Source: Wall Street News
Author: Chang Jiashuai

The perfect storm, from inflation to the debt ceiling crisis, has brought unspeakable suffering to the US economy, which is on the verge of recession, and the banking crisis, which has been going on for more than two months and has recently been rekindled, has made the “perfect storm” that hit the US even more frightening.

Although US regulators have frequently come forward to appease investors, and the stubborn Federal Reserve has also hinted that policy is about to change, two American finance professors examined databases on banking policy intervention since the 13th century and pointed out that many signs indicate,The successive failures of Silicon Valley Bank, Signature Bank, and First Republic Bank within two months were just the beginning of a systemic crisis. Judging from historical experience, it may continue for months or even years. The Bank of America crisis was far worse than the market initially thought.

The beginning of a systemic crisis

The two professors are Andrew Metrick from Yale University and Paul Schmelzing from Boston College, respectively.

In a paper published on March 24, they compared the actions of US regulators in the Silicon Valley banking incident with the 2,000 times regulators interfered with banks in 138 countries since the 13th century. They found that in the Silicon Valley banking crisis in March, the approach taken by US regulators was the closest to the previous 57 crises, and of these 57 crises, 45 were all so-called “systemic crises.”

The two authors wrote:

... How unique is the March 2023 combination of account guarantees and emergency loan interventions? In our database, this combination occurred 57 times (6.5% of all bank crises)... We found that 45 of these 57 crises were marked as systemic crises in the references...

... The evidence suggests that recent policy interventions are based on deep structural trends, as our database shows: Policy interventions are increasing in scale, accounting for a larger share of GDP. So far, the combination of these policy interventions — account guarantees, emergency loans, and private sector bailouts — suggests a rather unusual pattern of intervention.”

In a recent interview with financial services website MarketWatch, one of the authors, Schmelzing, said:

“We don't directly know how bad things are in the banking system right now. But we can look at the actions of the regulators; they probably know the seriousness of the matter better than we do. Their response pattern is closest to the previous 57 crises, which were often worse than average.”

According to the two authors, the collapse of Silicon Valley banks and other banking institutions in March 2023 marked the beginning of a systemic crisis in the financial sector. This is because the bailouts of Silicon Valley bank depositors by the FDIC and the Federal Reserve are not isolated incidents, but reflect the greater predicament faced by banks in the US and Europe.

They pointed out,These events have highlighted potential vulnerabilities in the financial system, such as high levels of debt and inadequate risk management practices, which could lead to further crises in the future.

How serious will a systemic banking crisis be? In an interview with MW, Schmelzing explained thatUnder a systemic banking crisis, corporate and financial sectors may default on a large scale, non-performing loans will increase dramatically, banks' capital will be exhausted, asset prices (such as stocks and real estate) may plummet, and real interest rates will rise sharply, accompanied by a slowdown in capital flows.

Most importantly, systemic crises are often protracted. In the database of the two authors, most of the 57 crises most similar to the current banking crisis continued for several months, and some even continued for several years. So, Schmelzing believes,From the Bank of Silicon Valley to the collapse of First Republic Bank, which lasted just two months, this was just the beginning of a systemic crisis.

Loss of confidence makes the banking crisis more difficult

Buffett's teacher and legendary investment master Benjamin Graham once made a classic analogy: in the long run, the market is a weighing machine that reflects reality; but in the short term, the market may also be a voting machine to express what investors think will happen.

However, recent market fluctuations suggest that many investors are voting against regional banks.

Confidence is the foundation on which the entire financial industry was founded, and in today's social media era where a little bit of Twitter hustle and bustle can trigger bank crowds, confidence has become more important than ever.

Wall Street Journal columnist Telis Demos wrote that the recent banking crisis shows thatWhat investors want is a “bank that will never fail.”

He pointed out,In fact, the risks faced by small and medium-sized banks in the US are not that serious. According to the Federal Reserve, as of mid-2022, more than 99% of community banks and all regional banks with assets of less than $100 billion reported a capital-to-asset ratio higher than the minimum requirement set by regulators.

Even if an increase in interest rates causes the bond assets they hold to depreciation, as long as they can be held until maturity, the losses will not become actual losses. Investment bank Jefferies also pointed out that it is expected that by the end of 2024, the losses in the bank's securities portfolios covered by the bank will improve by about 20% to 50%.

According to Demos,Most banks were able to mix up the crisis with reduced earnings and reduced financial flexibility. But market sentiment is unpredictable, making regional banks and smaller community banks particularly vulnerable to loss of confidence.Sudden crowding will trigger a fatal vicious cycle, forcing some banks to sell their HTM assets at a discount, turning losses into actual losses, quickly draining banks' capital. Silicon Valley banks, signatory banks, and First Republic are all victims of this market sentiment.

Demos pointed out that investors' aversion to risk has spread to well-functioning regional banks that have not faced loss of deposits. For example, last week's sharp decline of 43% and 27%, respectively$PacWest Bancorp (PACW.US)$with$Western Alliance Bancorp (WAL.US)$Although these two banks did not experience a large-scale loss of savers, their stock prices still plummeted. Demos warned thatIf investors only want banks that will never fail, this crisis of bank confidence will continue.

Editor/Hoten