In the US banking system, $9 trillion in uninsured deposits have been accumulated due to the twin crashes of the commercial real estate market and the US Bond market. In the age of cyberspace, such deposits can disappear in an hour.
In a short time, the second and third largest bank failures in US History followed . The US Treasury, and Federal Reserve want us to think that they are “idiosyncratic”. This is a dangerous way to avoid the truth.
Nearly half of America’s 4800 banks have already depleted their capital buffers. The US accounting standards may not require them to mark to market all losses, but this does not make the banks solvent. Someone will take the losses.
“It’s spooky. Professor Amit Serut, a Stanford University banking expert, said that thousands of banks were underwater. Let’s not pretend this is only about Silicon Valley Bank or First Republic. “A large part of the US banking sector is insolvent.”
The full impact of the Fed’s monetary tightening has not yet been felt. Over the next six months, a great debt edifice will face a refinancing “cliff edge”. The US financial system will only be able to deflate excess leverage caused by the extreme monetary stimuli during the pandemic.
According to a report from the Hoover Institution , Prof Seru along with a group banking experts calculated that over 2,315 US Banks currently have assets worth less than liabilities. Their loan portfolios are worth $2 trillion less than their stated book value.
Among these lenders are big beasts. One of the ten most vulnerable banks has assets in excess of $1 trillion. Three other banks are also large. He said that the problem was not limited to banks with less than $250 billion in assets, which did not have to undergo stress tests.
After the collapse of Silicon Valley Bank in March , the US Treasury and Federal Deposit Insurance Corporation thought they had quelled the crisis when they bailed out the uninsured deposits at Signature Bank and Silicon Valley Bank using a “systemic risks exemption”.
The White House was averse to a blanket deposit guarantee because it would appear as social welfare for the wealthy. The FDIC only has $127bn in assets and that number will drop very soon. It may need its own bailout.
Authorities preferred to keep the issue vague in hopes that depositors will discern implicit guarantees. The gamble was a failure. Last week, First Republic Bank’s depositors fled at a rapid and furious rate despite a $30bn infusion from a group big banks.
When they saw the extent of the damage to the real estate, white knights who were investigating a possible First Republic takeover backed away. FDIC had no choice but to take over the bank and wipe out all bondholders and shareholders. JP Morgan was compelled to take over the bank after receiving a $13bn loan and a subsidy of $13bn .
Krishna Guha, Evercore ISI, said that “no buyer would buy First Republic without public subsidies.” He warns hundreds of small- and midsized banks to tighten lending and batten down their hatches in order to avoid the fate he has suffered. Here’s how a credit crisis begins.
In late trading, PacWest shares, which is next on the list of sick companies, dropped 11pc. This will be a bellwether for what happens next.
By temporarily guaranteeing all deposits, the US authorities can limit the immediate liquidity crises. This does not solve the larger problem of solvency.
Treasury and FDIC remain in denial. The failures are blamed on reckless lending, poor management and the over-reliance of a few banks on uninsured, foot-loose depositors. This sounds familiar. They said the same when Bear Stearns collapsed in 2008. “Everything was going to be okay,” said Prof Seru.
First Republic has lent to start-ups in technology, but its biggest problem was commercial real estate. This will not be last time. The office blocks and industrial properties are at the beginning of a severe slump. Jeff Fine, Goldman Sachs’ real estate expert, said: “We are in the early stages of a deep slump.”
Rates have risen 400-500 basis points over the past year and finance markets are almost shut down. He said that there are four to five trillions of dollars in commercial (property sector) debt, and about one trillion of it is due to mature in the next 12-18 months.
CMBS packages are usually short-term and must be refinanced at least every two or three years. The Fed’s flood of liquidity during the pandemic triggered a boom in borrowing. This debt is due late in 2023 or 2024.
Could losses be as severe as those of the subprime mortgage crisis? Most likely not. Capital Economics claims that the US residential real estate investment bubble peaked in 2007 at 6.5pc. Commercial property is now 2.6pc.
The threat is also not insignificant. US commercial property values have fallen only 4pc-5pc. Capital Economics predicts a 22pc decline from peak to trough. This will further damage the loan portfolios held by regional banks, which account for 70% of commercial property financing.
In the worst-case scenario, this could lead to a “doom loop” that accelerates the real estate crash, which then feeds into the banking system, said Neil Shearing.
Silicon Valley Bank had a different set of problems. The bank’s mistake was to store excess deposits in US Treasury bonds, which are supposed to be one of the safest assets in the financial world. The Basel regulators encouraged it to do this by imposing risk-weighting regulations.
Some of these debt instruments have lost up to 20pc over long maturities. This is a paper loss that only lasts until you need to sell them in order to cover the deposit flight.
US authorities claim that the bank should’ve hedged these Treasury bonds with interest rate derivatives. As the Hoover paper shows, hedges are merely a way to transfer losses from one institution to another. Instead, the counterparty who underwrites the hedge contracts takes the hit.
The Fed and US Treasury have created perverse incentives and erratic behavior over a long period of time, which culminated in the current violent shift from ultra-easy to ultra-tight currency. The Fed and the US Treasury created “interest-rate risk” at a global scale. Now they are detonating their delayed timebomb.
Chris Whalen, Institutional Risk Analyst, said that we should be cautious of false narratives that place all the blame on banks. He said that the Fed’s excessive market intervention between 2019 and 2022 caused the failure of First Republic Bank as well as Silicon Valley Bank.
Mr Whalen stated that US banks and investors in bonds (i.e. Pension funds and insurance companies are “holding the bags” for $5 trillion in implicit losses caused by the Fed’s final blow-off phase. He said that US banks have only about $2 trillion of tangible equity capital.
He believes that the banking crises will continue to move up the food-chain from the outliers, all the way to the mainstream banks, until the Fed decides to back off and lower rates by 100 basis point.
It has no plans to back down. The Fed plans to increase rates even further. The US money supply continues to shrink at an unprecedented pace, with $95bn in quantitative tightening every month.
The truth is, the superpower’s central bank has created such a mess that it must choose between two poisons. Either it gives in to inflation or it allows a banking crises to reach systemic proportions. It chose a banking crises.