By Steve Evans
Morgan Stanley’s Michael Wilson, known as one of Wall Street’s most bearish strategists, last week recommended that investors unload any rebound in US stocks that may result from regulators’ support measures after the collapse of Silicon Valley Bank.
“We suggest selling any bounces on a government intervention to quell the immediate liquidity crisis at SVB and other institutions until we make new bear market lows, at a minimum,” Wilson wrote in a note March 13.
Not a single US bank failed that day, but to see the pounding bank stocks took, you’d think George Bailey from the classic film It’s a Wonderful Life (1946) was the last man standing.
So, realistically, in spite of the fear-driven selloff, what’s the impact on small, regional community banks?
Turns out there’s a world of difference between Silicon Valley Bank and the little regional banks that serve communities from Portland, Oregon, to Portland, Maine.
Silicon Valley Bank’s deposits were primarily from the tech industry and venture capital investors.
Silicon Valley Bank had one primary type of customer – tech startups – and one method of investing customers’ deposits – in securities. SEC filings show the company’s investment banking growth in the fourth quarter was driven by biopharma deals.
Small community banks, many of them traded as microcap stocks, typically make their money by investing back into their local communities. The traditional way to do this is through making loans to other customers, such as through home mortgages and, to a lesser extent, small business loans.
Silicon Valley operated differently. Following a 2020 surge in tech deposits driven by the pandemic, the bank poured that capital into treasury bonds, making hefty investments in government paper throughout 2022.
But last year the Fed hiked interest rates by 4.5% to put the brakes on the economy. When interest rates rise, existing bonds pay comparatively lower interest rates and therefore become less attractive. If sold before they mature, the bonds earn far less than the principal.
But that’s what Silicon Valley Bank had to do when companies in the tech industry slowed down and made a run on the bank to access cash to meet expenses. When that happened, Silicon Valley Bank had to come up with those cash deposits, so it sold bonds at a steep loss. That’s when the dominos began to fall.
The bank also had a high proportion of uninsured deposits – essentially unheard-of with community banks.
New York-based Signature Bank similarly had deposits tied mainly to the volatile tech industry and VC investors. Signature decided to sell $21 billion of its securities portfolio at a loss of $1.8 billion to cover demand for deposit withdrawals.
Fearing a broader run on the banks, the Federal Reserve announced a $25 billion emergency loan program for banks. It appeared to work as far as customers pulling deposits, but it also didn’t foster greater confidence in the US banking system. This, despite the fact that the FDIC insures more than 4,300 US banks (including more than 2,200 institutions classified as community banks) and that those insured deposits cover checking, savings, bank money market accounts and CDs.
It has been said that one role of government is to protect people from themselves. At the same time, public distrust in government has seldom been higher in the United States. So the Fed’s emergency program had Wall Street folks licking their lips and betting that customers would move their deposits over to megabanks like Wells Fargo, Chase Bank and Bank of America.
This is where a mistrust of the US banking system could become a self-fulfilling prophecy. If banking customers move their money into the vaults of banking behemoths, one result would be a rapid pullback in lending throughout the banking system. Then we will see banking services become more expensive for the majority of US households as fees start to climb.
Some will argue the Fed started this mess by raising interest rates too fast, and then the Fed tried to course-correct irrational public fears about the broader financial system that were triggered by Silicon Valley Bank. So the Fed stepped in with an emergency loan program, which had the unforeseen effect of scaring bank customers even worse.
And still, no other banks have failed since Silicon Valley Bank and Signature Bank went belly-up. Yes, Credit Suisse on March 15 said it would borrow up to $54 billion from the Swiss government, which ripped a page out of the U.S. “backstop” playbook. But Credit Suisse has been under duress for years.
Stateside, the real challenge facing the Fed is how to manage human psychology when a single individual hits the panic button.
It might be beneficial to remember the quiet wisdom of George Bailey, who observed that if we panic the whole ship goes down. “If we keep our heads, we’ll all get through this thing,” he told the good people of Bedford Falls.
Somewhere, in an ivory tower a thousand feet over lower Manhattan, Mr. Potter is cackling.