Why banks collapse. And why it doesn’t matter.
There are a multitude of reasons that a financial institution might fail, but very few are cause for widespread panic. The best thing you can do when a bank collapses…is nothing. Nothing’s changed, so don’t change your goals, and don’t change the life you live.
The first quarter of 2023 resembled a Shakespearean play for the financial industry. It’s been bloody, dramatic, and rife with hubris. Most importantly, no one in the banking sector thought it wise to take dear William’s advice and “beware the ides of March,” a month that saw the collapse of three major US banks.
The headlines say, “the sky is falling”
For all the headlines that warn of further financial carnage, or talking heads that surmise the cataclysmic return of 2008, these banking failures share more in common with the works of Shakespeare than one might think. Namely, they are sensationalized spectacles that have no tangible effect on the lives of audience members who watch their events unfold. We, the American consumers, ooooh and ahhhh at the pageantry laid out before us, only to comfortably return to our homes, unaffected by the drama that we’ve witnessed.
Before we delve further and “hold the mirror up to nature,” we need to understand what caused the recent banking failures in the first place.
Why are banks collapsing?
On March 10th, 2023, the US government’s Federal Deposit Insurance Corporation (FDIC) took control of Silicon Valley Bank, marking the biggest banking collapse since Washington Mutual. March 12th of the same year saw the collapse of Signature Bank, and three days later, Swiss authorities announced a backstop for the country’s second-biggest bank, Credit Suisse. The very next day, a group of American financial leaders deposited tens of billions of dollars of cash into First Republic Bank to prevent yet another collapse.
How did five days of financial turmoil come to resemble the closing scene of Macbeth? It all started when the Federal Reserve began raising interest rates a year earlier.
What happened to SVB, First Republic, and Signature Bank?
While rising interest rates usually mean a lag in purchases for consumers and a slow in the macroeconomy, they were the vehicle for SVB’s demise.
Silicon Valley Bank’s primary clients are start-ups, who have been strapped for cash as a result of various macroeconomic conditions and consumer spending trends. In an effort to increase their liquidity, many of these start-ups had been withdrawing large sums of funds from SVB over the course of several months. This would not have been a problem for Silicon Valley Bank, let alone for any financial institution, but the wise leaders of SVB had tied up most of their cash in long government bonds.
And although that’s not “wrong,” they had to free up cash for themselves. So they were forced to sell those bonds to replenish the reserves that were being depleted by massive withdrawals.
But that’s the thing about 30-year treasury bonds: they take 30 years to mature. When Silicon Valley Bank sold billions of premature bonds to avoid a liquidity issue, they did so at a massive loss. Depositors panicked, and the result was a good ole fashioned bank run.
A good ole’ fashioned bank run
But that’s the thing about 30-year treasury bonds: they take 30 years to mature. When Silicon Valley Bank sold billions of premature bonds to avoid a liquidity issue, they did so at a massive loss. Depositors panicked, and the result was a good ole fashioned bank run.
The subsequent failures of Signature and First Republic were the direct result of panicked customers, who were spooked by the implosion of SVB. Unfortunately for these two institutions, both were holding unusually high ratios of uninsured deposits to fund their businesses.
Are more banks at risk?
The nature of banks means they are exposed to various threats at any time, such as credit, liquidity, and interest rate risks. These risks can lead to significant problems for banks, especially when asset values decline. Deterioration in asset values can happen for a variety of reasons, such as a collapse in real estate prices, increased bankruptcies, or government defaulting on its obligations. When asset values decrease significantly, banks can become insolvent.
Banks can also face illiquidity when they do not have enough cash or assets that can be easily turned into cash to satisfy their liabilities. A banking crisis occurs when many banks experience severe solvency or liquidity problems simultaneously, which is precisely what caused March’s banking bloodbath.
No, this isn’t 2008 all over again
Tori Dunlap, author of Financial Feminist, once said, “You just realize at some point that all of this seems to be teetering on the edge at all times.” Banks, whether they serve regional clientele or global investors, are castles built upon mountaintops. They appear to transcend the laws of gravity that define other institutions, hovering over the day-to-day events and people who have their feet firmly planted on solid ground. They can operate quite effectively from their ethereal position, yet the financial system is, and always has been, built on confidence. When confidence wanes, the mountaintop begins to shake.
So why do the events of March 2023 differ from 2008?
The magnitude of the problem
The fundamental nature of today’s problem differs from that of the 2008 crisis. The Global Financial Crisis was driven by price declines in low-quality assets with poor disclosure, leading to a solvency crisis. In contrast, the recent banking failures stem from price declines in high-quality assets with transparent disclosure, resulting in a liquidity issue.
The failures of SVB, First Republic, and Signature Bank should not be seen as indicative of a repeat of the 2008 financial crisis, but rather, should be attributed to specific mistakes made by the leaders of those institutions. The events of March 2023 are not part of a widespread systemic failure. They are a series of singular events, connected by a plummet in the confidence of the banks’ respective clients.
If there is a lesson to be learned from the financial industry’s recent troubles, it’s not one that reflects the state of banking as a whole, but rather of human nature. Yes, the collapse of SVB, First Republic, and Signature Bank have, as William Shakespeare once wrote, “held a mirror up to nature,” reminding us of what this system is: a castle upon a mountaintop. The foundation has been rattled, but as long as those of us on the ground remain still, confident in our goals and in the plans we’ve enlisted to achieve them, no falling rubble can harm us.
Yes, your money is safe
The interconnectedness of the financial system in 2008 was difficult to quantify, with trillions of dollars tied up in opaque securities and complex derivatives. However, regulations implemented after the crisis, such as the 2010 Dodd-Frank Act, now require greater transparency and registration of such positions. Yes, history does indeed repeat itself, but 2008’s domino effect collapse is unlikely to reoccur thanks to today’s more stringent regulations.
As for the nitty gritty numbers: if you have less than $250,000 in an account at a US bank insured by the FDIC, then you almost certainly have nothing to worry about.
Banks collapsed, and the market went…up?
Silicon Valley Bank collapsed on a Friday. Would you believe us if we told you that the markets were up the following Monday? It’s true, which is why panicking and withdrawing funds as a result of market downturn is the worst thing you can do.
Nejat Seyhun, a professor at the Ross School of Business at the University of Michigan, generated a fascinating model to better illustrate this point. “Imagine that you held a giant basket of just about every U.S. stock and left it alone from 1975 to 2022. The return on that portfolio would have been 1,426 percent.” If you put just $5,000 in the market in 1975 and held the course through every financial crisis, you would have more than $70,000 in your pocket today.
So what’s the moral of the story?
Has the March 2023 banking crisis changed my financial goals?
If you’re still worried about the state of the baking industry, just ask yourself one question: “have my goals changed? Have the events of March, 2023 had any affect on my daily life or personal finances?” In all likelihood, the answer is no. There’s no need to obsess over the market. Sometimes, it’s ok to be a bystander. Shakespeare never invited audience members to come up on stage and involve themselves in the plot of his shows. We, the American consumers, are intended to be passive observers, brought along for a journey that can bring us great anxiety at times, and a comfortable sense of security at others.
At Stash Wealth, we help our clients discover how they can get the most out of their money. The most important part of what we do can’t be found on paper. Sometimes, our clients simply need someone to tell them, “sit back, relax, and enjoy the show.” And if we come to the point in the performance where it seems as if all hope is lost, we remind them that as long as they stay in their seats, this story will have a happy ending.
Stash Wealth provides financial plans designed to assist high earning young professionals build and manage their wealth.
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Written by Stash Wealth Staff Writer
Stash Wealth Staff Writers are knowledgeable about personal finance topics. Their objective is to unravel the complexities of finance trade jargon, products, and services in order to equip HENRYs with a sound understanding of financial matters.