What happened with SVB, and what is happening with banks?
On March 10, the Federal Deposit Insurance Corporation (FDIC) closed Silicon Valley Bank (SVB) and Signature Bank. You may have seen that investors are concerned about First Republic Bank, and that UBS has acquired Credit Suisse – a Swiss bank. The failures of SVB and Signature (and current concerns about banks generally) illustrate a fundamental banking problem – a mismatch of expectations between bank depositors and bankers.
Depositors want to be sure that their money is safe (as safe as money in the bank!). They subconsciously think that their bank is holding their money for them, when in fact they have lent their money to their bank.
Bankers earn profits by relending their customer’s deposits. However, bankers do not say to depositors, “we earn profits by lending (and taking risks with) your deposits.” They simply announce the interest rate that they are paying.
If a bank loses too much money on its loans, it will be unable to repay its depositors, bringing the expectations mismatch to the fore. Depositors in other banks notice and become concerned about their own deposits. When many depositors lose confidence in their banks and withdraw their money, it is called a “bank run”.
SVB depositors began the current bank run, which has now extended to First Republic Bank and other “mid-sized” or “regional” banks. First Republic may in fact be solvent. It might be able to repay its depositors, given enough time. However, in a bank run, banks don’t have time. Depositors want their money now, while many of the banks’ loans won’t come due for months or years.
The monetary authorities – the Federal Reserve Bank (the Fed), the Treasury, and the FDIC – are working to restore depositor confidence in banks. For SVB and Signature Bank the authorities extended deposit insurance to uninsured deposit accounts. The authorities also encouraged large banks like JPMorgan Chase and Bank of America
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These steps may or may not be enough to restore confidence in the banking system. In any event, there is likely to be an extended period of uncertainty – depositors and all of us are likely to feel very uncomfortable.
What will happen to the economy?
Banks perform several important functions. They make it easier to transact – to move money from buyers to sellers. They hold money for depositors. They provide credit – lending money to individuals and businesses.
When depositors lose confidence in their banks, banks can have a harder time performing those functions. It may become more difficult for people and companies to transact, to store money, and to find credit. This may lead to slower economic activity – a recession.
Of course, many analysts of the economy were already worried that a recession might be coming before SVB’s problems surfaced. They thought that the Fed’s recent rapid interest rate increases might cause the economy to slow down.
The US and global economies are very large and extremely complex. Many factors contribute to trends in economic activity. It is difficult to determine why economic events occurred even after the fact. Economists are still arguing about the causes of the Financial Crisis of 2007-2009.
Predicting what the economy will do next is even harder than finding the causes of historical events. It is safe to say that no one knows how the economy will develop over the next year.
What will happen to the stock and bond markets?
Many banks, including SVB and Signature Bank, are public companies. When such a bank fails, its stock price goes to zero, and its shareholders lose their entire investment.
If your portfolio includes broadly diversified stock mutual funds, you almost certainly held positions in those two banks through your stock mutual funds. However, if your stock portfolio is very well diversified, your positions in those banks (and your losses) were almost vanishingly small.
Signature Bank’s market value was $7.3B (billion) at the end of last year, and SVB’s was $13.6B, for a total of about $21B. For example, consider the Russell 3000, a broad US stock market index. The market capitalization of that index on May 6, 2022 was $44.9T (trillion). Thus, the two banks that failed represented approximately .05% of the value of the Russell 3000, and by extension, a similar fraction of a well diversified US stock investment.
Stock markets forecast future profits of public companies. Investors are already aware of the prospects for recession we discussed in the previous section, and current stock prices incorporate that knowledge. In the near term, if more banks fail, we might expect stock markets to decline. On the other hand, if the monetary authorities succeed and confidence is restored, we might expect stock markets to rise. In the longer term, stock markets will respond to many factors. The efficiency and effectiveness of the banking system is just one such factor.
Bond prices have risen over the last few days, as investors seeking safety and stability bought Treasury bonds. If banking sector uncertainty continues, we might expect bond prices to continue to rise somewhat. In the longer term, bond prices will respond to changes in interest rates. Just as with stock prices, interest rates respond to many factors, and the banking system is just one factor.
Coming economic and market developments are unpredictable. Bank runs are one of the many bad things that can happen to economies and markets. They are just one of the risks that investors face. Being unpredictable, they are one of the risks that make “timing the market” very hard (I would say nearly impossible) to do.
What should you do about your money and investments?
You can best protect your cash by ensuring that all your bank deposit accounts are within FDIC insurance limits. For extra cash you might also consider buying (in an investment account) money market funds that invest primarily in Treasury bills and short-term US Government obligations, such as Vanguard Treasury Money Market Fund (VUSXX), Fidelity Treasury Only Money Market Fund (FDLXX), and Schwab Treasury Obligations Money Fund (SNOXX). This is not an exhaustive list – there are several such funds.
A good investment policy carefully considers your financial situation and your financial objectives. While the recent SVB and related developments have certainly been a surprise in terms of details, they do not provide news about investment risks more broadly. There have been US bank failures ever since there have been US banks, including 5 in 2016, 8 in 2017, and 4 each in 2019 and 2020. If neither your situation nor your objectives has changed, maintaining your current well-designed investment approach probably makes good sense.
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