so the answer is probably only the very well-to-do. That means that the $100,000 limit didn't meet the original intent of protecting the average American family's savings; instead, it protected the wealthy, and as we discussed above, the cost was disproportionately borne by the average family.

Finally, in 2008, in response to the financial crisis, the limit was more than doubled again, to $250,000. Again, it protected large depositors - the wealthy, and institutional depositors (businesses and other financial institutions). And you can bet that when the next crisis rolls around, there will be another massive increase in the limit.

In fact, a friend told me that after the SVB and Signature Bank failures, he heard someone on a news show arguing that the $250,000 limit wasn't high enough. Who was making that argument? David Sacks, a tech venture capitalist and co-founder of PayPal, the kind of company that had millions of dollars deposited with SVB. Do you think perhaps his argument for a higher insurance limit was self-serving, and not in the interest of the average American family?

Okay, next, I want to talk about bailouts.

In discussing bailouts, I should mention that deposit insurance is, in essence, a "bailout before the fact." I'm okay with that in principle, since it's what deposit insurance was intended to do. But the higher the deposit insurance limit, the more risk the bank is encouraged to take, which creates a moral hazard. Set the limit too high, and the moral hazard becomes too great, and the bank takes on excessive risk, and makes bad decisions. Maybe that's why Silicon Valley Bank did some of the things it did.

When a bank does this, it's transferring risk to the other banks that aren't taking those risks, but are paying deposit insurance premiums ... except we now know that those banks aren't really paying the premiums, they're passing them along to their customers ... except we now know that they're disproportionately passing along the excess premiums, which we could also call the excess risk incentives, to their smallest depositors, the very people that deposit insurance is supposed to protect.

In other words, high deposit insurance premiums, in the event of a bailout, result in a massive transference of risk to small depositors.

It gets worse, however. As we now know (and it's happened way too often before), in the case of SVB and Signature Bank, even the uninsured depositors were made whole - in other words, they got an outright bailout. They were entitled to nothing under federal deposit insurance; the banks paid no premium on their behalf, and yet, they got the same benefit from the insurance fund as the insured depositors.

Why do I say "from the insurance fund?" Because that's where the bailout money came from! The government - FDIC, Janet Yellen, Joe Biden - all like to boast that it won't cost taxpayers a penny. (It actually will - more on that later.) But it will cost small bank depositors dearly, because in the case of SVB alone, 94% of its roughly $209 billion in deposits were uninsured, so the insurance fund has to cover about $194.5 billion of deposits that weren't entitled to one red cent of protection.

We saw a lot of this in 2008-09, and during the S&L crisis. Even worse, during those times, the failures were so widespread, the bailouts so prevalent, that the taxpayer eventually did have to pick up the tab for some of it, because the deposit insurance fund was insufficient to cover it all. (I'll talk more about that later, as well.)

So occasionally the taxpayer does have to pay, and in those cases, the risk is transferred to the taxpayer. But I'd say there's always some transference of risk to individual taxpayers. Why? Because banks pay income tax (credit unions don't - there's a very sound reason that I don't have time to explain in this post). And like most large organizations, big banks (the ones that would be most likely to cost the taxpayers money in the event of a bailout) avail themselves of loopholes that reduce their effective tax rate to a level much lower than you or I pay. Thus, if they ever do get bailed out, and it winds up costing the taxpayer, they've transferred their excess risk to the taxpayer.

It would appear obvious that the Treasury shouldn't be bailing out uninsured depositors, but their position in the case of SVB and Signature Bank is that these depositors are large corporations, and to not cover their deposits would undermine confidence in the U.S. banking system.

I'm going to throw the BS flag on that one. These are large corporations that make campaign contributions to the politicians who pressured Treasury to make the decision to cover those deposits, pure and simple. The only thing not covering their deposits would undermine is the confidence that, if they go ahead and deposit their money in another U.S. bank, and that bank fails, their uninsured deposits will be covered again. So they'll just keep depositing millions of dollars in a single bank.

In other words, we've set a precedent here, and as a result, de facto, there is no deposit insurance limit.

However, there is a limit on the premium paid into the fund. And that means that, sooner or later, when there is another systemic banking problem, the fund will be insufficient to cover all the deposits, and the taxpayer will pay the cost.

That is a massive moral hazard. What it says to large banks is, "Take all the risk you want. You're covered." What it says to huge corporations who want to be lazy and just park all their cash in one bank, rather than spreading it among different banks - or want to avail themselves of the same protections that the average American family enjoys, which was the original intent of deposit insurance, rather than assuming and managing risk, as huge corporations should be in the business of doing - is, "Go ahead and park your cash in one bank - all $500 billion of it, or whatever the amount. You're covered."

That moral hazard is the unintended consequence of the precedent set by bailing out uninsured depositors, which kind of sums up the title of this post.

Now, I mentioned that during 2008-09, and the S&L crisis, the insurance fund was insufficient to cover all the losses. Why, you may ask, would the Treasury set up an insurance fund that isn't enough to cover all the losses?

When Hurricane Katrina hit the Gulf Coast in 2005, the damage was far beyond anything ever anticipated or experienced in the region previously. And the insurance losses exceeded what insurers were able to cover, because their projections did not capture damage of the magnitude that Katrina wrought. That's why insurance companies now use hedging instruments related to weather events, buy reinsurance, etc.

Likewise, the insurance fund, as noted above, is set up to cover a "normal" expected level of losses, but not a crisis of the magnitude of the S&L crisis or the 2008-09 financial crisis, neither of which had ever been anticipated before. (I'd call them "once in a lifetime" events, except they both happened not only in my lifetime, but in my career.)

There are a couple of points to be made here. First, it would be prohibitively and probably unnecessarily expensive to set up the insurance fund to cover an absolute worst-case, S&L crisis or 2008-09 magnitude banking system event. The premiums would be very high, and that cost would be passed along to bank customers - again, disproportionately - and that level of coverage would only rarely be needed. It would be like property insurance companies charging premiums based on models that assumed a Hurricane Katrina-magnitude storm would hit the Gulf every year; nobody who lived there could afford insurance.

But this is the more important point:

The excessive level of deposit insurance creates a moral hazard that encourages the excessive risk-taking that results in these near-worst-case crises occurring every 20 years or so to begin with.

In other words, by setting the deposit limit so high, and by setting the precedent of bailing out uninsured depositors, and by setting another precedent that I'll address momentarily, banks are encouraged to assume outsized risk - in pursuit of outsized profits - that will eventually, when conditions are right (like a massive collapse in home prices combined with a lending model that required little equity and allowed questionable appraisals, as happened in 2008) result in a systemic banking crisis that will exceed the insurance fund's ability to cover it.

Since they do this in pursuit of outsized profits, they're actually transferring risk that should be borne by shareholders to depositors and taxpayers, yet another inappropriate transference of risk.

Now, what's that other precedent that I alluded to?

It's the concept of "Too Big to Fail." There is no magic threshold for TBTF, no minimum asset size. It's like the courts' definition of obscenity: "We'll know it when we see it." But we heard a lot about it back in 2008-09, when the government bailed out Washington Mutual, a $328 billion mortgage lender; Bear Stearns, a Wall Street firm that specialized in mortgage-backed securities; Lehman Brothers, another large Wall Street firm; and AIG, an insurance company that specialized in insuring the assets underlying collateralized debt obligations.

The concept was that, if these giant institutions were allowed to fail, it would threaten the entire global financial system and economy.

Well, let's see: 25 financial institutions failed in the U.S. alone in 2008. The U.S. unemployment rate ultimately reached 10% in 2009, and remained above 8% for 3 1/2 years. A total of 8.7 million jobs were lost from early 2008 to early 2010; it would take until mid-2014 to recover them. The housing market took a decade to recover. And the U.S. economy was in recession for 18 months, the longest and deepest downturn since the Great Depression. And as the U.S. goes, so goes the rest of the world, which didn't fare any better. So I'd say that even though we bailed out those institutions, it didn't do much to avoid the entire global financial system and economy being threatened.

Ah, the pundits say, but how much worse would it have been if the government hadn't intervened?

That's always the question, and I've addressed it before in this blog, always the same way. It's like those old Tootsie Pop commercials with the wise old owl, where the kid asks the owl, "Mr. Owl, how many licks does it take to get to the center of a Tootsie Pop?" The owl rips the wrapper off a Tootsie Pop and starts counting the licks: "One, two, three ..." then he bites into the center, and the voice-over says, "The world may never know."

So it is with the question of whether it's better to intervene and bail out banks (and other businesses, for that matter), or let them fail: the world may never know, because government always steps in and - "CRUNCH!" - takes the bailout bite.

Well, here's my proposed free-market solution. It would avoid the transference of risk from those who are in the business of risk-taking to those of us who shouldn't be, and keep the costs associated with risk where they should be.

1. Treasury should announce that there is no more "Too Big to Fail." Period. And they should mean it.
2. Treasury should make this clear to the banking system: if you take excessive risks, you will not be bailed out. The insurance fund will cover insured deposits, and that's it.
3. Treasury should make this clear to the markets: stockholders, bondholders, and banking analysts, there will be no more "Too Big to Fail." If you're going to buy stock in a bank, or invest in its debt securities, do your research, look at their financials, analyze their management, scrutinize their risk, and then - and only then - invest ... at your own risk. If they fail, you lose your investment. We will not, under any circumstances, no matter how much Jim Cramer screams, bail them out.
4. Treasury should make this clear to depositors: we will always, 100% of the time, cover all insured deposits, up to the insurance limit. We will never fail to do that. We will never, 0% of the time, cover a single penny of uninsured deposits. We will never fail on that promise, either. So if you insist on depositing $250,000.01, know that that last penny will be lost if the bank fails. If you insist on depositing $478 million (that means you, Roku), know that $477.75 million will be lost if the bank fails.

If those messages are made clear to the banks, the markets, and the depositors, the following should happen:

1. Bank stock prices will probably fall, to a level that is more realistically commensurate with the risk the banks are actually taking. But after that market adjustment, stock prices in the banking sector will normalize.
2. Banks' debt securities will probably get downgraded, to a level that is more realistically aligned with the risk the banks are actually taking. But as banks adjust their risk-taking, their debt ratings will be adjusted accordingly.
3. Large depositors will move money around to different banks to ensure they remain under the deposit limit per account. This will likely result in a run on deposits in banks that have a high concentration of uninsured deposits, therefore it would probably need to be phased in over some period of time to avoid a liquidity crisis that would result in those banks failing. An alternative would be to backstop the liquidity crunch with a temporary liquidity facility, but it would have to be funded directly by those large depositors to avoid billing it to the banks, who would just pass it along to their customers, probably disproportionately. So maybe charge an excess insurance premium directly to those depositors who need it, just as some of us carry umbrella insurance policies over and above our homeowners' policies.
4. Eventually - and this is the best news - banks would adjust their risk-taking behavior to a more reasonable level, making the banking system safer for everyone, resulting in fewer bank takeovers, fewer systemic crises, lower insurance premiums, lower fees, and higher deposit rates. Of course, lower risk-taking would mean lower returns to stockholders, but they're currently enjoying the transference of risk to depositors and taxpayers, when it should be borne by them.

A final step in my plan, and this one would have to be phased in over some time - at least a decade, I reckon - would be to adjust the deposit limit down to where it should be given inflation, and then increase it annually by the inflation rate. I'd take it down to maybe $75,000 to provide a bit of cushion. We could start by freezing it where it is, then gradually adjusting it downward until the appropriate threshold is reached. Allowing for future inflation, in a decade, that $75,000 limit should probably be about $106,000, assuming the long-run average inflation rate of 3.5%. So if you wanted to phase in the adjustment over a decade, you could reduce the limit by about $17,000 a year for ten years, and you'd be where you should be. That shouldn't be too painful.

Now, don't hold your breath for any of this to happen. There are too many powerful lobbying interests working to keep deposit insurance limits high, and Congress loves big numbers, so the next adjustment to the insurance limit will be upward, and it'll probably be big, especially if it's in response to a true systemic crisis. Even though the current situation doesn't meet that standard, I would not be surprised to see this administration push for an increase, and the current Speaker of the House would undoubtedly support it, given that special interests in his home state would be among the loudest voices clamoring for it.

But if my proposal were put in place, one of the benefits would probably be lower market interest rates. The reason for that is that there would be a reduced expectation that the U.S. Treasury would be called upon to bail out banks in the future, thus the market perception of Treasuries would result in lower yields on U.S. Treasuries. That would mean less debt servicing cost as a percentage of the federal budget, lower deficits, and ultimately, all else being equal, the ability to gradually reduce the federal debt.

I know, I know, it will never happen. But we can dream, can't we?

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.