Banks: no place for your money

Last week we said that it looked like the “game is over” for the US bank First Republic. So it has proved. It gives us no joy to say “told you so”; the costs of the takeover of the failed bank by the behemoth bank JP Morgan Chase – the inevitable turmoil of this shotgun marriage, the wiped-out First Republic shareholders and bondholders (it seems), the cost to JP Morgan shareholders, who will foot a $10.6 billion bill from the US government agency the FDIC (the Federal Deposit Insurance Corporation, which provides deposit insurance to depositors in US banks) …all of this is not just a financial but also a human mess. And it’s a mess that is a legacy of the 2008 Great Financial Crash. Jamie Dimon, boss of JP Morgan Chase, was asked if the First Republic name would survive. No, was the answer. America’s biggest bank, with 4,700 branches and operations in more than 60 countries, just got bigger.

In 1994 the US Congress barred a bank from buying another bank if the combined entity would hold more than 10% of the country’s deposits. JP Morgan Chase has more than 10% of national deposits. Clearly this is another ‘rule’ that can be ignored at will by the authorities, it seems. The FDIC ignored another rule, a cap of $250,000 on insurance compensation, when it bailed out all depositors of the failed Silicon Valley Bank in mid-March. “The banking system remains sound and resilient, and Americans should feel confident in the safety of their deposits,” said the FDIC, which took over First Republic for a brief period before JP Morgan Chase clinched the deal. This claim by the FDIC is clearly untrue; the reason First Republic went under was because its customers fled for the hills, taking more than $100 billion of deposits with them. First Republic (and SVB and Credit Suisse) died not from a physical bank-run stampede but rather a more sedate bank-trot. Confidence in the safety of deposits is a little thin on the ground.

2008 never ended

The Great Financial Crash of 2008-09 had very different causes than the collapse of the US banks and Credit Suisse. The current spate of collapses is if anything more worrying.

In 2008 banks thought they a new sure-fire winner; they ploughed into a new creation, re-packaged mortgage-backed securities called collateralized debt obligations (CDOs). Borrowers with a poor credit history (sub-prime borrowers) were encouraged to get into home ownership. The context was a lowering of the Federal Funds rate – the main US rate of interest – from 6.5% I May 2000 to 1% in June 2003. This very low rate of interest fuelled an upward spiral in houses prices, as borrowers took advantage of low mortgage rates.

In June 2004, by which time US home ownership was more than 69%, the Federal Reserve started to raise interest rates; by 2006 the Federal Funds rate was 5.25% and house prices started to fall. Sub-prime lenders started to fall like snow in winter. Banks discovered that their sure-time winner was a loser. According to the FDIC more than 500 banks failed between 2008 and 2015. Governments responded to the domino-collapse of banks that had ventured into the risk-laden CDO business by massive amounts of Quantitative Easing (QE), the creation of new money to prop up zombie companies and bail-out banks. We are still living with the consequences of 2008. According to one source leading central banks have injected more than $25 trillion into the global economy since 2008. The Bank for International Settlements (BiS) says that Federal Reserve’s cumulative loss from its QE now stands at almost $26 billion. The Swiss National Bank made a loss of 132 billion Swiss francs ($143 billion) last year, while the European Central Bank (ECB) now pays 2.5% interest on 4 trillion euros that commercial banks got for free during the crisis years.

According to a Bloomberg report, “the great quantitative easing experiment was a mistake.”

The situation today is dramatically altered from 2008. The root cause of the Great Financial Crash and that generation of bank failures was unregulated risky lending; the root cause of the current spate of bank failures is customers losing confidence in their banks, and perhaps the very nature of banking as currently practised.

Generation Bitcoin

If someone came up with the idea today of creating an entity that accepted a certain amount of deposits, say X, but lent out much more than X, say 3X or 4X, we would probably laugh, or maybe weep. As a business model it is obviously far too risky. And yet that’s what our banking system is like. We put our hard-earned money into banks as deposits and trust that we can get our cash back at any time. But the bank makes its profit by making loans, loans that are a multiple of the deposits it takes in. This inherent fragility makes periodic bank runs – when customers try to withdraw their deposits in a panic that the bank doesn’t have enough liquid funds – well-nigh inevitable.

Millennials (anyone born between 1981 and 1996), synonymous with Generation Bitcoin, have grown into an adulthood where disasters – financial and medical – have always been with them. They struggle to pay the rent, they struggle with huge debts if they have done a degree, they are surrounded by uncertainty, yet lack savings’ cushions. It is no surprise that they have turned to cryptocurrency, tempted by the get-rich-quick social media-fuelled hyperbole, and deterred by years of rock-bottom interest rates in banks, which appear fragile.

It is in the nature of banks that they fail. Depositors in the US with more than $250,000 at risk will feel cheated if they don’t get all their cash back, after what the FDIC did regarding SVB. In the UK depositors are insured up to £85,000; the Bank of England (BoE) has floated the idea this upper limit might be raised. Andrew Bailey, governor of the BoE, said at a recent meeting in Washington D.C.: “I do not believe we face a systemic banking crisis.” Not today, certainly; but tomorrow?