Last week the US saw the second and third largest bank failures in history. I’m sure it’s left many of you wondering: What is going to happen next? Do I need to be afraid? Let’s dig into what happened and then answer those two questions.
Silicon Valley Bank and Signature Bank failed last week because each had a “run on the bank”. A bank run is when a large number of depositors try to take their money out at the same time. No bank, no matter how large, ever has enough cash on hand to pay out a significant number of deposits. This is because banks use deposits to make investments on their own behalf (in things like car loans, mortgages, and Treasury securities) to make enough money to pay you interest and keep some profit for themselves. The more money kept on hand to pay out deposits the less money is out working for the bank.
In the case of both Silicon Valley Bank and Signature Bank, they had investments that lost value. This made depositors nervous about whether the banks had enough cash to function. This caused a wave of panic that had depositors heading for the exits and the banks not having enough money to cover the withdrawals. Bank runs are an interesting phenomenon because it is partly a self-fulfilling prophecy; the more people pull their money, the less money the bank has on hand, the more people get nervous and pull their money, and so on. At its core the problem stems from the banks being in a financial position that made their depositors nervous.
Which leads to the question: What happens next? Well, the Federal Reserve now owns both banks and is covering depositors using funds from the FDIC dues every bank pays, notably guaranteeing deposits beyond the $250,000 limit. The Fed will then try to recoup those funds by selling off the remaining assets of both banks. Remember, both banks have loans and investments outstanding that still have value to a bank in a sound financial position. The Fed has made clear it wants to shore up faith in the banking industry. Now we all wait and see if any other dominos will fall, or if this was a case of a few isolated bad actors. The coming weeks will tell is which path the future holds.
But should you be worried about whatever bank you happen to be using? My immediate response would be no. The Fed’s swift action shows they are serious of avoiding another 2008-like cascade of horror. And if you have $250,000 or less of deposits at any given bank, your deposits are covered by the FDIC. But if you likely don’t need to worry about your savings account, what about the broader economy? The answer there is complex because the current environment has incentives for banks to not only pull back and lend less, but also use higher interest rates to make more on investments. The most likely outcome is these two factors cancel each other out. So long as the crisis doesn’t spread, I don’t see these bank failures affecting the economy definitively in either direction.
So far, the banks in question each had a unique situation that put them in a risky position, whether the boom time deposits from tech in SVB or the Crypto exposure of Signature. It seems unlikely those particular circumstances will be widely replicated. For the vast majority of Americans, the bank will still be a safer place for your money than under the mattress or buried in the back yard. However, it does give good reason to look at how much of your money is in the banking system and if that’s the best place to have it given your current financial situation.
If, like my wife, this made you have more questions rather than less, contact me, and I’ll be happy to talk with you individually!