Major correction in bank shares worldwide. Local US banking crisis unlikely to spread to Europe.
On Friday, the U.S. Federal Reserve closed two U.S. banks, Silicon Valley Bank and New York's Signature Bank. A panic arose that there would be a new banking crisis and that everyone would run to the bank on Monday to withdraw their money. Such a bank run would have meant the end for many banks.
Over the weekend, the Federal Reserve and U.S. government took two measures to stabilize the situation:
Customers were assured that all their investments were secured. So not just the USD 250,000 covered by deposit insurance.
The banks were offered a one-year loan and to deposit government bonds at nominal value as collateral.
Currently, it looks like they have been successful with this.
How should these measures be assessed?
It is not a bailout of the banks, as various commentators write. The banks are given a credit of one year to solve the problems themselves and to absorb customer outflows.
The customers of the two closed banks lose nothing, but the investors lose everything. The government learned a lot from the 2007-2009 financial crisis. At that time, customers lost money and investors were protected.
What is critical, however, is that overnight the rules of deposit insurance were changed. Previously, only USD 250,000 was insured, but now all customer funds are. This is not a problem to handle the closure of the two banks, but if the crisis spreads to other banks, the deposit insurance would have to be supported with taxpayers' money.
The new rules have implications for investors in bank stocks, worldwide. Investors must be aware that they will no longer be rescued by the state in an emergency. There will be a completely new risk assessment. Many bank shares worldwide then also collapsed by up to 10%.
Will the banking crisis spread to the rest of the world?
We clearly think not. It is a local problem in the USA:
The two banks that closed are special cases. Both were strong in crypto and venture capital. The banks were already coming under pressure because of the sharp drop in value in the crypto space, plus the big correction in growth companies and companies with a lot of debt because of the sharp rise in interest rates. Since venture capital is illiquid, the only option left was to sell government bonds with massive book losses.
In the U.S., banks with less than 250 billion in total assets are regulated less. This is the law that Donald Trump has pushed through. Some local banks (like the two banks now closed) have therefore tried to stay just below this limit. This means that the larger banks are better regulated, more soundly financed, and now less at risk.
But the crisis may well spread locally to more local banks.
The chart shows other regional banks in the USA that are poorly financed. The share prices of these banks collapsed accordingly on Monday. But on the chart you can also see how much better positioned a big bank like J.P. Morgan is (red circle). We therefore do not think that the financial crisis will spread to the big banks in the USA and then to Europe or Asia.
Effects of the current banking crisis
In the last few days, interest rates have changed massively as everyone tried to stay safe. The yield on the two-year U.S. Treasury bond has dropped from almost 5% to 4%. This is the fastest move in this interest rate security ever!
The inverted yield curve has returned to 50% normal in 3 days.
We expect a counter move that will bring rates back close to 6%.
The big question is whether the Fed will raise rates less now to avoid adding fuel to the fire. In the middle of last week, the probability of a 0.5% rate hike on March 22 was 80%. Now the expectation is almost 90% for a rate hike of 0.25%. There has also never been such a radical turnaround.
We still expect important inflation figures this week. These will now be significant and could turn the expectations again.
However, the whole discussion throws a spotlight on the quality of the balance sheets of the banks in the USA.
In the U.S.A., banks have the option of pricing government bonds they want to hold to maturity at face value and not showing market losses. The probability that the U.S. government will go bankrupt is effectively zero, and at maturity, market prices will return to face value.
The problem only arises if a bank is forced to sell these bonds early, as is now the case with Silicon Valley Bank.
The chart calculates the maximum possible book losses in the books of all banks and investors on the number of outstanding government bonds. These go up to 600 billion. That would be the maximum amount the U.S. government would have to spend if all investors wanted a one-year loan on their government bonds. Even the government and the FED would reach their limits here.
Only transparency can remedy this situation. The banks must disclose in the next few days what positions they have in bonds and how high their book losses are. This is the only way to regain investor confidence.
We do not expect a bank run, but there is a strong possibility that more local US banks will have to be closed.
Volatility will remain high in the coming days. For the medium-term economic development, the inflation figures that will be published this week are more important.
The new risk assessment of investors in bank stocks will lead to lower valuations. We consider an immediate return of bank share prices to last week's level unrealistic.
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