In the next few weeks we may see headlines like ‘Is America Greece?; ‘is it Italy?. The headlines won’t refer to wine, food and culture but to banks, because America now has a periphery bank problem. In the past three months the index of America’s regional banks has nearly halved. The speed (witness the demise of Silicon Valley Bank) and scale of what is happening is worrisome. At the height of the global financial crisis some 150 financial institutions – with total assets of nearly USD 500 bn – ceased to exist, though today a handful of American banks have expired, with assets of close to USD 600 bn up in the air.
With politicians and policymakers in Washington focused intently on the debt ceiling, the risk is that a periphery (regional and community banks) banks crisis overwhelms the debt debate and produces the sort of crisis that is consistent with the end of every Fed rate hiking cycle. My ‘breaking things’ thesis on the Fed remains intact.
The regional banks crisis is largely one of confidence (most bank crises historically have been), of monetary policy and of banking practice. In all too simple terms, banks have taken in deposits and matched these by placing capital in the Treasury market. As interest rates and inflation rose, the value of these Treasuries fell, thus reducing the capital available to banks should depositors want their money back.
The problem now is that depositors want their money back. Some of this is flowing to money market funds in order to avail of high interest rates that the banks do not offer. Social media and financial cable tv have not helped induce a sense of calm either.
Europeans of course have seen all this before, though our problem was one of the structure of the monetary system, in the context of a brittle banking system. Since the euro-zone crisis, a good deal has been done to bolster the euro-zone monetary system, but very little to advance capital markets and banking union. Looking at the USA, Europeans will also recognize the brutal way in which market stress leads policymakers to reverse policy rules put together in calmer times, to rush to provide market liquidity and to predictably blame speculators (they are not without blame but are not the root of the problem).
From here there are two risks for America. The first is that many of the policy measures that should induce some faith in the banking system (generous deposit guarantees, a liquidity provision mechanism (the BTFP)) are already in place, so that in the absence of a new broad program of support for the regional banks (that would break many of the rules of financial policy making), the pressure on the banking system persists and could unravel into a full-fledged crisis. Some of the underlying conditions in the US banking sector – such as a weak commercial real estate sector and a sharp drop in lending are a concern.
What is more worrying are the enduring effects of the decimation of America’s periphery banking system – there is a credit crunch going on in Silicon Valley and beyond that will also lead many venture firms to write down the value of investments. Then, in other parts of the US, individual states will be hit by the consequences of weaker regional banks, the shift of deposits towards behemoths like JPMorgan may mean that the costs of banking are higher.
This shift in capital from periphery to core mirrors a deeper trend in the US, which is that in terms of its society, economy and financial system it is becoming pyramidical, with a successful core at the top of that pyramid and a very large base or periphery.
Wealth in the US is highly unequal – 35% of all wealth is held by the ‘top 1%’ a high for the developed world and a figure that is exceeded only by emerging nations (India, Russia and Brazil). For comparison, in Canada the top 1% own 25% of total wealth. The wealth outlook in the US reflects in part the growing concentration effect in the stock market (the top five technology companies make up close to 25% of the market capitalization of the stock market), and now in the banking system.
It may also reinforce a narrative that American politics has become a system that favors insiders (core) at the expense of outsiders (periphery), and in terms of other markers such as the quality and provision of education and healthcare, and metrics like life expectancy there is a significant difference between the core and periphery (there can be a difference in life expectancy of up to seven years between ‘mid’ and ‘southern’ states like Mississippi and wealthier coastal ones like California and New York). More generally, overall life expectancy is plummeting in the US, at a rate only seen in Russia around the fall of communism.
In that respect, deposit flight may reflect the innate fears Americans have about their country, and this is a warning sign for a much deeper malaise.
Have a great week ahead,