The banking crisis may not be over. True, regulators seized First Republic Bank early on Monday and sold it to JPMorgan Chase, the nation’s biggest bank. But other regional banks are still bleeding deposits. And the Federal Reserve is still putting pressure on the banks by raising interest rates, which tempts depositors to take out their money and put it in higher-yielding money market mutual funds.
The Federal Reserve — which announces its next rate decision on Wednesday — is in a bind. Chair Jerome Powell and the other rate setters could ease the banking crisis by reversing course and cutting interest rates. But that would increase the risk of a renewed outburst of inflation, which the Fed is just beginning to bring under control. Or the Fed could stay the course on fighting inflation. But that would increase the stress on the banks.
The Fed is widely expected to raise the target for the federal funds rate another quarter of a percentage point this week. The question is whether it will raise rates again after that, keep them high for an extended period or start cutting soon.
“We have a choice of two very poor decisions to make,” Danielle DiMartino Booth, a former adviser to the president of the Federal Reserve Bank of Dallas, told me on Monday. Dimartino Booth is the chief executive and chief strategist of QI Research, a research and analytics firm.
Flooding the banks with easy credit would be “acquiescing” to the notion that the United States has a fundamentally unstable banking system that requires unrelenting emergency assistance, she said. On the other hand, if something isn’t done, she said, “the idea of a slow-bleeding bank run cannot go away.”
When Jamie Dimon, the chief executive of JPMorgan Chase, spoke with analysts about the deal on Monday, he said he thinks that First Republic is the last sizable bank that will need to be resolved for now and that “the banking system is very stable.” But he also said that “down the road” is “a whole different issue.” Dimon also said, “this part of the crisis is over.” Note: “this part.”
In ordinary times, banks make money on the difference between the interest they pay for deposits and other sources of funds (low) and what they earn on their loans, bond holdings and other investments (high). The problem now, as I wrote in early March when Silicon Valley Bank was taken over by regulators, is that the math has gone bad for them. They’re losing their cheap funding and they’re still stuck with low-yielding investments that they acquired when interest rates were historically low.
Market forces have already brought down Silicon Valley Bank, Signature Bank and First Republic Bank, the slowest antelopes in the herd. In terms of assets, not adjusted for inflation, those are three of the four biggest bank failures in U.S. history. Share prices of other banks have fallen, indicating investors’ fears that they could be next. The SPDR S&P Regional Bank exchange-traded fund, which tracks the stocks of the regional banks, has fallen 28 percent since the start of the year. Stressed banks have stepped up emergency borrowing this year from the Fed and the Federal Home Loan Banks.
Regional banks’ balance sheets don’t look terrible at first glance, but that’s partly because the banks are allowed to value assets such as bonds at their face value so long as they declare that the plan is to hold them until they mature. If the bonds had to be valued for what they could be sold for now, the balance sheets would look much worse.
Banks accumulated $2.2 trillion in unrealized losses in the 12 months through March, and 10 percent had bigger unrealized losses in percentage terms than Silicon Valley Bank, scholars from the Stanford Graduate School of Business, University of Chicago Booth School of Business, Columbia Business School and Northwestern University Kellogg School of Management reported in March. (One of those scholars, Amit Seru of Stanford, told me Monday that because long-term interest rates have declined since March, the unrealized losses are probably closer to $1.6 trillion now.)
“Now we have mass insolvency thanks to Jay Powell,” Christopher Whalen, the chairman of Whalen Global Advisors, an investment banking firm, wrote in a weekend tweet. He tweeted last week that “it may take a few more bank failures” for the Fed to “admit fault and pirouette” from rate increases to rate cuts.
“Mass insolvency” is strong language. In reality, it’s not unusual for banks to go through periods when the market value of their loans and bonds is depressed. It doesn’t mean the banks are destined to fail. The banks that failed had the additional problem that they were highly reliant on uninsured deposits — amounts above the $250,000 per account that the F.D.I.C. guarantees.
The optimistic take is that JPMorgan Chase’s takeover of First Republic will help restore confidence in the banking system. The outflow of deposits from regional banks had already been slowing from its March rate, Dec Mullarkey, the managing director of investment strategy and asset allocation at SLC Management, told me on Monday. Mullarkey also said that new lenders, such as insurance companies, hedge funds and private equity funds, could at least partly fill the gap left by banks that are forced to retrench.
But the increase in interest rates remains a source of stress. Bankers like to say their deposits are “sticky” — that their depositors will stick with them because of inertia or loyalty or the exceptional service that the bank provides. But high interest rates are a solvent. Some banks are finding out that their sticky deposits aren’t sticking so well anymore. If a credit crunch forces banks to scale back lending, it will be a problem not just for them, but for the entire economy.
Outlook: Houze Song
The growth of China’s economy “could well” exceed the 5 percent target that the government set in March, according to an April 24 blog post by Houze Song, a fellow at the Paulson Institute’s MacroPolo think tank in Chicago. Employment has recovered rapidly, allowing Beijing to taper stimulus earlier than expected, “which means it has reserve fire power to stimulate in the third quarter if growth flags again,” he wrote.
Quote of the Day
“Time can’t be measured in days the way money is measured in pesos and centavos, because all pesos are equal, while every day, perhaps every hour, is different.”
— Jorge Luis Borges, “Juan Muraña,” in “Brodie’s Report” (1970); translated by Andrew Hurley, “Collected Fictions” (1998)
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