Recent shenanigans at several banks have stoked fears of another financial crisis similar to the Great Recession of 2008 or the 1980s meltdown (I wrote a book about that). Not to worry! The underlying problems for each of the affected banks came down to inadequate risk management and problems specific to their situation rather than any system-wide weakness.
Swift action by the Federal Reserve, the Treasury Department and the FDIC calmed markets and depositors enough to contain the fallout. No doubt there will be some jitters and turns around the world for a while, but the system is solid.
Banks are the lifeblood of modern economies, taking deposits from some customers and lending them to others. Usually, when numerous banks have large-scale problems, it is due to high-risk practices (such as the origination and securitization of bad mortgages before the Great Recession); changes in the regulatory environment (such as the schizophrenic fiscal and financial policies that first incentivized unions and then scuttled them in the 1980s); or similar systematic problems.
Silicon Valley Bank’s (SVB) clients were heavily concentrated in technology sectors (start-ups, in particular). As these companies were under pressure, they needed additional cash to fund operations. However, SVB had invested its assets in US Treasuries and similar bonds with interest rate sensitive values. Such vehicles are risk-free if held to maturity, but subject to fluctuation in the event of an unexpected liquidation. As interest rates rose, the value of SVB’s portfolio declined. The bank has been quick to sell them at a loss or raise capital in other ways to handle the surge in withdrawals, but social media musings have created and amplified a major run on deposits.
Clearly, SVB’s risk management was inadequate. The excess funds were too concentrated and a hedge against interest rate risk should have been implemented. A greater diversification of the loan portfolio would also have been wise. In essence, the wrong choices brought down SVB. The other two failures were basically generated by bets on the cryptocurrency market that were not successful.
Fear can be contagious and it will take some time and some data to fully restore confidence. The regulators’ response (which does not reward shareholders, management or bondholders) was appropriate given the situation and the need to keep the economy functioning well.
One result of this debacle is that the Federal Reserve now has yet another concern to address in its ongoing quest to promote both economic growth and modest inflation. The important point, however, is that neither technology dominance nor cryptocurrency concentration is the norm among US banks. This is neither 2008 nor the 1980s and our financial infrastructure is fundamentally sound. Stay safe!
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com), which has served the needs of more than 3,000 clients over the past four decades.