For the first time in over a decade, the banking industry is in crisis. Silicon Valley Bank and Signature Bank have been shut down by regulatory authorities. Credit Suisse has been acquired in an emergency rescue brokered by the Swiss government. Eleven banks infused $30 billion into First Republic in order to hold off the effects of fleeing depositors, and regional bank PacWest needed to obtain a billion-plus dollars of its own to hold the fort there.
The question is whether the crisis is ending or beginning. Many of the financial sector’s own leaders believe—or at least claim to believe—that the crisis will fade. Citi’s CEO, Jane Fraser, said Wednesday that while mobile banking has dramatically increased the speed at which bank runs can occur, the core issues were limited to a “few banks” that had “some problems.” But a group of financial researchers out of Stanford, Columbia, Northwestern, and USC believe more banks may be at risk than that—and in fact that something like one in 10 U.S. banks have either more unrecognized losses or are less well-capitalized than SVB.
To the researchers, the sudden loss of confidence in the global banking system was not entirely surprising. When the SVB news hit, the group was already in the process of trying to discern the impact of rising interest rates on the overall health of the banking sector. The answer they discovered in their analysis felt significant well before the banking crisis became national news.
“We had been saying that there's a flight risk” from uninsured depositors, said Amit Seru, a finance professor at Stanford’s business school and one of the researchers. “It didn't resonate much, as you can imagine. Probably needed a couple of bank runs for people to pay attention.”
While the particulars vary from bank to bank, the fundamental issue facing the industry right now is this: Before inflation became an international issue, many banks received a large increase in deposits from flush customers. With that money, many banks invested in long-term, illiquid bonds and securities, which at the time were seen as relatively safe. The issues started last year, once the Federal Reserve decided to tackle rising prices by raising interest rates, which made long-term bonds and securities rapidly decline in value. If depositors get nervous about that and start to pull money, like they did at the handful of troubled banks so far, the bank would need to offload the securities at a loss. “That’s the Catch-22 here,” said Seru.
The question was how far the value of banks’ assets had dropped. According to Seru and the rest of his team’s analysis, the answer was $2 trillion lower than the stated book value. Another way of putting it is that the assessed current value (known as “marked-to-market”) of assets across all banks had dropped 10 percent.
In retrospect, it’s no surprise that SVB was the first domino to fall. The bank had a bad combination of both uninsured deposits and unrealized losses from bad bond bets. But the researchers also wanted to better understand how vulnerable the broader banking system was. To do so, they analyzed how many banks were at risk of not being able to pay back depositors and, as a result, at risk of a rational bank run—in which customers have a valid reason to believe at least some of their deposits are not safe—if uninsured depositors pulled half their money.
They found that nearly 200 banks were at risk in such a scenario, and that if people started to pull even some uninsured deposits, even more banks were at risk. Seru didn’t name the banks in the paper or to Motherboard, but he made clear that some of them were of significant size. “These are not just small banks or a couple of banks on the West Coast,” he said. Ten percent of banks, they found, actually have larger unrecognized losses than SVB, and 10 percent are also less well-capitalized than the California bank.
“Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs,” the authors wrote in a report published this week in the National Bureau of Economic Research.
In an attempt to stem the panic, the federal government moved quickly to guarantee all deposits at SVB and Signature, whether they were above or below the $250,000 insurance threshold. And on Wednesday, both Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen said they would do what is needed to make sure Americans’ savings remain safe—strongly implying, though not outright stating, that uninsured depositors will be made whole if necessary.
The comments might calm the panic somewhat, which is the point: If customers believe their savings are safe, they have much less reason to worry, and unworried customers will not withdraw their money from banks whose balance sheets can’t withstand it. Yet when asked a more direct question about whether financial regulators were willing to bypass Congress and insure all deposits in the U.S, Yellen stopped short of doing so. “I have not considered or discussed anything having to do with blanket insurance or guarantees of all deposits,” she said to a Senate subcommittee Wednesday.
Taken altogether, the comments collectively led to confusion. Billionaire financier Bill Ackman said Yellen's unwillingness to commit to a “temporary system-wide deposit guarantee” would lead to more bank customers pulling their money.
But federal regulators are facing a difficult decision, and either way there could be negative consequences. If the government doesn’t guarantee deposits, they could face further bank runs. If they do, there could be reason for concern there too. Seru told me worries about the long-term context of essentially “subsidizing” banks by reducing the amount of potential risk they face if things go south.
“Whatever excessive risk we think banks were taking, you can expect that to only go up,” he said Wednesday.
Seru and the rest of the researchers see the current issues facing the sector as similar to the saving and loan crisis of the 1980s, when one-third of the of the “thrift” institutions failed for a very similar reason to SVB: They had invested their customer deposits into long-term assets like mortgages. For a while, “everything was hunky dory,” Seru said. But eventually, they also dealt with the same “mismatch problem” when interest rates rose to combat inflation. Suddenly, the return on deposits seemed too low to customers, and the institutions had to either raise the deposit rate or face a run. “Either way, you became insolvent,” Seru said.
In the end, taxpayers eventually bailed out the financiers behind the savings and loan crisis, and the entire mess set the stage for the 2008 financial crisis. It was an old story with which bankers are well familiar—you can put off a day of reckoning, but all bills eventually come due, with interest.