Since the news hit the wires that Silicon Valley Bank shuttered its doors, people have been filling my inbox with questions about what it means to the everyday Joe.
It’s a scary event to many and they have a right to be concerned. After all, who wants to wake up one morning and read their bank is closed and that their money is locked behind closed doors? In a bank closure, it can be days before regulators sort out the mess, at least enough to open the doors and turn on the ATM so you can withdraw your money.
For me, it’s frustrating. I can’t tell you how many times I have covered bank blow-ups and the promises by bank regulators they’ve fixed the problem.
Apparently not so, so here we go again.
As we have progressed along in the U.S. banking system, the idea of FDIC coverage for bank balances has morphed into somewhat of a joke.
I can best explain this by saying the day after Silicon Valley Bank folded, Secretary of the Treasury and once Federal Reserve Chief Janet Yellen went on national TV and said there would be no bailout of Silicon Valley Bank.
When I saw that on my evening news, I literally yelled out “BULL…T”!
Turns out I had good cause, as Yellen now is suggesting FDIC remove the current 250K deposit insurance limit altogether and put the government (and you) on the hook for it.
Can you say bank due diligence is gone forever?
In reality, we have arrived at a point in time where it could be argued the government is handcuffed when it comes to guaranteeing retail bank accounts over and above 250K, the current FDIC limit. In my opinion, they have little choice but to cover all retail accounts. A cluster of their own doing.
The reasoning is a simple one.
Because of the way modern-day banking mechanisms work, banks only have to keep a certain percentage of deposits in cash or cash equivalents. This limit is called the Liquidity Coverage Ratio (LCR). Typically this ratio is between 10 and 15%. Although banks are highly regulated as to what they can do with remaining
funds, they place them in a variety of assets, and not all of them are as
immediately liquid as holding a vault full of cash. These assets allow the bank to make profits on customers’ deposits.
The problem materializes that when a bank goes under, people everywhere start thinking what if their bank closed as Silicon Valley Bank did? That can start a run on other banks where folks line up to withdraw their money. When the bank falls under the ratio of cash on hand, they have to start selling assets to meet the increased demand. In a down market, these assets may have to be sold at a loss. If the withdrawals keep coming, the losses can skyrocket. If the bank cannot stomach the losses, they close its doors.
This is how the proverbial bank run can eventually turn into a bankrupt bank. Think of the classic movie with Jimmy Stewart, called “It’s a wonderful life”. It details the problem succinctly,
Bank contagion occurs because as the dominoes begin to fall, more people, fearing their bank could fail, run to their banks and close their accounts. With more withdrawals comes more asset selling, resulting in more losses, which in turn can cause more banks to fail. The run usually affects only the smaller regional banks. The money then moves into only the largest of banks, further concentrating our banking system, making them even larger and even more “too big to fail”.
Amplifying the problem, since the banks trade with each other, one bank failure can cause another bank failure as each bank starts doubting the next bank will pay them so they stop paying other banks.
In conclusion, the modern-day financial system is massively intertwined and heavily invested. The FEDS cannot afford to let even one bank fail, regardless of the FDIC limits, due to the contagion that might take hold if all involved are not made whole. They must then widely publicize the FED rescue to stem any fears that may arise in bank customers everywhere.
Hence Ms. Yellen’s suggestion we do away with all FDIC insurance limits.
This is not to say the government will guarantee all bank failures, as who knows what they will eventually decide to do. But my guess is a complete backstop of all U.S. banks everywhere is forthcoming.
And then the wild west of banking shenanigans will be in full swing.
And that isn’t much of a surprise after all is it?
“Watching the markets so you don’t have to”
(As mentioned please use the below disclaimer exactly) THANKS (Regulations)
This article expresses the opinion of Marc Cuniberti and is not meant as investment advice, or a recommendation to buy or sell any securities, nor represents the opinion of any bank, investment firm or RIA, nor this media outlet, its staff, members or underwriters. Mr. Cuniberti holds a B.A. in Economics with honors, 1979, and California Insurance License #0L34249. (530)559-1214. He was voted best financial advisor in the county 2021.