I remember the first time I saw the Christmas movie classic “It’s a Wonderful Life” with Jimmy Stewart, and I was fascinated with the famous bank run scene.
I was just a kid, and of course didn’t understand the scene completely, but I knew it was about something unusual and significant.
I was particularly curious about how George could say in the scene the money being demanded by the bank customers was actually in “Joe’s house, and the Kennedy house, the Macklin house and a hundred others.”
The scene is a dramatic depiction of the fractional reserve banking system. This week we got a crash course in this concept, with a very modern spin.
I am referring to the Silicon Valley Bank (SVB) crisis that emerged late last week. To discuss the issue, we do have to talk a bit about SVB itself, but I think the lessons from this predicament are not necessarily unique to this bank and are concepts we all should work to understand.
As a quick primer, SVB, the 16th largest bank in the United States, experienced a modern bank run on Thursday, March 9, when its customers began attempting to remove their capital from the bank in droves. The reason for the run is largely thought to be the result of negative social media activity that ended up being echoed in the real world. The bank was unable to meet the demands of its depositors and government regulators had to shut the bank down and put it into receivership.
Now, banks shut down every year, and as this news broke, I was attending an investment conference and my reaction was mostly curiosity. I was familiar with SVB but didn’t consider it a critical part of the financial infrastructure of the nation, and I candidly wasn’t overly concerned about the collapse of a faraway California regional bank.
It was when I received a phone call from my nephew in Ohio, who works for a startup software company, that I became more concerned. He told me he had just forwarded me an email, and wanted me to read it and tell him what I thought. The email was alarming; it was from his company’s founder who in the message was notifying the company’s employees that the firm’s entire capital base was held at SVB, and they were monitoring the situation and at that point confident they would have enough access to their insured deposits to make the next payroll. The next payroll!
The email was terrifying. If a well-capitalized software company in Ohio stood to lose all its startup capital in this collapse, just how widespread could this get? The answer, as we would learn later, was “very widespread.” SVB had relationships with small tech companies, not just in California, but all over the country, and if the bank could not honor its deposits, hundreds of fledgling enterprises stood to lose their startup capital. The loss of jobs and potential innovation would be catastrophic. Now I was concerned.
I pulled SVB’s financials online. I’m not a financial analyst, but I do have experience with balance sheets, and after reviewing, my opinion was, the financials didn’t look that bad, and despite running a highly specialized business model serving start-up tech companies, the report actually didn’t look very unusual to me either.
I would describe many community and regional banks across the country as bloated with capital. As the Fed exploded the money supply over the past two years, and the government pumped stimulus into the economy during COVID, households and businesses deposited their largess into these banks. Having been already required by regulation to maintain higher cash reserve levels, and now flush with excess deposits, many banks stored this capital in U.S. Treasuries and Mortgage Backed Securities (the modern version of the neighborhood homes in “It’s a Wonderful Life”) in the zero percent rate environment of the past few years. As the Fed began raising interest rates aggressively, these low yielding securities lost material market value, leading to massive unrealized losses on many bank balance sheets. It is the prospect of these unrealized losses that led to the bank run on SVB, and this process could have, and may be, repeated with many other banks.
Fortunately, the Fed and the FDIC took a very proactive approach toward this crisis, and while the response was not technically a “bailout,” no depositors were impacted financially by the banks that have failed thus far. In my opinion, both Fed zero interest rate policy and regulatory failures contributed to this unfolding calamity, so the special policies to protect depositors were warranted.
Unfortunately, while the system is stable, the underlying causes still persist. With inflation still heated up, and a financial system now flashing signs of extreme stress, predicting Fed policy going forward is now even more murky. These are not easy times.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
