The events in the banking sector in the last few weeks have highlighted a few key trends, and their consequences.
The Evolution of Bank Runs
Bank runs of the past faced a lot more friction because most people were required to physically go to the bank and wait in line to withdraw their money. In today’s digital world, a funds transfer is a few clicks away. This exponential increase in speed is exacerbated by panic spreading via social media. Our fractional reserve banking system was established and built in a slower, simpler time. As the speed of information will only increase going forward, the industry has no choice but to adapt in order to survive, and it will.
Why is a lot of money leaving banks?
Interest rates. Interest rates are the gravity of an economy. You cannot see them, but everyone and everything feels them. Due to the Federal Reserve’s low interest rate policy since 2008, banks have had access to prudent investments that yield just 2-3%. After their operating expenses, they cannot pay depositors much more than .5% interest. Recently, bank depositors have had a higher yielding alternative, enter money market funds. Money market funds are mutual funds that invest in very short term (1-3 month) government treasuries. Slowly, but steadily, money has been leaving traditional bank deposit accounts, and moving towards money market funds. This is forcing the banks to sell their lower yielding securities at a loss in order to meet withdrawal demand.
Is this 2008 again?
The short answer is we do not know. 2008 was caused by banks knowingly selling mortgages to people that could not afford them. Banks then sold these bad loans as quality investments, and they made their way throughout the economy. When the housing bubble burst, and people walked away from their mortgages, these quality investments revealed themselves as anything but quality. As Warren Buffet is famously quoted, you see who is swimming naked when the tide goes out.
From that angle, this is not another 2008. The current events within the banking sector were caused by a rapid rise in interest rates, which devalued assets the banks have as collateral for deposits. As with any stress test, the outliers crack first and that is what we saw with Silicon Valley Bank and the others. The Fed stepped in and provided an initial solution to the problem. We could very well look back six months from now and the current events could be almost forgotten. The good news is that if the Fed engineers a more long-term solution, and interest rates normalize, these depressed assets will return to their full value in time.
It is more important than ever to remain calm, and stay focused on the long term nature of investing. More to come on this topic in the next email. As always, if you have any questions, do not hesitate to give us a call.
Citrus Wealth Management
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