The Federal Reserve’s campaign to reduce inflation by raising the fed funds rate and grrrraaadddually cutting their bloated book of long-term Treasuries and mortgage bonds has caused a banking crisis since the market value of banks’ bonds has dropped.
At the same time, savers have moved huge amounts of cash from bank accounts to money market accounts to get higher interest rates. Unlike banks, which lend their deposits into the real economy (e.g. commercial and industrial real estate lending), money market managers use the Fed’s ‘overnight reverse repurchase agreement facility’ to get interest but this money doesn’t enter the real economy. This threatens the banks as well as the real economy.
The Crisis Bearing Down on Us
By Sean Brodrick, Weiss Ratings, April 12, 2023
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The banking crisis isn’t over. Heck, no.
Did you know that:
• More than $900 billion in deposits have flowed out of banks since the Fed began to raise interest rates in March of last year.
• The past two weeks have experienced the largest cut to bank lending in U.S. history.
• We’re also seeing the largest decline in lending to the real estate industry in history…
Assets held in money market funds hit a record $5.2 trillion earlier this month, as savers added more than $300 billion to them in the past three weeks… Close to $2.3 trillion of all money market funds are parked at the Federal Reserve’s reverse repo facility. Doing that effectively removes the money from circulation… This is a real problem for real estate, as mid-size banks are especially crucial players in the commercial real estate industry. Those smaller banks provide 67% of all loans in commercial real estate…[end quote]
How Silicon Valley Bank’s Failure Could Have Spread Far and Wide
New research suggests large parts of the country remain vulnerable to widespread bank failure in the event of a run on deposits.
By Jim Tankersley, The New York Times, April 13, 2023
…
The analysis of geographic risks from a banking crisis, prepared at the request of The New York Times, was done by economists at Stanford University, the University of Southern California, Columbia University and Northwestern University…
Although the damage has so far been contained, the research shows that larger runs on banks vulnerable to rate increases could result in a significant drop in credit available to store owners, home borrowers and more. Because so many counties rely on a relatively small number of financial institutions for deposits and loans, and because so many small businesses keep their money close to home, even a modest run on vulnerable banks could effectively stifle access to credit for entire communities…
To map the vulnerabilities of smaller banks across the country, the researchers calculated how much the Fed’s interest rate increases have reduced the value of the asset holdings for individual banks, compared with the value of its deposits. They used that data to effectively estimate the risk of a bank failing in the event of a run on its deposits, which would force bank officials to sell undervalued assets to raise money. Then they calculated the share of banks at risk of failure for every county in the country.
Those banks are disproportionately located in low-income communities, areas with high shares of Black and Hispanic populations and places where few residents hold a college degree…
In counties across the country, smaller banks are crucial engines of economic activity. In 95 percent of counties, Goldman Sachs researchers recently estimated, at least 70 percent of small business lending comes from smaller and regional banks. Those banks, the Goldman researchers warned, are pulling back on lending “disproportionately” in the wake of the Silicon Valley Bank collapse…larger financial institutions are unlikely to quickly fill any lending vacuum in those communities if smaller banks failed…[end quote]
This is a potentially catastrophic danger to the economy over vast swathes of the U.S.
Small savers won’t be wiped out in the event of a bank failure since they are protected by the FDIC insurance. But the local economies could be devastated since the failure of a small or medium-size local bank could wipe out business accounts and also the ability of local businesses and property buyers to borrow.
The FDIC got heavy criticism for bailing out Silicon Valley Bank and Signature Bank on the grounds that they were systemically important. A similar case could not be made for small and medium-size regional banks. They would be allowed to fail.
These communities are “fly over country” to people who live in the big coastal cities. But they are the heartland of America and millions of people live there, although very spread out. Widespread bank failures would depress economic activity, worsening a recession.
Wendy
