The Only Thing You Can BANK on Is Political Self-Interest – Daily Reckoning Australia

The 19 December 2022 issue of The Gowdie Letter asked…

‘Are US banks the canary in the coal mine?’

To quote from the issue (emphasis added on last sentence):

‘Systemic risk is the known unknown. We know there has been so much new debt loaded into the system. What we don’t know is the degree of malinvestment and level of risk-taking that surrounds a good portion of this debt.

‘Case in point, the appalling level of contempt and total lack of care shown by Sam Bankman-Fried. How many more SBF clones have operated in cavalier fashion in recent years? Or maybe he’s just the only one? I wouldn’t bet on it.

‘When market pressure is applied — like it was in 2008 — hairline cracks turn into giant crevices…swallowing up institutions like Lehman Brothers.

‘Keep an eye on US and European banks.’

To be fair, you didn’t need a PhD in finance or economics to figure out the US and European banks were vulnerable.

Curing the 2008/09 debt crisis with (truckloads) more debt, could never end well. Risk was piled upon risk.

Until last week, the only unknown was when this shaky edifice would start crumbling.

SVB is far from an isolated case

If you think Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank are the ‘worst of the banking breed’, think again.

This month’s issue of The Gowdie Advisory alerts readers to a white paper published by Stanford Graduate School of Business on 13 March 2023:

Here’s an edited extract from the Abstract (emphasis added):

‘We analyze U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financial stability. The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity.

‘A case study of the recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower capitalization than SVB.

‘To assess the financial stability of U.S. banks, we use bank call report data capturing asset and liability composition of all US banks (over 4800 institutions) combined with market-level prices of long-duration assets.’

If US banking assets were priced on a ‘mark-to-market’ basis (like they once were), there would be a US$2 trillion shortfall between notional value and actual value.

What’s US$2 trillion between friends when the Fed offers to take assets off your hands at the notional, NOT real, value?

This may come as a surprise, but SVB was NOT the worst offender in miscalculating interest rate and duration risk.

How long is the queue of undercapitalised banks standing behind the now-collapsed SVB?

Let’s do the maths…10% of more than 4,800 institutions is near enough to 500 banks. But don’t worry, we’re assured by the same incompetent morons who created this mess, the crisis has been averted.

How so?

Another Fed entity

The Fed, together with the clueless US Treasury Secretary, Janet Yellen, have created yet another entity. This one is called the ‘Bank Term Funding Program’ (BTFP).

Rather than selling securities at market prices to meet a run of deposit withdrawal requests, banks can tap the BTFP…where the Fed will accept the ‘par’ value of the security as collateral.

This Bloomberg headline says it all…this hastily convened program was designed to avert a crisis:

And in addition to this, ALL depositors in the failed banks — not just the depositors with up to US$250k — will be made whole. What messaging on moral hazard does this send to the market?

Contrary to popular thinking (and blatant self-promotion by bullion dealers) there has been NO Bail-In.

On the other side of the Atlantic, Swiss politicians have forced UBS into an arranged marriage with the ailing Credit Suisse:

Why are the officials not letting the system sort out this mess?

With a global economic model so utterly dependent upon debt-funded consumption to remain upright, the need for public confidence is paramount.

In recent weeks, I wrote a three-part series in The Daily Reckoning Australia — 21 February 2023, 28 February 2023, and 7 March 2023, titled Anxiety Levels Quietly Rising.

Reader concern over the prospect of Bail-Ins was the motivation for writing this series.

There are lots of half-truths and mischievous interpretations of legislation being bandied around the internet.

The series was my attempt at dispelling the myths and presenting the facts.

In Part Three (published 7 March 2023 — BEFORE SVB went south) my conclusion was:

‘7 per cent of the institutions have 87% of the deposits.

‘The concentration of deposits in so few institutions, means the government — in practical terms — has no choice other than to backstop the nine larger banks.

‘Allowing one or more of these nine banks to fail is not an option. Public confidence would be shattered. People would start second guessing which major bank is next. A run on the banks would become a self-fulfilling prophecy.

‘What if one of the smaller ADIs runs into trouble?

‘After exhausting all avenues to recapitalise the bank, would they confiscate (some or all) of the deposits in excess of the $250k limit?

‘According to the letter of the legislation, yes they could.

‘But what signal would that send to deposit-holders in other banks?

‘Watch out…you could be next.

‘Imagine the frantic switching of accounts out of the banking minnows into the Big 9? The loss of deposits in smaller ADIs would almost certainly trigger further bank failures.

‘Before acting, authorities would need to seriously consider Merton’s Law of Unintended Consequences…making a bad situation worse would be a really dumb move in a time of heightened anxiety. My guess is APRA would work behind the scenes to orchestrate merger/s.

‘Should one of the Big 9 fail, authorities might start with bail-ins from shareholders and investors in hybrids. 

‘Confiscating investor capital — either fully or partially — to recapitalise the ailing bank/s would be perfectly acceptable to the general public.

‘If that’s not sufficient, then prior to APRA seizing deposits greater than $250k, other options might be…

‘Facilitating mergers between the Big 9.

‘Capital controls could be invoked (to stop bank runs).

‘Or, thanks to the precedent established during the pandemic, government could roll out a “Bank Keeper” programme and have the RBA print sufficient funds to finance an expanded deposit guarantee scheme.

‘There are a variety of measures the authorities have at their disposal to (potentially) quell public anxiety and unrest.

‘With 87% of deposits held in nine banks, it’s unlikely the government would allow any of them to fail. The risk of contagion would be far too great.

‘Before taking any action, government needs to act very, very carefully…public confidence is a brittle commodity. Easily broken, but not so easily restored.

‘While, when push comes to shove, I am of the opinion bail-ins are unlikely…’

While my observation related to Australia, they’ve proven to be reasonably accurate when applied to the US and European problems.

In the US, when faced with the challenge of maintaining public confidence, the Fed blinked and rolled out its version of ‘Bank Keeper’.

And, as reported by CNBC:

‘Treasury Secretary Janet Yellen told senators that government refunds of uninsured deposits will not be extended to every bank that fails, only those that pose systemic risk to the financial system.’

What Yellen was effectively saying is…allowing one or more of [the big] banks to fail is not an option.

In Europe, the politicians and Swiss central bank worked ‘behind the scenes to orchestrate a merger’.

These international precedents may or may not be adopted in Australia.

However, when push comes to shove — like it did with the RBA printing money during the pandemic — our equally hapless central bank tends to be a follower, not a leader.

APRA might hold firm to the letter of the legislation and insist on any depositor with more than $250k takes a haircut.

While APRA might want to flex its muscles, I’m not so sure about Anthony Albanese and Jim Chalmers. They don’t look like ‘Men of Steel’ to me. Perhaps I’m just a bad judge of character.

Bottom line…be prepared for more problems in the US and European banking sectors.

And, when it comes to Bail-Ins, recent action in the US and Europe indicates there’s a great deal of flexibility in what’s been said and what’s been done.

As Wall Street starts its next, and far more brutal, descent to a much lower level, expect to hear a lot more from the clueless clowns in central bank land about proposed ‘solutions’.

The one absolute in all of this is central banks are THE problem, not the solution.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia