First let’s remember the basic bond prices and yields, and then let’s look into what’s next for banks and what we can do as individuals.
I am unhappy, I have to talk about my least favorite subject in the world: accounting. The very bane of my existence, however so I will try and keep it simple and brief. I think it is important for people to hear with all these big new happenings in the banking system and perhaps we can shed some light on it, but before we do I’d like to give our listeners an update on Brady Lowry and Kendell Cummings. Ryan Hockensmith writes a nice piece on ESPN.com and we will attach the link for those wanting more detail. These were the two wrestlers that got in a knock down drag out fight with a grizzly bear and lived to tell the tale. Brady was hiking and got attacked and was being mauled and Kendell charged the bear and jumped on its back and almost lost his own life in the process. Well, we have an update. Brady recovered from his injuries and was able to wrestle again bear scars and all. Brady wrestled well, but lost his first match, in fact he lost his first three matches which had never happened to him before. His friend Kendell hasn’t been cleared to wrestle yet, told him afterward to “Move forward.” This is excellent life advice as well as prescient for Brady. He was able to qualify for nationals despite a poor record and being unseeded despite entering the year with national title aspirations. Hopes for him were not high entering the tournament, but then a strange thing happened. Brady pinned the number 12 seed in the first round, and then he won against the 5th seed, and then he took out the 4th seed and then he jumped out to an 8-1 lead on the number 1 seed. The story of the grizzly bear survivor was on everyone’s minds as the number 1 seed came back to win and Brady ended up taking 5th in nationals despite being attacked by a grizzly. His friend Kendell was there to cheer him on the entire way. Lots of people take 5th in sporting events every year, but Brady and Kendell’s courage and grit made sure that people would remember this story for a very long time. “Move Forward.”
Move forward is what the banks must try and do despite bank failures, depositors fleeing, and the Secretary of the Treasury coming out and telling Congress that big banks will get treated differently than smaller regional banks in one of the most damning pieces of video I have ever watched. First let’s address some accounting. Assets equals liabilities plus owner’s equity. This is an absolute and the accounting equation. What we are seeing first is an exchange on the asset side of the equation. Banks have loans, mortgages, and treasuries (that they assumed safe collateral) on the asset side of the equation to generate income. Their primary liabilities on the other side of the accounting equation are customer deposits ( which are available upon demand). I will try and keep it simple and just focus on the big accounts here. The bank tries to manage these two things, but recently the Federal Reserve has raised interest rates as quick as any time in history. Having a treasury bond that matures in 10 years is normally a save place to park money and the bank did just that at 1.6% in the case of Silicon Valley Bank (SVB). Unfortunately, those bonds are currently going for 3.6%% (let’s say because the bond moves have been crazy but let’s keep it simple). Remember when we went through the primer on how bonds work that when yields go up the price of bonds go down. Bond prices have gone down. Normally this isn’t a problem because the bank has time on its side, but SVB had depositors that were taking money out which drained the liability side of the balance sheet and in order to raise cash to meet the cash demands SVB was forced to sell some securities, but by doing so early incurred a loss and a big one.
We talked about how this was do to the mismatch last week, but now we are seeing this phenomenon spread across the country as anyone with a google machine can pull up a 10-Q or a 10-K and look for the unrealized losses section of the balance sheet. It isn’t good and there are lots of banks that have this problem. That is only the first problem that banks are facing, there are three more. Yes, three. First, commercial real estate loans are held by lenders and like long term treasuries they are not marked to market. They are merely behind as we saw with Brookfield turning in the keys on some Los Angeles real estate towers a couple weeks ago. If they were to sell those assets it would be another loss which creates more stress on the asset side of the balance sheet. So banks with commercial real estate exposure could be a future casualty. Next, uninsured depositors are realizing that keeping their money in a not big enough to fail bank is foolish and they are pulling excess deposits and depositing them back in a too big to fail bank or a financial instrument like a money market fund or a sweep account. This causes banks stress because they have to liquidate assets (usually at a loss) to meet cash demands. Lastly, insured creditors who might otherwise stay in their checking accounts are reading this and hearing this and asking themselves why they are buying treasuries and getting 5% on their money versus the sub 1% that most banks are charging their customers. If a bank wants to fight this trend of withdrawals they will hurt their own profit margins by raising the interest rate of deposits.
Move forward is what Kellen told Brady as he faced grizzly recovery and I wish I could be so insightful as to offer wisdom to these small and regional banks facing a bear market. The Fed has opened the discount window which basically allows banks to get some much needed liquidity, but has also been a spotlight on banks that you don’t want to bank with. Why? Remember, when we said that trust was the most important thing in banking? Banks you can trust right now aren’t going to the discount window. Banks you can trust aren’t losing 50-60-70% of their stock price in a day or two. Banks you can trust are too big to fail, a systemic risk to do so. Like 2008, we are going to reward the too big to fail even if they have the same issues as the little guy. It helps to have lobbyists people. Right now as we speak just about all the bailed out depositors’ accounts were either in San Francisco or New York. Is it any wonder why everyone is starting to anticipate a debt ceiling fight? The flyover states have had enough, and if their banks are going to be taken over by big city institutions, well then you want to fight, then let’s fight. Social tensions are high across the globe as we have covered here, but the teapot is starting to whistle here in America. Stay tuned.
Sincerely yours,
C Thomas Printer
This week’s financial tip
Unless you bank with JP Morgan, Wells Fargo, Citibank, or Bank of America don’t keep more than $250,000 in your account. That’s not my advice that’s the words of the Treasury Secretary because regulators will determine who is too big to fail.
On this date in history
20 years ago to be exact, George W Bush launched air strikes against Iraq and Saddam Hussein, who was accused of manufacturing weapons of mass destruction.
Also born on this date
Famous american west lawman: Wyatt Earp
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