First and foremost, everyone’s money should be safe, and it does not appear to be 2008 all over again. If we look more closely at these banks that failed, it is apparent that there was a mixture of excessive risk taking, structural issues, mismanagement of client deposits, and outside forces involved.
Starting with the outside forces aspect…. The sudden surge in short-term interest rates from 0% to almost 5% within just one year, driven by external factors, has resulted in several anticipated and unanticipated outcomes. It has been a long time since we witnessed such monetary policy implementation, and it would be unrealistic to assume that there would be no repercussions from such a significant shift.
The impact of the interest rate hike was felt across all banks, but it was especially profound for those that failed. In 2008, banks had aggregated sub-prime mortgages, believing them to be secure and reliable assets for their balance sheets. However, it was soon discovered that these asset pools were highly risky and almost caused a collapse of the entire US financial system.
This time, the banks that failed were not invested in sub-prime mortgages or high-yield bonds. According to reports, they were actually invested in short-term government securities and high-quality mortgage-backed securities, as mandated. However, it seems that they mismanaged these government securities, and the rapid increase in interest rates led to significant marked to market losses, as per current banking regulations. (Marked-Market- What you would receive for a security for it you had to sell it immediately)
The mismanagement of these companies' balance sheets required them to seek additional funding through equity. However, once this announcement was made, their customers panicked and began withdrawing their funds. It is essential to note that many of these customers had deposits exceeding the FDIC threshold and were unwilling to risk losing their funds beyond the insured limit of $250,000.
This sudden and intense withdrawal of funds caused a run on the banks, and within a matter of days, they were unable to remain open.
The federal government intervened by announcing that they would provide backing to all depositors at the three affected banks. It is crucial to note that the term used was "backstop," indicating that this is not a bailout in the same vein as 2008. This time, all management, equity, and bondholders were completely wiped out. The backstop was put in place to ensure that all depositors would receive their full funds, making it a significant distinction from the 2008 bailout.
Another significant distinction is that the banks' U.S. Treasury and mortgage bond portfolios are considered "money good" over time, and losses are unlikely to be incurred in the long run (Ted Truscott Columbia Threadneedle CEO). This is different from 2008 when sub-prime mortgages were considered highly risky and were avoided by most.
Where does that leave us?
Currently, it seems that the bank failures have been limited to three banks, with Credit Suisse being acquired by UBS. The Fed has expressed its commitment to focus on controlling inflation and believes that it has a good handle on the banking system. Moreover, the lessons and policy solutions that emerged from the 2008 financial crisis seem to be beneficial for policymakers this time around.
To conclude, every economic cycle has a pivotal moment that signals the transition from the current cycle to the next. In recent times, the Federal Reserve has been the driving force behind the economy, controlling its movements with their interest rate hikes and cuts. However, with the recent surge in inflation and interest rates, the economy has begun to falter, indicating that a new cycle may be on the horizon. While it is uncertain when and for how long this cycle will persist, a lot of the damage has been down, but now that the Fed Funds rate is closing on the 5%, the Fed finally has tools in its toolkit to affect change if things get worse.
From an allocation perspective- we remain overweight domestic equity, short term bonds, and U.S treasuries with a slight underweight to cash.
As always please don’t hesitate to reach out if you or anyone know has any questions.
Thanks
Frank Vance
Retirement Capital Advisors
800 Battery Ave SE
The Battery, Suite 100
Atlanta, GA 30339
Office- 412-722-3795
Securities and Advisory Services offered through Commonwealth Financial Network®, member FINRA/ SIPC, a Registered Investment Adviser. Fixed insurance products and services are separate from and not offered through Commonwealth Financial Network
Disclaimer: The term markets, market, S&P 500, or any other reference to financial markets are notional concepts and not specific investment advice or suggestion. This article does not constitute specific investment advice, and none is implied or inferred. This article is for clients of Retirement Capital Advisors only. Investing entails risk of loss of principal and no guarantee of returns are inferred or implied