It’s understandable why investors are concerned by the recent bank failures. The sudden collapse of two U.S. banks stoked fears of the 2008 financial crisis. What occurred at Silicon Valley Bank (SVB) was a modern adaptation of a 1930s-style bank run seen in It’s a Wonderful Life. While the Federal Reserve has introduced new measures to support banks, it’s still uncertain whether they will be enough to prevent further bank contagion. However, this current episode is unlikely a replay of the 2008 financial crisis involving exotic securities with questionable worth stuffed inside large banks. Today, the collateral is underwater U.S. treasuries that retain underlying value despite current unrealized losses. There is a lot we do not know, but banks generally are in better condition than before. Investor sentiment is fearful. But we know that in the wake of a bank failure, stocks are historically higher one year later. So, yes, it’s important to be alert, but it’s also important to recognize that market downturns can present opportunities for focused investors to scoop up undervalued stocks at attractive valuations.
Lulled into complacency by a decade of zero-interest rates, banks boosted holdings of government bonds and federally-backed mortgage bonds in search of yield. As you know, bond prices go down when interest rates go up. SVB had locked itself into a long-term bet that interest rates would stay low. Those bonds market values plummeted when rates began to rise sharply in 2022 to tame inflation. Further complicating SVB’s predicament, its deposit base was concentrated. Once the deposit withdrawals began, it cascaded into a traditional bank run with SVB unable to sell enough underwater bonds to service requests.
Panic spreads quickly, and financial distress, in particular, never takes long to cross the Atlantic. Credit Suisse, one of Switzerland’s two mega banks, has been beleaguered since the financial crises. When its share price plunged, and deposit flight accelerated following SVB’s collapse, the Swiss regulators stepped in to arrange a shotgun wedding to its rival UBS.
Fortunately, in response to the failure of two U.S. banks in a little more than a week, Treasury Secretary Janet Yellen announced a de facto guarantee (without approval from Congress) of all U.S. bank deposits. Regional banks’ stocks rallied on the news. This pronouncement was designed to send the message that depositors need not worry about the safety and soundness of banks. In addition, the Federal Reserve has introduced a new Bank Term Funding Program that offers banks one-year loans against underwater Treasuries and mortgage-backed securities at par value. This gives banks access to liquidity to meet potential deposit outflows. Is that enough?
The 2008-2009 financial crisis was worse. No one knew what was inside all of those weird derivatives Wall Street invested in, and no one wanted to hold them. This time, it’s a case of underwater bonds as interest rates have risen – someone will buy those bonds at a discount. But it’s important to remember that Treasury bonds remain a safe haven asset in financial markets.
It’s often darkest before dawn. The more 500-point market declines due to bank failure fears, recessions, Russia, or whatever widespread concern of the day, the closer we are to wringing all the positive sentiment out of investors. Remember that “no one rings a bell at the bottom (or the top) of markets.” When the news is bad, many people capitulate and sell stocks at the worst time possible. Instead, we believe that’s the time to get your bucket ready to scoop up the next wave of great companies that get thrown out with the bath water. These market-disrupting events that come and go over time, allow us to find great companies selling at huge discounts. Time to get to work!