SPECIAL UPDATE: The Big Bankster Bust

Christine Lagarde, president of the European Central Bank (ECB), said at a Brussels conference last week that the European banking industry is “strong” and the ECB stands ready to intervene.

PUBLISHER’S NOTE: As the banking crisis continues, each week we will provide Trends Journal subscribers with an overview of the current events forming the future banking crisis trend. The following is one of dozens of economic articles found in this week’s issue of The Trends Journal. Consider subscribing here for in-depth, independent geopolitical and socioeconomic trends and trend forecasts that you won’t find anywhere else.

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While the European Central Bank and the U.S. Federal Reserve have vowed to do all it takes to prevent a banking crisis, there are fears of a bad situation becoming much worse. 

As we have warned, the higher interest rates rise, the greater the risk for banks to lose more money on their U.S. Treasuries and mortgage backed securities. According to The Wall Street Journal, banks took depositor’s money and invested it in mortgage backed securities valued at $2.8 trillion at the end of 2022. 

The unrealized losses on these, according to the FDIC are $368 billion. And unrealized losses in the commercial real estate debt sector reached $43 billion last quarter, while the banks hold $444 billion of these securities according to the FDIC.

Thus, as we have been the first to forecast an Office Building Bust, the owners of these half-empty office buildings won’t be able to pay their debt, will default on their loans and more banks will go bust. And as we have warned, it will escalate the banking crisis and may be the spark that ignites a global economic crisis.

Indeed, as reported by RT, yesterday the CEO of Australia and New Zealand Banking Group (ANZ), Shayne Elliott, warned on Monday the threats facing some U.S. and EU banks have the “potential” to trigger a global financial crisis.

While saying it was premature to forecast “another GFC [global financial crisis]” like the one that set off the Panic of ’08, Elliot stated, “We shouldn’t be surprised that things like this happen, it’s a crisis for some obviously, but is it a financial crisis? Who knows. Does it have the potential to be one? Yes, it does have the potential.” 

The following is an overview of the current banking situation… its ups and downs.

FIRST CITIZENS BANK SET TO BUY FAILED SILICON VALLEY BANK 

First Citizens Bank Shares will take the failed Silicon Valley Bank (SVB) off the U.S. government’s hands in an all-stock deal worth up to $500 million, leaving federal insurers owing about $20 billion to customers who had deposits in SVB when it failed on 10 March.

First Citizens’ share price rocketed up 50 percent on the news.

Instead of paying cash, First Citizens gave the FDIC “equity appreciation rights” in its stock that could eventually be worth up to $500 million, compared to SVB’s estimated value of $13.3 billion at the end of 2022.

The FDIC will be able to cash in those rights for First Citizens stock from now until 15 April.

First Citizens will assume Silicon Valley Bank’s assets of $110 billion, deposits of $56 billion, and loans of $72 billion as part of the transfer. First Citizens also is buying SVB’s private wealth management business.

First Citizens, based in Raleigh, NC, has a long-established appetite for failed competitors. It has completed 21 similar takeovers, including 14 since 2009 after the Great Recession arrived, according to brokerage Piper Sandler.

Taking over SVB will speed First Citizens’ expansion in California and give it a wealth management operation in the U.S. northeast, First Citizens said.

WHAT TO EXPECT NEXT FROM THE FED

First Citizens has assets of about $109 billion and deposits totaling $89.4 billion. The new combined entity will have $219 billion in assets and $145 billion in deposits, First Citizens said.

“The FDIC estimates the cost of the failure of Silicon Valley Bank to its Deposit Insurance Fund to be approximately $20 billion. The exact cost will be determined when the FDIC terminates the receivership,” First Citizens added.

“The Federal Deposit Insurance Corp.’s (FDIC’s) sale of SVB helps show business can go on as usual for the banking industry,” Wells Fargo analysts wrote in a 27 March note.

FIRST REPUBLIC BANK LAVISHED MILLIONS ON FOUNDER AND HIS FAMILY

First Republic Bank, still teetering on the edge of failure, paid millions of dollars to relatives of founder James Herbert in recent years, including for consulting services related to risk, according to the bank’s regulatory filings reviewed by The Wall Street Journal.

The bank paid Herbert $17.8 million in 2021, more than CEOS at most similar-size banks earn, the WSJ said.

Prior to founding First Republic, Herbert oversaw fixed income at the now-failed Credit Suisse, guiding the division successfully through the early days of the Great Recession.

A consulting business owned by Herbert’s brother-in-law collected $3.5 million in 2021 and a similar amount in 2020 to advise the bank on “investment, risk management, interest rate, economic outlook, and other financial matters,” the filing said.

The consultancy, Capra Ibex, was created in 2010 specifically to advise the bank, according to the WSJ.

Herbert’s son earned $3.5 million running one of the bank’s lending operations during each of those two years, according to the WSJ.

The bank, which specializes in serving wealthy customers, has seen its stock price shrink by 90 percent this year. 

Depositors have pulled their money out for fear that First Republic shares similar problems with Signature and Silicon Valley banks, which collapsed in mid-March.

Herbert and other bank executives have sold at least $11 million worth of First Republic stock this year, as we reported in “First Republic’s Tailspin Continued Monday” (21 Mar 2023).

The bank’s hefty portfolio of mortgages has lost billions of dollars in value as interest rates have risen.

First Republic was the 14^th largest U.S. bank at the end of 2022, measured by assets.

PUBLISHER’S NOTE: As comedian George Carlin used to say, “It’s one big club and you ain’t in it.”

First Republic’s outsized enrichment of its founder and his family members is another aspect of lax supervision by regulators.

However, without changes by Congress to current regulations, little will be done to curb these real or apparent abuses.

LAX OVERSIGHT ALLOWED BANKS TO FAIL, EXPERTS SAY

Bank regulators did not respond quickly or effectively enough to changes in the banking industry and broader financial environment, thus allowing Signature and Silicon Valley banks to fail, according to industry experts interviewed by The Wall Street Journal.

Regulators failed to recognize the impact of rapidly rising interest rates on banks’ bond holdings, the insiders said, pointing to the U.S. Federal Reserve’s delay in raising interest rates until inflation was deeply rooted in the economy.

The Fed then had to play catch-up with inflation, jacking interest rates steadily from 0.25 percent to 5 percent over 12 months.

It was only in late 2022, when the Fed’s base rate had moved from 0.25 percent to between 4.25 and 4.5 percent, that Fed regulators warned Silicon Valley Bank (SVB) that it was failing to address interest-rate risk in its portfolio of low-yield bonds.

The market price of those bonds had been falling for months, leaving U.S. banks with an estimated $620 billion in unrealized losses. However, regulators did not begin raising red flags about the problem until mid-2022 at the earliest, the WSJ found.

Monitoring changing interest rates and their effect on banks’ investments is a key obligation of regulators. As bond values fall, banks’ cushion between assets and liabilities becomes thinner and the risk of insolvency increases.

“Stress tests for big financial institutions haven’t considered a scenario of high inflation and rates for years,” the WSJ said.

Despite some SVB employees pushing executives to hedge against rate hikes, the bank’s leaders continued to expect interest rates to fall, telling investors last fall the bank was “shifting focus to manage downrate sensitivity.” 

Regulators and executives also allowed the now-failed banks to become too dependent on accounts with balances exceeding the Federal Deposit Insurance Corp.’s (FDIC’s) $250,000 insurance cap.

The Fed’s most recent semi-annual financial stability report noted that deposits in excess of the FDIC’s $250,000 insurance cap were growing, but the report did not flag this as a risk.  

“Not only were roughly 90 percent of SVB’s deposits uninsured,” the WSJ wrote. “They were concentrated in companies and people linked to tech and venture capital,” sectors that were taking a beating in the stock market as interest rates moved higher.

“Regulators acknowledge that they didn’t stress such a concern because the big deposits were from SVB’s and Signature’s core customers who, it was thought, would stick around,” the WSJ said.

The opposite came to pass: once the banks showed signs of instability, deposits vanished as fast as customers, inflamed by social media posts, could tap an order into their smartphones. 

Supervisors met with Signature Bank’s board on 15 February “and didn’t say anything about ‘we’re worried that your uninsured depositors are going to fly’,” Barney Frank, a Signature board member and former U.S. representative who co-authored the Dodd-Frank banking reform act, said in a WSJ interview.

“There was no alarm, no warning that ‘you guys are in trouble’,” he said.

A month later, the bank collapsed.

Also, supervision itself has become more bureaucratic and focused more on process than on responding quickly to warning signs at a time when the speed of banks’ operations were accelerating, the experts said.

“The supervisory process had not evolved for rapid decision-making,” Eric Rosengren, former president of the Federal Reserve Bank of Boston, told the WSJ. “It’s focused on consistency over speed.”

“Over decades, bank supervision has evolved to put priority on consistency, fairness, and transparency rather than speed,” the WSJ confirmed. 

Also, since the 1990s, regulation has drifted from local offices to Washington, especially after the Great Recession and passage of the Dodd-Frank Act, slowing responses even more.

In 2018, Congress and the Trump administration raised the threshold for the most vigorous oversight.

Instead of the strictest rules applying to banks with $50 billion or more in assets, those rules now apply to those with at least $250 billion, leaving many small and regional banks receiving only cursory reviews.

“It’s difficult for supervisors to take formal action in the absence of clear proof a bank is in danger,” the WSJ said.

The debacle of Signature’s and SVB’s sudden implosion calls for a broad-based reconsideration of the current regulatory approach, Fed chair Jerome Powell said in 22 March testimony to the U.S. Senate.

“There’s need for possible regulatory and supervisory changes because supervision and regulation need to keep up with what’s happening in the world,” he acknowledged.

TREND FORECAST: The focus will now shift to Congress as a actions-speak-louder than words fight rages between those who will push for reinstatement of stricter Dodd-Frank requirements, and probably new controls as well and those who will fight the changes… leaving the clown Congress gridlocked over yet another issue.

Meanwhile, the Fed and treasury department are likely to tighten their oversight activities and guidelines within the bounds defined by Congress while the country waits for legislators in the Capitol to end their wrestling match. 

DEPOSITS AT U.S. BANKS DECLINE BY MOST IN ALMOST A YEAR

During the week ending 15 March, deposits at U.S. banks plunged as households and businesses transferred money from smaller banks to bigger ones or to money market funds and other non-bank accounts, according to U.S. Federal Reserve data.

Deposits slipped by $98.4 billion to a total of $17.5 trillion. Deposits at smaller banks fell by $120 billion; the 25 largest banks took in about $67 billion more than usual.

The amount of money in bank-held checking and savings accounts declined by 6.1 percent, year on year, the steepest decline since the early 1970s, Bloomberg reported.

In contrast, money market funds collected more than $117 billion during the week that ended 22 March, according to the Investment Company Institute.

Banks have been watching deposits leak away to money market funds and other venues paying higher interest rates than the fractional yields most banks still offer.

Then Signature and Silicon Valley banks crashed in mid-March, spooking depositors already frazzled by rising interest rates and lingering economic uncertainty.

After the two banks collapsed, the treasury department and U.S. Federal Reserve opened new lending venues for banks seeing disturbingly high rates of withdrawals.

U.S. banks had borrowed $165 billion through those programs as of 23 March, Fed data showed, in “a sign of escalated funding strains,” Bloomberg said.

BANK INDUSTRY’S ILLS MAY SPREAD MORE WIDELY, MOODY’S WARNS

Although federal regulators and other officials moved quickly to contain damage after Signature and Silicon Valley banks failed in mid-March, a risk remains that the troubles may spread, “unleashing greater financial and economic damage than anticipated,” Moody’s Investor Services warned in a 23 March note.

Officials may be “unable to curtail the current turmoil without longer-lasting and potentially severe repercussions within and beyond the banking sector,” the note said.

However, Moody’s expects the containment steps will “broadly succeed.”

Moody’s alert followed assurances by treasury secretary Janet Yellen and U.S. Federal Reserve chair Jerome Powell that the U.S. banking industry is “sound and resilient.”

Still, worries remain among professionals.

Depositors may accelerate their withdrawals from small and regional banks, William Ackerman, Pershing Square Capital Management founder, said. 

In a new Bank of America poll, 31 percent of 212 money managers surveyed said that a systemic credit crunch is now the biggest danger to markets. 

Moody’s agreed, writing that the “most potent” risk from the banking crisis is that investors will avoid risk and banks will be reluctant to issue credit, leading to “a crystallization of risk in multiple pockets simultaneously.

“Over the course of 2023, as financial conditions remain tight and growth slows, a range of sectors and entities with existing credit challenges will face risks to their credit profiles,” Moody’s predicted.

A less likely outcome, though still possible, is that investors in other areas of the economy could be damaged by having deposits in, loans from, or holding stock in banks that become troubled.

Also, policy makers focused on inflation could wait too long to respond forcefully enough to ongoing struggles among banks, Moody’s said.

BANKS’ COLLAPSE KILLS CREDIT AND IPO MARKETS

From 10 March through 17 March, no new investment-grade bonds were issued. 

It was the first March week without a high-grade bond sale since 2013, The Wall Street Journal reported.

There were almost no new junk bond sales during the time and no company went public between 10 March and 24 March, the WSJ noted.

Typically, March is a busy month for borrowing. Companies typically secure new financing before the “blackout period” between the end of the quarter and earnings announcements.

However, investors’ general twitchy outlook, volatility in the treasuries market, and now the banking industry’s tumult has corporations sitting pat as institutional investors and other bond-buyers have lost their appetite for risk.

Corporate bond interest rates are determined by adding a risk premium to the so-called “risk-free” yield on treasury securities.

With the treasuries market’s recent volatility, “a company that launches a bond sale in the morning expecting to pay one rate could find the market has changed when the deal is priced in the afternoon,” the WSJ noted.

This month through 24 March, the highest-rated companies sold $59.9 billion in bonds, compared to the five-year March average of $179 billion.

Junk bonds fetched only $5 billion during the period; their five-year March average is $24 billion.

Corporations’ decision to wait to borrow will cost them, analysts predict.

Not only has the U.S. Federal Reserve raised its base interest rate again, but also the banking industry’s travails will tighten lending standards and are likely to add a higher risk premium to interest rates, the WSJ said.

“Ultimately, financial conditions will tighten further, either via additional central bank tightening or a deterioration in the current banking crisis,” Seema Shah, chief strategist at Principal Asset Management, said in a WSJ interview.

U.S. BANKS ARE STRONG BUT NEED BETTER OVERSIGHT, POWELL SAYS

The U.S. banking system is “sound and resilient” but the U.S. Federal Reserve needs to improve its regulation and supervision of banks, Fed chair Jerome Powell said in 22 March testimony before the U.S. Senate.

The Fed had direct supervisory responsibility for Silicon Valley Bank (SVB), which failed spectacularly earlier this month, briefly shaking the U.S. banking industry.  

Crypto-focused Signature Bank imploded at the same time as SVB. First Republic Bank has teetered on the edge of collapse, prodding 11 banks to pour $30 billion into an attempt to rescue it. The bank’s fate is still uncertain; its shares closed at $13.82 on Monday, 27 March, down from a high of $147 on 2 February. 

Several banks have followed First Republic downward. 

Western Alliance Bankcorp’s shares have lost more than half their value since SVB sank. 

PacWest’s share price also has shed more than half its stock value, losing 17 percent 22 March alone after revealing it had borrowed billions from the Fed, its regional Federal Home Loan Bank, and Apollo Global Management to fill a financial crater left after a large volume of deposits had fled.

Like SVB, PacWest has catered to venture-capital-related businesses.

“History has shown that isolated bank problems, if left unaddressed, can undermine confidence in healthy banks,” Powell said.

Withdrawals from banks tapered off last week, he noted, adding that the ills that sank SVB were not widespread among U.S. banks.

“These are not weaknesses that are at all broadly through the banking system,” he emphasized.

SVB “was an outlier in terms of both its percentage of uninsured deposits and of its holdings” that were not hedged against rising interest rates, he said.

Regulators guaranteed reimbursement of all of SVB’s deposits, not just those that fell within the U.S. Federal Deposit Insurance Corp.’s (FDIC’s) limit of $250,000.

Several SVB depositors held tens of millions of dollars in single accounts to meet payrolls and pay ongoing bills. Refusing to reimburse those losses would have damaged workers as well as the regional and national economies, treasury secretary Janet Yellen and others have emphasized.

However, this does not mean that every depositor in any failed bank will be fully insured for their total losses, she noted; any such situation will be reviewed on its own particulars.

“You’ve seen that we have the tools to protect depositors where there’s a threat of serious harm to the economy and the financial system and we’re prepared to use those,” Powell told the Senate. “Depositors should assume their deposits are safe.”

Some legislators have proposed raising the FDIC’s insurance cap.

SVB’s unhedged assets included a portfolio of low-yield bonds that it was unable to sell to raise cash after interest rates began rising last year.

Many banks hold similar assets as well as debt backed by loans secured by office buildings.

As a class, office buildings have been sliding in value for the past three years. Many loans against those properties are due to expire in the next two years. 

With interest rates having risen from less than 2 percent to more than 6 percent in the past year, many landlords may be unable to finance those buildings on profitable terms and may walk away, as we reported in “Office Tower Owner Defaults on $1.7 Billion in Mortgages” (28 Feb 2023).

Powell dismissed concerns that office buildings’ sinking value could bring other banks to SVB-style collapse.

“We’re well aware of the concentrations people have in commercial real estate,” Powell said. “I really don’t see that as at all analogous” to the reasons for SVB’s failure.

SCHOLZ DISMISSES DEUTSCHE BANK COMPARISON TO CREDIT SUISSE

Deutsche Bank, Germany’s largest commercial lender, saw its share price dive 14 percent at one point on 24 March as stock-pickers probed more banks for weaknesses. 

The stock ended the day down 8.5 percent.

German chancellor Olaf Scholz sought to stanch the financial bleeding.

“Deutsche Bank has fundamentally modernized and reorganized its business and is a very profitable bank,” Scholz said in a public statement after markets closed Friday, 24 March. “There is no reason to be concerned about it.”

Deutsche Bank’s stock tumble was among several large European banks to see shareholders exit amid ongoing fears that Credit Suisse would not be the region’s only major lender to collapse.

The sector’s stock performance had already been weakened by continuing inflation and rising interest rates. The collapse of two U.S. banks and Credit Suisse earlier this month heightened investors’ fears.

Scholz’s comments were part of European leaders’ efforts to calm market fears about the continent’s financial sector.

Christine Lagarde, president of the European Central Bank (ECB), said at a Brussels conference last week that the European banking industry is “strong” and the ECB stands ready to support banks that prove otherwise.

TRENDPOST: Deutsche Bank has one thing in common with Credit Suisse: a history of scandal, including dodgy bond sales techniques, money laundering, fiddling interest rates, mortgage fraud, and violating international sanctions against pariah states. 

Law enforcement squads have raided the bank’s Frankfurt headquarters twice since 2018.

Large banks are the most likely to repeatedly find themselves on the wrong side of the law. (See “Bankster Bandits: ‘Serial Crime Wave at the Largest U.S. Bank” 21 Dec 2021.) When financial conditions tighten, banks with rap sheets are the ones most likely to see depositors leaving.