By Clark Troy
It’s easy to hate on banks. Everybody loves to do it. We just can’t make up our minds which ones to hate the most.
Following the financial crisis of 2008-2009 — and gosh we all hope we can just keep referring to it as a proper noun (“The Financial Crisis”) rather than qualifying it with dates — the Big Banks were everyone’s preferred betes noires. Arianna Huffington’s “Move Your Money” campaign energetically encouraged people to punish the large money center banks by moving funds to the lovely-sounding community banks and credit unions.
This time round, the shoe is on the other foot. The heavier regulation imposed by the SiFI (Systemically Important Financial Institution) designation has protected big banks from making the same mistakes that the smaller “problem banks” seem to have made, namely that the latter bought too many long-duration bonds which are highly-sensitive to rising interest rates.
We all profess to be shocked, shocked, that the smaller banks should have done such a poor job matching their liabilities to depositors (which can be requested at any moment) against their assets (which in this case can mature over decades and therefore which rise and fall in value). On the other hand, everyone has veritably frolicked in the verdant meadows of 30-year fixed mortgages in the neighborhood of 3% and the way they have propped up our home values. How do we think this magical state of monetary bliss happened?
The universe of mortgage bonds backed by Fannie Mae, Freddy Mac, and the smaller Ginnie Mae – the so-called “GSEs” or government-sponsored entities who constitute the backbone of the US secondary mortgage market — is about $8 trillion in size. The bonds are created through another process which became a dirty word in 2008-9 — “securitization” — whereby mortgages of like characteristics are bundled together into mortgage-backed securities (MBS) and sold on to investors.
Homeowners benefit from this arrangement in the form of easier housing finance and therefore higher home values. But somebody has to buy the bonds. The US Treasury has been the largest single purchaser of MBS since the beginnings of quantitative easing back during the financial crisis but had begun to gradually shrink its holdings beginning last year as part of its program to shrink the money supply, raise the cost of capital and fight inflation.
Who is the next logical purchaser of MBS? When we round up the usual suspects, the list includes domestic and foreign insurers, individuals, pooled investment vehicles (mutual and hedge funds, ETFs), endowments, pension funds, sovereign wealth funds and banks. Of these, banks are the largest type of institution, and therefore the largest potential pool of MBS purchasers.
Let’s think about it from the point of view of a bank. Banks can either loan money to individual borrowers (persons or businesses) or buy fixed income securities like MBS. Obviously finding people and businesses to lend money to is much more capital- and labor-intensive than having a trader sit at a terminal and buy MBS. It also exposes banks to considerable credit or counterparty risk in the form of small businesses and individuals who might or might not be able to pay back the loan.
Small wonder that asset-lite banks, the magical online banks of recent vintage that attracted deposits with higher interest rates, own lots of MBS. Many of them lack the infrastructure to originate their own loans. So they buy bonds, of which MBS form a big pool. Smaller regional banks have been pressured on the one side by online banks which have low costs and — in towns and cities where they even bother to have branches — the bigger national banks whom we all started loving so much last week. So regional banks have to think carefully about where to have branches and bankers, lest they become too expensive to operate.
The real problem has been that people have freaked out too much, when doing so only hurts ourselves. Let’s think about what I outlined above. We put our money in banks. We want our banks to remain profitable and stable – especially the smaller, regional banks, if we want the local businesses that depend on them for funding to thrive. We have benefited from the banks owning MBS by letting them not spend the money to staff extra branches with surplus bankers while still investing in government-insured bonds, albeit ones with interest rate risk.
If we want the banks to survive, all we need to do is not take money out except when we need it, which means we need to plan better for when we need cash. We all need to be thoughtful about when we need money and plan and act accordingly. But financial planning is complicated, and few of us emerge from the womb or from adolescence, or even from early adulthood, marriage, parenthood… each life stage throws new challenges at us that the prior ones didn’t prepare for. This explains the wide range of tools and professionals available to us to help us make good decisions.
Right now this is all much more easily said than done when memories of the last financial crisis linger all too freshly in our memories like low-level PTSD. Hearing and reading on the news about bank runs comforts no one. Back in 2008-9, we were soothed by the words and actions of a number of market eminences grises: Warren Buffett, John Bogle of Vanguard, and David Swensen of the Yale Endowment stand out. Bogle and Swensen have since passed away, while Buffett has been keeping a lower profile, which makes sense given that he’s 92 and well past his prime as a market participant. We have failed to replace them, having become enamored of fast money gurus like Chamath Palihapitiya, Masayoshi Son of the Vision Fund, venture capitalists and tech bros. Don’t get me wrong, I’m not down on these people, but they’re not good financial role models for most of us.
Instead, we are left to ourselves as the adults in the room. Which is fine. We’ve been through these things a couple of times now, first in 2008-2009, again in the COVID spring of 2020. We know that if we just think it through and tune it out, it will run its course. When we take money out of banks, even to put our assets in seemingly safe assets like money market funds (a topic for another day), we upset the financial substructure on which our lives depend. We pull money out of the housing markets, which nudges interest rates higher and housing prices down, which chills the home construction and upgrade industry which helps our economy grow and gives new families and newcomers to our land places to live. And so on. The less we do, the less the Fed has to do and the better off we are in the long run.
Clark Troy was born in Durham and educated in the Chapel Hill-Carrboro City Schools, then elsewhere. He is a financial planner at Red Reef Advisors and may be reached at clark.troy(at)redreefadvisors.com. When not working, he reads, plays sports, naps, drinks coffee and plays guitar, not necessarily in that order.
For further reading, check out https://www.wsj.com/articles/small-bank-failures-history-c27f5bdd
After being treated poorly by a bank back in the 1970s, I have never had a bank account. Instead I’ve enjoyed the services of two credit unions. Not owning a business, credit unions have been wonderful to deal with and have the same FDIC insurance as banks AFAIK.
I find it odd that credit unions have not been mentioned in all the articles on the banking crisis. I know credit unions had a crisis some years ago, but they seem okay since.
George, it’s good to see you out here. Accounts at credit unions are in fact not FDIC insured but are instead insured by the NCUA (National Credit Union Administration) up to the same $250k limit.
Which is all good and well. However, one thing we learned in the big financial crisis was that the sheer heft of an insurer/regulatory agency carried weight. The FDIC was huge and was helmed aggressively and credibly by Sheila Bair. The NCUA was run, for a time, by a nice UNC grad I met at the bar at Lantern one night while waiting for someone else to show up. In a real crisis, if push came to shove for accessing money from Congress, the FDIC would win,
Credit unions may not be in the news because they are even more opaque than banks and, because they aren’t publicly traded, nobody has as much of a motivation to drill down on their balance sheets. People underestimate the extent to which the press and the markets act in concert to bring to light problems that regulators don’t have staff, budget, technologies or capability to go after. It’s also possible that, lacking the motivation to maximize profits, credit unions on average don’t take as much risk as banks do. We don’t really know which of these hypotheses is true. By the same token, because credit unions lack the motivation to take risk, they probably don’t enable growth in the same way banks do. Which also has upsides and downsides.