Federal Reserve Uncovers Even More Financial Instability
From Peter Reagan at Birch Gold Group
In response to the bank collapse that started in March, both Janet Yellen and Jerome Powell had to do their best to reassure the public the financial system wouldn’t collapse. Unfortunately, as most regulators do, both did so in a rather absurd way.
We’ll start with Yellen’s comment to the media shortly after the initial collapse of SVB and New York’s Signature Bank in March:
“The Council discussed current conditions in the banking sector and noted that while some institutions have come under stress, the U.S. banking system remains sound and resilient,” the Treasury said in a statement.
Leaving aside the fact that at the time, eleven more regional banks were being placed on Moody’s “death watch” list, let’s see how Powell characterized the financial situation in the United States this month in a recent article at The Hill:
Federal Reserve Chairman Jerome Powell said Wednesday that the financial system is “sound and resilient” following the biggest bank collapse since 2008.
“There were three large banks from the very beginning that were at the heart of the stress we saw in early March. Those have all been resolved, and all the depositors have been protected,” Powell told reporters, referring to Silicon Valley Bank, Signature Bank and First Republic Bank.
Both Yellen and Powell tell us the financial system is just fine following the second largest bank collapse in U.S. history.
In fact, on May 8th the Federal Reserve published an 85-page Financial Stability report to that effect. So let’s take a closer look at key parts of that report to get a better idea of what Powell and Yellen are actually referring to when they say the system is “stable.”
This is what “stability” looks like?
The report included the results of a survey that tried to capture the “salient risks” to the financial stability of the banking system in this country.
The survey was conducted in both November 2022 and May 2023, then the results were compared to see how things have progressed.
The graphic taken from the report is below, and the result is self-explanatory:
Aside from the minimal progress seen by respondents in the areas of inflation and monetary tightening, and the impacts from the Russia-Ukraine conflict…
Every other category shows an increase in risk.
Obviously, the stability of the banking system is on everyone’s mind right now…
So how healthy is the banking system, really?
The report examined four areas of stress to reach the conclusion that Powell reached earlier this month.
It would require auditing a college-level economics class to fully expand on each of these stresses in this piece. But just know that all four are playing out in terms of impact on the financial system right now, and were at the root of the major bank collapses that have already taken place this year.
- Valuation pressures have to do with the risk currently priced into assets.
- Borrowing is done by businesses and households to cover expenses during tough times, but high debt loads at high rates can overwhelm them. According to the New York Fed: “American households in total hold $11.67 trillion in debt… That’s up $2.36 trillion since the end of 2019, before COVID-19.”
- Credit crunch: If banks are “leveraged out” because they are poorly managed, they can’t land or give credit to businesses and households in the first place, making the “borrowing” stress explained above even
- Finally, bad investment choices on the part of banks, like taking uninsured deposits, increase funding risks and the potential for consumer “bank runs” that stem from the panic created when they sense a bank is going to collapse.
The Fed report also summarized one big reason why the major banks that have already failed did so.
You can also clearly read how at least one, if not two of the stresses above collapsed these huge banks:
The failures of SVB and Signature Bank, along with strains at some other banks, highlighted vulnerabilities associated with high concentrations of uninsured deposits. Uninsured deposits are prone to runs, in part because they lack an explicit government guarantee. From the start of the pandemic in 2020 to the end of 2021—a period when interest rates remained low—banks received $3.7 trillion in domestic deposits, most of which were uninsured. As interest rates increased throughout 2022, bank deposits became less attractive for depositors and banks experienced outflows, led by uninsured deposits. As of the fourth quarter of 2022, aggregate uninsured deposits stood at $7.5 trillion. Although aggregate levels of uninsured deposits in the banking system were high, SVB and Signature Bank were outliers in terms of their heavy reliance on uninsured deposits, as most banks had a much more balanced mix of liabilities.
But uninsured deposits haven’t magically stopped.
That, and they wouldn’t be the only reason the banking system appears unstable right now, despite Powell and Yellen’s optimism.
But it’s easy to see banks aren’t truly “stable and resilient” at all:
If too many depositors pull their money over fears that a regional lender is insolvent, banks might have to sell those securities at a huge loss, further weakening their balance sheet.
Put simply, what the quote above generally means… Bank balance sheets are suffering under the weight of their self-imposed financial liabilities.
When you think about it, that doesn’t seem like a “stable and resilient” banking system at all. That sounds a lot like an opportunistic banking system, where some (not all) banks in that system might take unnecessary risks and fail their customers miserably.
Which brings us to another graph in the report…
You don’t have to have an economics degree to see that the liabilities in the banking system compared to GDP as a percentage is rapidly declining to levels similar to the 2008 – 2011 financial crisis, including uninsured deposits (again):
The graph above indicates that banks are still holding a high mix of liabilities compared to GDP, and that mix obviously crashed during the 2008 financial crisis.
Will that happen again? Is it happening right now? We’ll have to wait and see.
But according to this recent report, liquidity issues are still a concern in the commercial sector, among other things:
Among the lending officers’ concerns were deposit outflows, a weakening economy and bank liquidity. Commercial and industrial loans were cited as particular points of stress, as was commercial real estate.
That doesn’t bode well for Powell’s “stable and resilient” financial system.
And the report contradicted itself at the end, repeatedly…
Despite decisive actions by the Federal Reserve, the FDIC, and the U.S. Department of the Treasury, concerns about the economic outlook, credit quality, and funding liquidity could lead banks and other financial institutions to further contract the supply of credit to the economy. A sharp contraction in the availability of credit would drive up the cost of funding for businesses and households, potentially resulting in a slowdown in economic activity. With a decline in profits of nonfinancial businesses, financial stress and defaults at some firms could increase, especially in light of the generally high level of leverage in that sector.
Finally, if inflation doesn’t ease, then rates aren’t likely to be eased either. That means it’s possible we could be stuck with tight monetary policy for quite some time:
If inflationary pressures prove to be more stubborn than anticipated, lighter-than-expected monetary policy could prompt sharp increases in longer-term interest rates and weaken economic growth worldwide. These developments could strain the debt service capacity of governments, households, and businesses abroad.
The last thing to keep in mind is we don’t know exactly how this very complex and large situation will play out. We’ll have to wait and see what happens.
“Stable and resilient,” Powell and Yellen said.
Maybe they read a different report?
Your defense against financial sector chaos
If the banking system does head into crisis, then consider the possibility that both gold and silver could deliver their historic safe haven performance, delivering some much-needed shelter for your hard-earned dollars.
Physical gold and silver are stored in vaults, not balance sheets. Diversifying with tangible precious metals can give you a potent antidote to the heartburn and stress of a teetering banking system.
If this sounds appealing to you, take a few minutes to familiarize yourself with the benefits of physical precious metals.2023, bank run, Featured, federal reserve, financial crisis