In this post, I want to discuss the strength or lack of strength in United States banks. We’ll dive into several issues with the banking model and why today we’re at much bigger risk of a bank run than ever.
Just recently a report came from the FDIC showing 63 problem banks in the US. Now, the reason that these banks are considered problematic is they are holding a large proportional number of unrealized losses.
Bonds and Interest rates
Recall when interest rates were low, many banks went out and bought bonds at ultra-low interest rates. Bond prices and interest rates move in opposite directions. As interest rates increased from 0 all the way to 5.25%, the value of those bonds decreased. Now remember as bonds mature and reach par value, banks don’t take a loss on the asset. Still, right now there is a massive amount of these unrealized losses in the banking system
This is dangerous because if the banks have to sell, the bonds are marked to market, given the current market price and the banks will take a significant loss in many cases. We saw this happen in March 2023 with SVB.
How big is this issue though?
It’s pretty significant. From 2008-2021, unrealized losses were around 75 billion to 150 billion in the banking sector. Today, they are over 500 billion and growing. In the first quarter they increased 39 billion.
In addition, a report was published by a consulting firm named Claros Group. They analyzed around 4,000 banks and found 282 were at risk of failure. This is of course due to overexposure in the commercial real estate market and also losses tied to higher interest rates.
To give a little more detail on this specifically, many buildings were financed before 2020. Today with so many people working hybrid or remote, these buildings are sitting empty in cities across the country. The values of these buildings have plummeted, and the banks own these assets, so they’re going to realize the losses. Mainly it is smaller banks and regional banks that are overexposed in this area.
So, with only 63 or 276 at banks at risk why is this a big deal?
The Interconnectivity of the banks.
If some of these banks go under, and I believe it’s going to happen we could see spillover effects into the other banks. While numerically speaking, these banks certainly wouldn’t cripple the banking sector. It will almost definitely shake the stock market and also hurt confidence in the banking sector.
Did the government destroy small banking?
Even more important, we probably can expect these unrealized losses in the banking sector to continue for some time. It’s pretty much guaranteed that interest rates are not going to go down to these ultra-low levels we have seen the last 10 years or so. The bonds will remain at a loss and it’s really just a matter if the banks can hold enough of these to sell at maturity in which they would get par value for the bond. If liquidity issues come up, like at Silicon Valley Bank, then we can almost certainly expect big losses at many banks.
Could we see a Run on the Banks?
How A Bank Run could happen extremely fast
The banking system runs completely on trust or confidence. As most of you probably know, banking is based on a fractional reserve system, meaning when you deposit your money in the bank only a certain amount is kept on hand. The rest is lent out by the banks.
One thing that I don’t believe is discussed enough is how a bank run would be much more extreme this time. If banks started failing, with social media today we could expect a domino effect and people withdrawing their money online. This could easily and quickly collapse the system.
More than likely, we would see the FDIC step in and try and guarantee deposits. I think people would still be pulling their money though. Ultimately, since the banks don’t have the money, they would have to limit withdrawals until confidence is restored in the system.
It’s definitely a frightening scenario but it’s very reasonable to assume a bank run could happen extremely fast and even worse not be able to be controlled. Even a few banks, could set off a wave of panic. Silicon Valley Bank, for example, lost 25% of its deposits in one day.
Back in 2008, Washington Mutual and Wachovia lost 10% and 4.4% of deposits over weeks. So, we see these bank runs are becoming more severe and it makes sense why this is occurring.
What will happen if the bank system collapses?
I think a strong possibility is that we will end up with just a handful of banks. Another possibility is that the Government will nationalize the banks. Mexico nationalized its banks in 1982 with rising interest rates and issues in the oil market. With a CBDC coming in the future, nationalization of the banks would make implementing the CBDCs easier.
In sum, I believe we could see issues in the banking sector moving forward. It’s not all but given, but the economy is fragile, and it is getting tougher and tougher for DC to make the economy look rosy.
