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Just How Fragile Is The Banking System?

By Paul J. Carroll, CFP®March 24, 2023Videos


With all the news of bank failures, just how fragile is the banking system today and what, if anything, can you do about it?

If you’re one of my clients, you already know that interest rates, when they rise, cause bond values to fall. Long bonds fall a lot. This is why for the last two to three years, we have been putting our clients in short-term bonds to protect them from the ravages of the bond market in a rising interest rate environment.

Somehow, to my great fascination and to the consternation of regulators, the Silicon Valley Bank, Signature Bank, First Republic Bank*, and probably more to come broke that most fundamental rule, and when loaded up with cash post-COVID because everybody got disbursements, they got bailout money, they got PPA money, they wanted to put that money somewhere and they decided that treasuries weren’t yielding enough, “We’ll put them in 20 year treasuries and get ourselves an extra half percent interest.” Well, that half percent interest was a fool’s errand because now that interest rates are rising, those long bonds have plummeted in value. Their portfolios have lost billions of dollars and the banks now have insufficient funds to meet the minimum requirements for a cushion of funds, customers are getting nervous, they’re withdrawing.

Signature Bank and the Silicon Valley Bank and also First Republic all had one thing in common, especially the first two: a lot of tech exposure and a lot of clients with more than the $250,000 FDIC insured limit. The word got out that these banks weren’t as safe as people thought and that money flew out the front door. Now, there are some minor differences. Signature Bank had a little more crypto exposure, they both had a lot of tech exposure. The challenge for the Federal Reserve has been how do you solve this problem? How do you protect the system while also not causing the economy to go into a nose dive? This was particularly true for SVB and Signature Bank because they were very highly concentrated in tech.

The concern was that a total failure of these two banks would cause a large number of small tech companies to not be able to make payroll, to literally go out of business through no fault of their own. So now the Fed has to balance the moral hazard of bailing out people above 250 versus the cost and damage of an entire sector, of an entire industry, going out of business. I think they made the right call. If someone asked me, I would’ve said they should have put a 10% haircut or a 20%, but it’s easy to Monday-morning quarterback. These things happen in a matter of hours and they have to make these decisions under a lot of pressure, a lot of duress, so I’m a little more forgiving on the margin.

First Republic has a little less tech exposure but they still had long bonds. They still had a lot of uninsured deposits. When you have huge losses and you have large uninsured deposits, you get a run on the bank.

The question is just how bad is this and how unexpected or expected? First we hear that these are the two largest bank failures in history. Yeah, but the largest one was WaMu in 2008, factoring inflation. Even without inflation, Washington Mutual was a far bigger bank failure. These are regional banks. The next thing we get is it’s this global contagion. Credit Suisse. Yeah, but Credit Suisse was appallingly badly managed, made some of the same mistakes, riddled with corruption, riddled with poor investments, billions of dollars of losses over the last decade. It was a bad bank and the Swiss basically sold it for pennies on the dollar under duress to UBS, who didn’t even want it.

What’s really going on here? What’s causing these shock waves in the banking system? This is the end of free money. With interest rates going up, it’s the end of ZIRP, zero interest-rate policy, and these interest rates are likely going to stay up longer than people thought at first. Inflation as it comes down to 6% is getting more stubborn. To get it down to the 3%, that’s the more likely target even if 2% is the headliner, it’s going to mean a long period of elevated interest rates. There are good reasons to think the demand for money’s going up with all the infrastructure projects going on in the world and other situations.

Is this even good? I would argue it’s great. That sounds crazy, but zero interest-rate policy and free money is extremely unhealthy for a vibrant economy. The reason is because it enables what’s known as zombie companies, companies that in the more normal environment couldn’t make the interest payments because they’re so badly run. There’s a term called Schumpeter’s creative destruction. The true value of a market economy is the fact that the weak fail and are replaced by newer, healthier, better run companies that can provide a better service at a better price in the long run, so this is actually good for the health and dynamism of an economy.

How afraid is the Fed? The Fed’s concerned. I think the Fed told us yesterday, plus quarter percent, inflation’s still the 300lb gorilla in the room. 0% or no hike would’ve meant, “We’re really, really afraid of the stability of the banking system.” It’s probably reasonable to assume that future hikes are going to be moderated, but this was a very important thing for the Fed to do. The reason is if they’d have gone to zero, that would’ve been a signal to the markets that inflation is no longer the number one priority. What we would’ve actually seen is long bond interest rates and the market’s estimation of future inflation going up. We don’t want long-term inflation. The markets love to hear that the Fed takes inflation seriously.

What can you or should you be doing? How does this affect you, the retail investor? Well, first and foremost, you should never have more than $250,000 in an insured account. Really, most checking accounts don’t pay enough interest to justify. We did a video not long ago, money markets, ETFs. Any money market or ETF that’s backed up by treasuries or near treasury instruments, hey, there’s no run there. The reason there’s a run on the bank is the money’s loaned out. The true faith and credit of the bank is being tested. But when you’re investing in treasuries, you are now investing in a entity that has a printing press. If you’re inventing in short-term bonds that invest in ultra short-term AAA paper from corporations, the only way you’re not getting that money back is if a huge percentage of these companies fail in less than 90 days.

I would posit that if that actually happened, you’ve got much bigger problems than whether or not your account is insured by the FDIC, so don’t do much other than keep those balances to $250,000. If you want to profit from this, we’re looking at some big bank exchange traded funds, baskets of the big banks that are actually going to make hay out of this as the dust settles because all of the banks were hammered by this event. I was listening to the podcast this morning by NPR on Jerome Powell. It was a report card on Jerome Powell, how’s he doing? You can ask five people and get five different results. Personally, depending on what you’re talking about, somewhere between a C and a B+ is probably the best assessment. It’s so easy to grade someone else when you’re not under the gun. It’s a great little podcast and I’ll put it at the bottom of this if you’re interested in hearing that.

If you have any questions or concerns about where to put savings, how to protect your savings and how concerned you should be about America’s banking system, reach out to me or any of my team. Call me, email. In the meantime, we wish you the best of success. Thank you.

* To be clear, First Republic Bank has not yet failed. They are in trouble, with the stock down over 90% and the FDIC still trying to broker a takeover.


Paul J Carroll
Founder & CEO at Avion Wealth

Paul is the founder and CEO of Avion Wealth, LLC. He leads a team of wealth managers in building and executing financial plans for high net worth individuals and families. Contact Avion Wealth to speak with a financial advisor.