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  • Writer's pictureRichard Murff

Oh Snap!

Did the proverbial something just break?



Adam Smith famously wrote in The Wealth of Nations that he was opposed to licensing physicians on the grounds that a government stamp of approval would give a clever quack something to hide behind when simple market forces – presumably word of mouth and a pile of corpses – would root out the bad actors more effectively. He’s not wrong. A tad indelicate, but not wrong.


Don’t sneer, when Christopher Duntsch rolled out of University of Tennessee medical school with CV full of licenses and gold stars, he was able to pile up so many cripples and corpses that they made mini-series out of the guy. Without the sheen of establishment protection, he’d have just been some tit from Memphis with a cocaine problem. Bernie Madoff was the darling of his regulators.


Which brings us to the thorny question, once again, of bailing out the banking system. Of course, the Biden administration is claiming it wouldn’t be a bail-out but simply “intervention.” The FDIC insures deposits up to $250,000 the implied guarantee beyond that of some $17.6 trillion in bank assets is a hell of an intervention. Senator Elizabeth Warren thinks it’s necessary, opining that small business owners with more than $250,000 in the bank simply cannot be expected to know whether their bank is well run or not.

 

I recall studying for the Series 7 exam to sell bonds and got the following advice before a sat for it: “Remember that all the government rules are there to protect the little guy. The rich should know better…or hire someone who does.” I read that seven-pound study guide once over six weeks while selling cars and passed on the first try, so it must have been good advice. I’d argue that someone with better than a quarter million in one bank account should know the difference. If you have less than $250,000 your deposit is secure. If more, spread it around. If you’re dealing with a few million, hire someone to do the homework. That’s common knowledge.


Silicon Valley Bank had some idiosyncratic issues, like being lopsided on tech in both liabilities and assets. It’s unrealized losses of long-term Treasuries was a bitch, but it wasn’t the only piece of the puzzle. Perhaps, like Dr. Death mentioned above, it simply needed to fail.

A lot of finger pointing has been of the “the Fed Raises rates until something breaks” sort. And something did snap last week. Those rate hikes are largely responsible for the drop-in value of older, lower rate bonds that banks hold as reserves. On 31 December of 2022, the vast pool of Treasuries represented $620bn in unrealized losses. Of course, unrealized losses are just that until you sell. Which happens in a bank run.


On the other side is the Fed, that does not want the blame for triggering a 2008 redux. They’ve been running every reasonably camera-ready suit in front of the news cameras to explain why this string of collapses is a matter of de-regulation and easing of the Dodd-Frank in 2018.


Of course, all banks can suffer a run: deposits can be withdrawn on demand and the loans made with them cannot be recalled so quickly. The underlying truth, however, is that bank runs don’t generally start on the spreadsheet. Money is too emotional, human risk-aversion is too visceral to not pull your money out before the perceived problem becomes real.

This week, Janet Yellen said that the banking system has largely stabilized, but the government will continue to back deposits in mid-tier banks. Emergency functions are already in place – but they need to be provided by the government with a haircut so banks remember what they screwed up. Implied guarantees are dangerous – if not for depositors, then for the taxpayer.


Yesterday, the S&P 500 shed nearly 1.7% after the Fed raised rates a 9th consecutive time while signaling that while Jay Powell signaled in that they’d take the late banking unpleasantness in account, a rate cut this year is not part of Powell’s “baseline expectation.”


It looks like a mild banking panic, cratering stocks and the inevitable recession just might finally get inflation under control.

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