[Bank failure discussion mega-thread]

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exodusing
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Re: [Bank failure discussion mega-thread]

Post by exodusing »

It's important to remember the purpose of banks in today's society:

1) Take in deposits. The vast bulk of these deposits will be repayable on demand and won't charge for that privilege.

2) Make loans. Loans are rarely payable on demand and they entail risk. Credit is a very important function in the economy. There are numerous articles today to the effect tightening credit curtails economic activity. Society likes economic activity.

To make the system work, there's deposit insurance and regulation to make sure banks are not taking excessive risk (e.g., capital requirements).

Banks borrow short, lend long and are supported by confidence in the system. In normal times, it all works rather well. Without confidence, you get bank runs that render banks insolvent.

Whether or not another system would be better, it's very hard to see a fundamental change in this structure. It's especially hard to see a fundamental change in reaction to a few situations that regulators and other influential types are spinning as unique situations. Today Powell said he was in favor of increased supervision and regulation, but I didn't hear anything about fundamental changes. "The U.S. banking system is sound and resilient" is not a clarion call for a massive rethinking. I'm not hearing that call from anyone capable of causing it to happen. Demand deposits and available credit are too important.
CuriousTacos
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

HP-12Cing wrote: Wed Mar 22, 2023 7:14 pm
CuriousTacos wrote: Wed Mar 22, 2023 6:05 pm That's why I'm saying don't allow them to take risk with demand deposits. They be segregated and held in riskless liquid assets. Anything else is fraud and punishable.

If depositors want higher interest or lower fees, they must bear the risk through other instruments.
"Riskless" is a high bar to clear. Cash in the vault is not entirely risk-free, since it can be destroyed by a natural disaster, stolen by employees who circumvent controls, or robbed. And if banks start holding significantly higher sums of currency, they would presumably become a higher value target.

Overnight funds at the FRB don't contain credit risk and should be available on short notice, so they might be a better bet.

U.S. Treasury and Agency securities don't contain any credit risk but do evidence price risk and liquidity risk (due to settlement times).
Yeah, see my previous post about The Narrow Bank, which aims to hold all demand deposits as reserves at the Fed, but the Fed rejected/stonewalled them.

Something else is driving the Fed to vehemently stick with the current system, and I suspect they want the money creation/destruction offered by fractional reserve banking in order for them to manipulate the economy. Whether that is actually a benefit is up for debate (let alone the tradeoff for the risk fractional reserve banking entails).
CuriousTacos
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

exodusing wrote: Wed Mar 22, 2023 7:18 pm 2) Make loans. Loans are rarely payable on demand and they entail risk. Credit is a very important function in the economy. There are numerous articles today to the effect tightening credit curtails economic activity. Society likes economic activity.
Well, I agree there isn't much talk of an overhaul, but that doesn't mean there shouldn't be. The Fed's existence depends on the current system, so there's that also.

Regarding credit and economic activity, there's some unknowable sweet spot. Too much more, and it just leads destruction of capital. Too little, and we don't innovate enough. What's your basis for thinking an extremely low reserve demand deposit system results in the optimum amount of credit?

I've previously argued that term deposits are a more appropriate way to match true savings with investment. I've acknowledged that I'm somewhat open to the idea of banks doing some maturity transformation with term deposits as long as there's no government backstop that systematically biases the mechanism of banks to over-estimate future available capital.

But telling lots of people they all have an immediate claim to the same capital does not result in the appropriate level of credit- it's just a game of musical chairs with actual capital, and that inevitably leads to a boom then bust. Sure, that boom looks like increased economic activity to researchers, but then the researchers are poking around trying to find some other cause to blame for the bust. These busts are costly to government and individuals in a lot of ways, and cancel out all the apparent economic progress of the booms.
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nisiprius
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Re: [Bank failure discussion mega-thread]

Post by nisiprius »

Interesting piece in the "The Indicator from Planet Money" podcast: What Banks Do when Nobody's Watching. The importance of bank examiners, what they do, and why there is a looming shortage of them.

Among other details:
WOODS: ...the remote working revolution hasn't hit the bank examining workforce as much as it could in other industries. There's still this protocol of in-person visits, which can be really valuable.

WONG: Yeah. Kiah points to what happened at a small bank in Chicago a few years ago when an examiner was doing an on-site visit.

HASLETT: An employee pulled the bank examiner over and basically said, this bank is a giant fraud, and you need to come back and do a big, thorough examination of this bank.

WOODS: I mean, that's not the kind of thing you can do over Zoom, right, Wailin?

WONG: No. Like, what are you going to do - organize a breakout room and invite the examiner in so you can be a whistleblower? No.

WOODS: No. You need a corridor. And a fuller review uncovered a massive embezzlement scheme that resulted in criminal charges for 14 people. And the bank - the Washington Federal Bank for Savings - was shut down.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
HP-12Cing
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Re: [Bank failure discussion mega-thread]

Post by HP-12Cing »

nisiprius wrote: Wed Mar 22, 2023 7:46 pm Interesting piece in the "The Indicator from Planet Money" podcast: What Banks Do when Nobody's Watching. The importance of bank examiners, what they do, and why there is a looming shortage of them.

Among other details:
WOODS: ...the remote working revolution hasn't hit the bank examining workforce as much as it could in other industries. There's still this protocol of in-person visits, which can be really valuable.

WONG: Yeah. Kiah points to what happened at a small bank in Chicago a few years ago when an examiner was doing an on-site visit.

HASLETT: An employee pulled the bank examiner over and basically said, this bank is a giant fraud, and you need to come back and do a big, thorough examination of this bank.

WOODS: I mean, that's not the kind of thing you can do over Zoom, right, Wailin?

WONG: No. Like, what are you going to do - organize a breakout room and invite the examiner in so you can be a whistleblower? No.

WOODS: No. You need a corridor. And a fuller review uncovered a massive embezzlement scheme that resulted in criminal charges for 14 people. And the bank - the Washington Federal Bank for Savings - was shut down.
Very interesting indeed, and thanks for sharing. FDIC, FRB, and OCC are have current postings out for bank examiner positions, so if anyone has ever wanted to get into that world, you have your choice.
CuriousTacos
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

rockstar wrote: Wed Mar 22, 2023 7:04 pm
CuriousTacos wrote: Wed Mar 22, 2023 6:05 pm
rockstar wrote: Wed Mar 22, 2023 5:13 pm
Risk will continue to benefit the top of these banks. And tax payers will be on the hook for bail out after bail out. Nationalize it, so the Fed could print to backstop a run. Clearly bank leadership is lacking.
That's why I'm saying don't allow them to take risk with demand deposits. They be segregated and held in riskless liquid assets. Anything else is fraud and punishable.

If depositors want higher interest or lower fees, they must bear the risk through other instruments.
Nobody ever gets punished. The CEO of SVB is probably chilling out on the beach in his 3.5m Hawaii home now.
Incompetence and/or excessive risk taking isn't currently illegal, so that's exactly what I would expect. But if the rules required full reserves, such actions should be punishable.
rockstar wrote: Wed Mar 22, 2023 7:04 pm Best to nationalize and move on. Regulations will get degraded through lobbying. It's futile.
I share the fear that any change in regulations would get degraded over time. That's partly why I hold the line at full reserves. Sure, 95% reserves puts the likelihood of failure very very low, and even 50% probably seems safe for a while too, but then some will lobby that 30% is worth the risk, or some slightly risky asset should count.....kaboom
skierincolorado
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Re: [Bank failure discussion mega-thread]

Post by skierincolorado »

CuriousTacos wrote: Wed Mar 22, 2023 5:04 pm
skierincolorado wrote: Wed Mar 22, 2023 2:14 pm The system insured system wide bank failure in 2008. Not only did the system insure depositors, it also insured bondholders and shareholders. Which made it even more expensive (and created at least some moral hazard).

If bank assets suddenly all become worthless overnight we've got bigger issues. Most likely in that case the Fed would have to step in and support asset values (which also happened in 2008).

Not insuring deposits doesn't make any of this better. It makes it worse by concentrating risk at big banks and accelerating the panic if something goes wrong.
To summarize: we have this industry that's critical to businesses and everyday people, and it takes great unnecessary risk that cannot be truly pooled since failures can cascade through the system rapidly. We can insure it to some degree, and maybe more than I think it can be (essentially pre-paying part of the cost of the inevitable crises), but eventually in some crisis too much money is potentially at risk and rather than let too many banks fail, eventually some part of the government will step in and either provide liquidity injections or purchase assets above their cost, or send stimulus checks, etc.

I sense that you're arguing that we should beef up the insurance to pre-pay the cost of a crisis rather than pay for it after the fact. OK, fine, that moves some of the cost around and makes it so fewer depositors lose money. But it doesn't prevent the next crisis, or at least I don't think you've laid out your argument for how you think it would.

I'm arguing instead that we should focus on more radical changes to prevent these crises in the first place, such as requiring much higher reserves at all banks. That avoids crises, and avoids concentration at big banks.
Oh I wasn't proposing this as way to prevent bank crises. I was mostly focused on how this is just formalizing what everybody already knows and preventing bank errors from hurting guiltless depositors.

Some regulations to decrease the risk of bank crises could be warranted as well. But if the depositors are insured I'm not sure how much we care unless it's system wide. The losses of shareholders and bondholders at SVB on their own arent substantial enought to significantly effect the rest of the economy. We only have 14 years of data, but so far the stress tests have prevented the kind of system wide failure seen in 2008. Insuring deposits above 250k could be a way to assert more control. Passing stress tests would be a condition for being able to advertise to customers that their deposits are insured. This should apply to banks like SVB as well. Clearly it is riskier to insure a bank with so much duration risk and dwindling reserves. They either should pay more or meet the same stress test standards as the big banks.
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Harry Livermore
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Re: [Bank failure discussion mega-thread]

Post by Harry Livermore »

nisiprius wrote: Wed Mar 22, 2023 9:59 am
It seems to me that "we" should take a big step back and rethink the system as a whole.

Individual investors need $250,000 of insurance Maybe more.

There is an intermediate class of investors, like small-to-medium businesses, that should not be expected to perform sophisticated due diligence for an ordinary necessity. There should be business accounts with a higher amount of insurance. What's the right number? $10 million? $50 million? Whatever it is, it should be a different account, and banks should have to pay a larger assessment into the FDIC to cover the additional insurance, which should get reflected back in the form of lower deposit rates.

Beyond that, depositors are big boys and uninsured should mean uninsured.

Customers who legitimately need more insurance should be able to get it, but they should have to pay for it in some way.

Whenever a bank's ability to meet withdrawals is challenged, they should be able to invoke mechanisms like liquidity fees and redemption gates, and be allowed to delay the withdrawal. Want to make a huge withdrawal? Great, we'll charge you a 1% liquidity fee of front, you'll get your money two days from now, and if you change your mind in the next two days you can cancel the withdrawal and we'll refund the fee.

The stock market, bond funds, money market mutual funds, are allowed to pump the brakes when descending a mountain, why not banks?
Well said.
Cheers
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Harry Livermore
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Re: [Bank failure discussion mega-thread]

Post by Harry Livermore »

Also, since we are bouncing around ideas for the FDIC and the Fed, how about this one?
As Nisiprius said, institute different tiers of depositors. For individuals, up to $250K, demand deposits that pay interest. For businesses, up to $1MM, demand deposits that pay interest. Above that, on some sort of sliding scale, or tiers, as some have suggested:

Bank brokered Treasuries of appropriate duration for that particular depositor
Certificate Of Deposits with various periods appropriate for that particular depositor
DIF insurance, paid by each individual depositor

Mom and Pop investors with $900K sit down with a specialist, and buy a mix of Treasuries as appropriate to hold the $650K in excess of the FDIC limit.
Small and medium sized businesses have their CFO work with a specialist, and buy a mix of Treasuries, a mix of CDs, and "opt-in" to some amount on which the company has to pay DIF insurance directly.

If everyone could agree on a framework such as (or similar with different ideas, I'm just spitballing) and such practices were industry-wide, it might make for a more stable, orderly environment, where the FDIC could likely charge individual banks lower premiums due to less overt risk. Sure, it would cost everyone something, but we are paying for it now in a less overt way (higher bank fees or lower interest to cover FDIC dues, who-knows-what at the federal level by running the press) If the framework and method of paying for the framework were in plain sight and ironclad, wouldn't that take the edge off businesses and the public panicking from time to time?
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water2357
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Re: [Bank failure discussion mega-thread]

Post by water2357 »

Interesting how people make recommendation for FDIC insurance based solely on only their limited knowledge of their situation or what they personally have encountered in life and in their area of the US. And what they propose will not work at all for someone else. I have no idea what would work for a small business. But I have encountered countless other situations where $250,000 FDIC insurance for an individual is ludicrously inadequate. Of course that $250,000 can currently be circumvented in many cases by an individual by opening accounts at multiple banks and/or multiple different titles.

But why should an individual have to work with multiple banks or multiple accounts simply to be sure their deposits are insured?

If you don't have a pension, you are resonsible for managing your own retirement savings. 401ks can be worth several million dollars over a lifetime and often at retirement must be converted to IRAs due to the 401k plan document requirements. Some of that money will no doubt be placed with a broker. But not all of it. Some of it will be invested in some safe securities like bank certificates of deposit. Some will appear and disappear from a bank account as property is sold or needed for purchase of a property. Some will be in transit as savings and investments are changed over time.

So, why should an individual be held to $250,000 insurance when the financial industry, employers and government regulations have transferred the investment risk from employers to the individual for the individual's retirement.

And as people age, they need to be able to understand and agree to the level of risk they take on with their retirement savings.

While bank deposits are not glamorous investments, they are suppposed to be safe. If the public is to put their trust in banks and the deposts they hold, the level of insurance should be commensurate with what at least a middle class individual requires throughtout their retirement. And since it now appears that middle or upper middle class is being defined as income less than $400,000 then anyone with that level of income would have funded their retirement much above $250,000. At the least people truly require several million dollars of retirement savings if they ultimately are expected to pay for the high level of medical, drug and assisted living and long term care costs in the US.

So, if middle class retirement deposits in banks are to be safe for all middles class individuals, regardless of whether they decide to invest in bank certificates of deposits or decide to take on a high level of risk and invest totally in stocks, the risk averse should be afforded as much consideration as any of these businesses or billionaires and have the millions that they will need in retirement covered by FDIC insurance, not the unrealistic sum of 250,000, per account per bank. Why should individuals have to worry about finding multiple banks to obtain insurance, when businesses won't have to do that as well.

FDIC insurance needs to be in the millions for individuals per account per bank, particularly to lessen the complications of safe guarding the deposits of the elderly. I've seen too many elderly individuals who have attempted to deal with the current multitude of government regulations, bank rules, brokerage rules, tax rules, etc. etc and lose money because they inadvertantly didn't move their savings in a timely manner to guarantee that it would be insured or placed in a low risk account or not rolled over automatically into a horrendously low interest paying deposit account with draconian penalties. If nothing else the FDIC should at least make sure their money is insured.
rkhusky
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Re: [Bank failure discussion mega-thread]

Post by rkhusky »

Can one buy insurance to cover FDIC shortfalls? If so, not sure why the government has to provide more than $250K.
Jaylat
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Re: [Bank failure discussion mega-thread]

Post by Jaylat »

The focus should also be on bank ownership.

A properly incentivized shareholder with a financial interest in a bank should IMO be a better administrator than any bank examiner or regulator with no money at risk. A shareholder base concerned about its investments would have been more tuned to the risks in SVB’s portfolio and could have forced changes to their balance sheet before it was too late.

The big losers at SVB were the shareholders. Ironically, the biggest shareholder by far was Vanguard, which means that our BH community of risk averse, diversified investors ended up taking most of the brunt of the SVB collapse. Luckily that risk was highly diversified, and so the impact was relatively small.

However, institutional mega investors like Vanguard are not going to spend much time on a miniscule position in their portfolio. This is a problem, because it allows zombie banks like SVB to fly under the radar. So add the dominance of index funds to the list of culprits here.

Nationalizing the banks would be a disaster, as it would wipe out any incentive to be frugal or profitable. And after seeing how well the Fed manages its own balance sheet why would we want to hand it the whole banking system?
exodusing
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Re: [Bank failure discussion mega-thread]

Post by exodusing »

Jaylat wrote: Thu Mar 23, 2023 9:16 am The focus should also be on bank ownership.

A properly incentivized shareholder with a financial interest in a bank should IMO be a better administrator than any bank examiner or regulator with no money at risk. A shareholder base concerned about its investments would have been more tuned to the risks in SVB’s portfolio and could have forced changes to their balance sheet before it was too late.
The problem is that a shareholder's downside is limited to their investment while the upside is unlimited. It can make sense from a shareholder's point of view to take a very large degree of risk, because that substantially increases the upside without changing the downside.
Jaylat wrote: Thu Mar 23, 2023 9:16 amAnd after seeing how well the Fed manages its own balance sheet why would we want to hand it the whole banking system?
The Fed can create money and therefore can't run out of money. Its balance sheet is not like other balance sheets and typical analysis is irrelevant.
km91
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Re: [Bank failure discussion mega-thread]

Post by km91 »

Jaylat wrote: Thu Mar 23, 2023 9:16 am Nationalizing the banks would be a disaster, as it would wipe out any incentive to be frugal or profitable. And after seeing how well the Fed manages its own balance sheet why would we want to hand it the whole banking system?
You understand the Fed is the central bank of the United States?
CuriousTacos
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

exodusing wrote: Thu Mar 23, 2023 10:22 am
Jaylat wrote: Thu Mar 23, 2023 9:16 am The focus should also be on bank ownership.

A properly incentivized shareholder with a financial interest in a bank should IMO be a better administrator than any bank examiner or regulator with no money at risk. A shareholder base concerned about its investments would have been more tuned to the risks in SVB’s portfolio and could have forced changes to their balance sheet before it was too late.
The problem is that a shareholder's downside is limited to their investment while the upside is unlimited. It can make sense from a shareholder's point of view to take a very large degree of risk, because that substantially increases the upside without changing the downside.
In addition, since the government has at least implicitly promised not to let too many fail at once, there is a subsidized reduction in risk for the industry as a whole. Any single bank can fail, but that's diversifiable risk. By holding a basket of all bank stocks (as a standalone fund or as part of a total market fund), equity holders enjoy the rewards of the risk without bearing all the downside.

As long as there's a lender of last resort, government promises not to allow contagion, etc, then equity and bond holders will not bear enough risk to drive them to change bank practices.

And since politicians and the public don't have the appetite to allow lots of banks to fail because of the presumption that it would bring down the entire economy, we have to pursue other ways to reduce risk.
Jaylat
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Re: [Bank failure discussion mega-thread]

Post by Jaylat »

CuriousTacos wrote: Thu Mar 23, 2023 11:27 am
exodusing wrote: Thu Mar 23, 2023 10:22 am
Jaylat wrote: Thu Mar 23, 2023 9:16 am The focus should also be on bank ownership.

A properly incentivized shareholder with a financial interest in a bank should IMO be a better administrator than any bank examiner or regulator with no money at risk. A shareholder base concerned about its investments would have been more tuned to the risks in SVB’s portfolio and could have forced changes to their balance sheet before it was too late.
The problem is that a shareholder's downside is limited to their investment while the upside is unlimited. It can make sense from a shareholder's point of view to take a very large degree of risk, because that substantially increases the upside without changing the downside.
In addition, since the government has at least implicitly promised not to let too many fail at once, there is a subsidized reduction in risk for the industry as a whole. Any single bank can fail, but that's diversifiable risk. By holding a basket of all bank stocks (as a standalone fund or as part of a total market fund), equity holders enjoy the rewards of the risk without bearing all the downside.

As long as there's a lender of last resort, government promises not to allow contagion, etc, then equity and bond holders will not bear enough risk to drive them to change bank practices.

And since politicians and the public don't have the appetite to allow lots of banks to fail because of the presumption that it would bring down the entire economy, we have to pursue other ways to reduce risk.
It’s not realistic to assume all shareholders want to gamble with their investments. Most of them will try their best to keep their investments intact.

One of the reasons why SVB got into this mess is that the regulators allowed them to ignore losses in their bond portfolios. Again, a properly incentivized bank ownership concerned with maintaining its equity value would not have allowed that to happen. While index funds diversify the risk of ownership, they also have the unfortunate side effect of removing that kind of oversight from the equation.
CuriousTacos
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

Jaylat wrote: Thu Mar 23, 2023 11:56 am
CuriousTacos wrote: Thu Mar 23, 2023 11:27 am
exodusing wrote: Thu Mar 23, 2023 10:22 am
Jaylat wrote: Thu Mar 23, 2023 9:16 am The focus should also be on bank ownership.

A properly incentivized shareholder with a financial interest in a bank should IMO be a better administrator than any bank examiner or regulator with no money at risk. A shareholder base concerned about its investments would have been more tuned to the risks in SVB’s portfolio and could have forced changes to their balance sheet before it was too late.
The problem is that a shareholder's downside is limited to their investment while the upside is unlimited. It can make sense from a shareholder's point of view to take a very large degree of risk, because that substantially increases the upside without changing the downside.
In addition, since the government has at least implicitly promised not to let too many fail at once, there is a subsidized reduction in risk for the industry as a whole. Any single bank can fail, but that's diversifiable risk. By holding a basket of all bank stocks (as a standalone fund or as part of a total market fund), equity holders enjoy the rewards of the risk without bearing all the downside.

As long as there's a lender of last resort, government promises not to allow contagion, etc, then equity and bond holders will not bear enough risk to drive them to change bank practices.

And since politicians and the public don't have the appetite to allow lots of banks to fail because of the presumption that it would bring down the entire economy, we have to pursue other ways to reduce risk.
It’s not realistic to assume all shareholders want to gamble with their investments. Most of them will try their best to keep their investments intact.

One of the reasons why SVB got into this mess is that the regulators allowed them to ignore losses in their bond portfolios. Again, a properly incentivized bank ownership concerned with maintaining its equity value would not have allowed that to happen. While index funds diversify the risk of ownership, they also have the unfortunate side effect of removing that kind of oversight from the equation.
Shareholders don't (and shouldn't) expect a reward from diversifiable risk, since someone else will appropriately diversify that risk away and pay more for the stock, hence driving down the expected return. So all single-company stocks are "overpriced" relative to their risk in isolation, but are not overpriced when held in a diversified portfolio. Bank stocks are no different. The shareholders of SVB, on the whole, held at least a somewhat diversified portfolio, and priced all bank stocks in light of government promises to prevent cascading failures.

In other words, the first few banks in a given crisis will be allowed to fail, and the rest will be rescued. By holding enough bank stocks, investors enjoy the rewards of taking risk during the good times, and have a government-provided limit on the downside when a major crisis hits. If industry wipeout were a possibility, investors would see it differently, but the public and politicians don't have the stomach for that (right or wrong).

As long as our society won't allow industry wipeout, then the insurer (govt) needs to make sure it never gets to that point. It's just like an insurance company having requirements before agreeing to insure your home, except in this case they're dealing with an interconnected industry that could fail at once (and thus isn't truly insurable in the typical sense since you can't pool that risk).

I'm essentially agreeing with your bolded statement, but just clarifying how the current system washes away that incentive (and that index funds aren't the cause).
Jaylat
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Re: [Bank failure discussion mega-thread]

Post by Jaylat »

CuriousTacos wrote: Thu Mar 23, 2023 12:14 pm Shareholders don't (and shouldn't) expect a reward from diversifiable risk, since someone else will appropriately diversify that risk away and pay more for the stock, hence driving down the expected return. So all single-company stocks are "overpriced" relative to their risk in isolation, but are not overpriced when held in a diversified portfolio.
We seem to agree on the big picture but disagree on the particulars. If it were always true that single-company stocks are "overpriced," relative to diversified holdings, then no one would start a new company – they’d just buy index funds.

People start companies because they believe they can beat the market. SBV is a good example of a potentially great niche, creating a bank for Silicon Valley startups. The initial owners probably made out very well, and could have done even better if they had kept their eyes on the ball.

Vanguard, with over 10% of the stock ownership, obviously did not have its eye on the ball. And why should they bother looking closer at SVB if it’s less than 0.01% of its portfolio? So I would maintain that index funds were indeed a factor in its demise.

Still, the process worked as the main shareholder was easily able to absorb the losses. However the SVB debacle could have been avoided altogether.
Harmanic
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Re: [Bank failure discussion mega-thread]

Post by Harmanic »

CuriousTacos wrote: Thu Mar 23, 2023 12:14 pm
Jaylat wrote: Thu Mar 23, 2023 11:56 am
CuriousTacos wrote: Thu Mar 23, 2023 11:27 am
exodusing wrote: Thu Mar 23, 2023 10:22 am
Jaylat wrote: Thu Mar 23, 2023 9:16 am The focus should also be on bank ownership.

A properly incentivized shareholder with a financial interest in a bank should IMO be a better administrator than any bank examiner or regulator with no money at risk. A shareholder base concerned about its investments would have been more tuned to the risks in SVB’s portfolio and could have forced changes to their balance sheet before it was too late.
The problem is that a shareholder's downside is limited to their investment while the upside is unlimited. It can make sense from a shareholder's point of view to take a very large degree of risk, because that substantially increases the upside without changing the downside.
In addition, since the government has at least implicitly promised not to let too many fail at once, there is a subsidized reduction in risk for the industry as a whole. Any single bank can fail, but that's diversifiable risk. By holding a basket of all bank stocks (as a standalone fund or as part of a total market fund), equity holders enjoy the rewards of the risk without bearing all the downside.

As long as there's a lender of last resort, government promises not to allow contagion, etc, then equity and bond holders will not bear enough risk to drive them to change bank practices.

And since politicians and the public don't have the appetite to allow lots of banks to fail because of the presumption that it would bring down the entire economy, we have to pursue other ways to reduce risk.
It’s not realistic to assume all shareholders want to gamble with their investments. Most of them will try their best to keep their investments intact.

One of the reasons why SVB got into this mess is that the regulators allowed them to ignore losses in their bond portfolios. Again, a properly incentivized bank ownership concerned with maintaining its equity value would not have allowed that to happen. While index funds diversify the risk of ownership, they also have the unfortunate side effect of removing that kind of oversight from the equation.
Shareholders don't (and shouldn't) expect a reward from diversifiable risk, since someone else will appropriately diversify that risk away and pay more for the stock, hence driving down the expected return. So all single-company stocks are "overpriced" relative to their risk in isolation, but are not overpriced when held in a diversified portfolio. Bank stocks are no different. The shareholders of SVB, on the whole, held at least a somewhat diversified portfolio, and priced all bank stocks in light of government promises to prevent cascading failures.

In other words, the first few banks in a given crisis will be allowed to fail, and the rest will be rescued. By holding enough bank stocks, investors enjoy the rewards of taking risk during the good times, and have a government-provided limit on the downside when a major crisis hits. If industry wipeout were a possibility, investors would see it differently, but the public and politicians don't have the stomach for that (right or wrong).

As long as our society won't allow industry wipeout, then the insurer (govt) needs to make sure it never gets to that point. It's just like an insurance company having requirements before agreeing to insure your home, except in this case they're dealing with an interconnected industry that could fail at once (and thus isn't truly insurable in the typical sense since you can't pool that risk).

I'm essentially agreeing with your bolded statement, but just clarifying how the current system washes away that incentive (and that index funds aren't the cause).
Banks overall have been a really bad investment over the last 20 years.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

Jaylat wrote: Thu Mar 23, 2023 12:53 pm
CuriousTacos wrote: Thu Mar 23, 2023 12:14 pm Shareholders don't (and shouldn't) expect a reward from diversifiable risk, since someone else will appropriately diversify that risk away and pay more for the stock, hence driving down the expected return. So all single-company stocks are "overpriced" relative to their risk in isolation, but are not overpriced when held in a diversified portfolio.
We seem to agree on the big picture but disagree on the particulars. If it were always true that single-company stocks are "overpriced," relative to diversified holdings, then no one would start a new company – they’d just buy index funds.

People start companies because they believe they can beat the market. SBV is a good example of a potentially great niche, creating a bank for Silicon Valley startups. The initial owners probably made out very well, and could have done even better if they had kept their eyes on the ball.

Vanguard, with over 10% of the stock ownership, obviously did not have its eye on the ball. And why should they bother looking closer at SVB if it’s less than 0.01% of its portfolio? So I would maintain that index funds were indeed a factor in its demise.

Still, the process worked as the main shareholder was easily able to absorb the losses. However the SVB debacle could have been avoided altogether.
Most people starting a company hope to get other people's money sooner rather than later (if not from the very beginning), and either way it's also a job instead of a purely passive investment. VCs likewise view it differently from a passive investment, since they bring their own expertise and connections to improve a startup's chances of success. Plus, VCs can have a somewhat diversified portfolio and/or hedge some of those risks if they want to. So while I agree that the founder and VC have more skin in the game than an index investor, neither the VC nor the founder needs to be excessively concerned with single company risk. Ultimately, the valuation of bank startups by VCs, etc, is influenced by the valuation of public bank stocks, which is influenced by their expected reward adjusted for non-diversifiable risk, which is affected by government promises.

Getting back to index investing, there's no question that total market investors are benefiting (at least in the short term) from the fact that the government stepped in before more banks failed. I have no idea when Vanguard could reasonably have noticed that SVB was taking "too much" risk. Unfortunately, with fractional reserve banking (especially where all banks have pretty low reserve/capital ratios), it's pretty difficult to predict which banks are taking the risks that will blow up first until it's too late. So even if Vanguard tries to keep this from happening again, I have little hope that they'll be able to predict which risks cause the next crisis. If they got really bold and insisted that all banks reduce risk to guarantee no failures, they'd be leaving money on the table offered by government bailouts.
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Re: [Bank failure discussion mega-thread]

Post by Jaylat »

CuriousTacos wrote: Thu Mar 23, 2023 3:19 pm So while I agree that the founder and VC have more skin in the game than an index investor, neither the VC nor the founder needs to be excessively concerned with single company risk.
Why not? It's their money!

I've worked at financial firms where the owners are actively involved. They watch things like a hawk.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

Jaylat wrote: Thu Mar 23, 2023 3:37 pm
CuriousTacos wrote: Thu Mar 23, 2023 3:19 pm So while I agree that the founder and VC have more skin in the game than an index investor, neither the VC nor the founder needs to be excessively concerned with single company risk.
Why not? It's their money!

I've worked at financial firms where the owners are actively involved. They watch things like a hawk.
I agree nobody wants to fail. But...

Enough banks in the marketplace are owned by regular shareholders. Those shareholders can diversify as much as needed to eliminate single company risk. Those banks enjoy government promises of bailouts if the industry is at risk. So investors want those banks to take various risks to be able to generate profits and/or attract more depositors and borrowers, knowing that some will fail but the government will step in before it gets out of hand. (Note: TBTF banks are somewhat restricted in the risks they can take and must bear certain compliance costs, which partly explains their puny deposit interest rates, but they likely attract customers based on other things, so they're playing a slightly different "game").

So, yes, it's their money and they care. But they'd be doomed to failure if they didn't play along and take similar levels of risk. So I think it's likely that someone starting a bank either:
- gets other people's money from the beginning and can collect a sufficient salary such that the equity is more like icing on the cake compared to what they would otherwise be doing
- thinks they've found some niche where they can attract customers based on things other than interest rates, so they can take less risk. Maybe the owners you've been around fit into this category? Not everyone can, or at least can't count on nobody else entering that niche and taking risks.
- is ignorant of these risks and/or just wants to swing for the fences (and found a VC that can sufficiently diversify the risk).
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Re: [Bank failure discussion mega-thread]

Post by Weathering »

How about the preferred shares of regional banks? Who is the target audience buying them?
I see the senior unsecured bonds of regional banks are back to normal (5%) range (except for very short duration). However, the preferred shares (subordinate to senior unsecured bonds) are still falling off a cliff with the common shares.
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Re: [Bank failure discussion mega-thread]

Post by Harmanic »

Weathering wrote: Thu Mar 23, 2023 5:37 pm How about the preferred shares of regional banks? Who is the target audience buying them?
I see the senior unsecured bonds of regional banks are back to normal (5%) range (except for very short duration). However, the preferred shares (subordinate to senior unsecured bonds) are still falling off a cliff with the common shares.
They would be safer than common shares, but still likely to get wiped out in an SVB style rout.

Also, they could suspend the dividends at any time.

FRC bonds traded at a new low today of 50 cents on the dollar, but that is still only a 10% yield. Hardly worth it given the risk of default. I might take a chance at 20% yield.
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Re: [Bank failure discussion mega-thread]

Post by smooth_rough »

"Deutsche Bank is not the next Credit Suisse, analysts say as panic spreads."

Which means it really is.
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Re: [Bank failure discussion mega-thread]

Post by technovelist »

smooth_rough wrote: Fri Mar 24, 2023 10:51 am "Deutsche Bank is not the next Credit Suisse, analysts say as panic spreads."

Which means it really is.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

I've been looking closer at the bank regulations being mentioned in the media lately. Two of those are the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). Here's a summary of these as far as I understand:

LCR:
- intended to ensure a bank could handle 30 days of elevated outflows during system-wide stress. The idea is to give a central bank time to evaluate solvency and provide additional liquidity if that's all that's needed
- is a ratio of assets (at fair market value and weighted by liquidity & credit rating) divided by estimated 30-day net outflows during a crisis
- gradually phased in by the US and fully effective by the beginning of 2017

NSFR:
- intended to measure how stable a bank's funding is over a one year time-frame relative to the composition of their assets. The idea is to make sure there are enough "sticky" deposits (or other funding sources) relative to illiquid assets
- is a ratio of funding sources (weighted by stickiness) divided by assets (at fair market value and weighted by illiquidity and credit risk)
- became effective in the US in July 2021

In the US, these ratios need to be above 1 for the largest banks, with gradually relaxed requirements for the next few tiers, and no requirement for the lowest tiers (note that the Basel III framework these are based on applies to all banks equally without any tiers). The 2018 changes to Dodd-Frank (in the EGRRCPA) reworked these tiers just in time for SVB, as they were about to size-up into a tier that would have essentially required these ratios to be above 70%.

I found this post that tries to estimate SVB's LCR from their 2022 Q4 reports and suggests that it's hard to say whether it would have raised flags. But since this metric counts long and short term treasuries the same (both at FMV), they would have easily passed before their bonds dropped too much. So this metric clearly doesn't prevent banks from taking excessive interest rate risk in the first place.

What about the NSFR? The Basel III document says that one goal is to limit maturity transformation risk. Great! But then I looked at the details. There are many categories of funding types (i.e. deposits) and asset types, so I can't calcate the ratio for SVB, but let's just take a very simple relevant example. Suppose a bank exclusively takes non-operational deposits (excess cash not used for things like payroll and expenses) from companies and uses all that money to buy 30 year treasuries. Deposits of that type are multiplied by 50% (they are partially sticky), while treasuries of any maturity are multiplied by 5% (they are very liquid). The ratio would be 5.0, and it would pass the TBTF threshold with gobs of room to spare. Am I missing something? It seems like this test is still only looking at liquidity rather than the kinds of risks that could lead to losses and insolvency.

There are of course many other metrics, like capital requirements, which try to ensure solvency, but I think those tend to count treasuries at par value. The assumption is that if a bank has enough liquidity based on the above ratios, then it can hold treasuries to maturity and survive. Whoops.

There are many interpretations of this, but it clearly runs deeper than the 2018 modifications to Dodd-Frank or even US politics since I don't see how the Basel III framework would have prevented this. Maybe regulators across the world know exactly what needs to be done but keep losing to bank lobbies. But that would just reinforce my opinion that fractional reserve banking is a fragile system that we're never practically going to make safe through regulation. But I suppose neither are we likely to try something radically safer.
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Re: [Bank failure discussion mega-thread]

Post by alex_686 »

CuriousTacos wrote: Fri Mar 24, 2023 7:43 pm I found this post that tries to estimate SVB's LCR from their 2022 Q4 reports and suggests that it's hard to say whether it would have raised flags. But since this metric counts long and short term treasuries the same (both at FMV), they would have easily passed before their bonds dropped too much. So this metric clearly doesn't prevent banks from taking excessive interest rate risk in the first place.



There are many interpretations of this, but it clearly runs deeper than the 2018 modifications to Dodd-Frank or even US politics since I don't see how the Basel III framework would have prevented this. Maybe regulators across the world know exactly what needs to be done but keep losing to bank lobbies. But that would just reinforce my opinion that fractional reserve banking is a fragile system that we're never practically going to make safe through regulation. But I suppose neither are we likely to try something radically safer.
Do you have a specific question?

I haven’t reviewed your link yet but I suspect that trying to estimate these values from the annual reports is going to be futile.

I will point out that these measures don’t measure solvency or risk. i.e. the duration risk which knocked the value of loans/assets on SVB books. Rather it is a better measure of how much time and space they have to address those issues.

I am a bit more relaxed on fractional reserves. It is a inherent part of money and banking. Creation of safe and stable risk-less money is littered by failure. Better to embrace active risk management to address issues of a dynamic system. I will point out that Basel III comes from the lessons learned from Basel I & II.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

alex_686 wrote: Fri Mar 24, 2023 8:00 pm Do you have a specific question?
...
I will point out that these measures don’t measure solvency or risk. i.e. the duration risk which knocked the value of loans/assets on SVB books. Rather it is a better measure of how much time and space they have to address those issues.
My post was mostly an observation, but I did ask if I was missing anything regarding those metrics. It seems like you agree that they generally target liquidity rather than insolvency (much less interest rate risk).

Now I'm wondering what metrics aim to prevent excessive interest rate risk. I found a Basel III document called "Interest rate risk in the banking book", but it aims to be a conceptual framework rather than a standardized requirement. It does propose a potential metric, but I don't see pass/fail criteria, and it suggests US banks should consider interest rate shock scenarios of either 2% across the yield curve, or 3% focused at the short end, or 1.5% focused at the long end. All of these were exceeded, so the guidelines might have been insufficient anyway.

Even if I try to put aside my disagreement with fractional reserve banking, I still come away very unimpressed with the attention given to interest rate risk. Maybe that's easy to say in hindsight, but with many people insisting that maturity mismatch with demand deposits is the key role of banking, I would think that interest rate risk is pretty obvious and - as long as government is going to back the system - worthy of required stress tests at much greater extremes.

There also appears to be a fairly pervasive idea that even creeps into the Basel III regulations that each bank is very different, and it's pretty much impossible to create generalized standards that prevent excessive risk for some unique type of bank while allowing typical risk for all the others. For example, the Basel document on interest rate risk says (note that Pillar 1 includes the required metrics, while Pillar 2 generally consists of recommendations):
These updated Principles were the subject of consultation in 2015, when the Committee presented two options for the regulatory treatments of IRRBB: a standardised Pillar 1 (Minimum Capital Requirements) approach and an enhanced Pillar 2 approach (which also included elements of Pillar 3 – Market Discipline). The Committee noted the industry’s feedback on the feasibility of a Pillar 1 approach to IRRBB, in particular the complexities involved in formulating a standardised measure of IRRBB which would be both sufficiently accurate and risk-sensitive to allow it to act as a means of setting regulatory capital requirements. The Committee concludes that the heterogeneous nature of IRRBB would be more appropriately captured in Pillar 2.
So my question then is how would you propose to fix all this? Does each regulation just need to be a bit tighter so there's more buffer? Are there some obvious ones missing? Or do we need something that's maybe a bit more broad and has fewer possible gaps but might restrict some existing banking operations?
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

As a follow up...

While Basel III contains some stricter requirements in direct response to 2008, the bias towards government securities means that banks are doing even less to lend to businesses that can generate wealth.

I'd much rather have a bank take term deposits and loan a good portion out to local businesses, than take demand deposits and use almost all of them to buy long dated government-backed securities. But the regulations encourage the latter much more than the former.
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Re: [Bank failure discussion mega-thread]

Post by technovelist »

alex_686 wrote: Fri Mar 24, 2023 8:00 pm I am a bit more relaxed on fractional reserves. It is a inherent part of money and banking. Creation of safe and stable risk-less money is littered by failure. Better to embrace active risk management to address issues of a dynamic system. I will point out that Basel III comes from the lessons learned from Basel I & II.
Can you name one of those failures, since there have apparently been many of them?
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Re: [Bank failure discussion mega-thread]

Post by nisiprius »

technovelist wrote: Sat Mar 25, 2023 9:20 am
alex_686 wrote: Fri Mar 24, 2023 8:00 pm I am a bit more relaxed on fractional reserves. It is a inherent part of money and banking. Creation of safe and stable risk-less money is littered by failure. Better to embrace active risk management to address issues of a dynamic system. I will point out that Basel III comes from the lessons learned from Basel I & II.
Can you name one of those failures, since there have apparently been many of them?
9,000 bank failures during the Great Depression? The article doesn't name all of them, but it does name one--this one, in Haverhill, Ohio:
Image

And probably a similar number during the Long Depression of 1873-1894.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

nisiprius wrote: Sat Mar 25, 2023 9:25 am
technovelist wrote: Sat Mar 25, 2023 9:20 am
alex_686 wrote: Fri Mar 24, 2023 8:00 pm I am a bit more relaxed on fractional reserves. It is a inherent part of money and banking. Creation of safe and stable risk-less money is littered by failure. Better to embrace active risk management to address issues of a dynamic system. I will point out that Basel III comes from the lessons learned from Basel I & II.
Can you name one of those failures, since there have apparently been many of them?
9,000 bank failures during the Great Depression? The article doesn't name all of them, but it does name one--this one, in Haverhill, Ohio:
Image

And probably a similar number during the Long Depression of 1873-1894.
Those were all fractional reserve banks with government fiat. The ones in the great depression were even after the creation of the Federal Reserve.
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Re: [Bank failure discussion mega-thread]

Post by technovelist »

nisiprius wrote: Sat Mar 25, 2023 9:25 am
technovelist wrote: Sat Mar 25, 2023 9:20 am
alex_686 wrote: Fri Mar 24, 2023 8:00 pm I am a bit more relaxed on fractional reserves. It is a inherent part of money and banking. Creation of safe and stable risk-less money is littered by failure. Better to embrace active risk management to address issues of a dynamic system. I will point out that Basel III comes from the lessons learned from Basel I & II.
Can you name one of those failures, since there have apparently been many of them?
9,000 bank failures during the Great Depression? The article doesn't name all of them, but it does name one--this one, in Haverhill, Ohio:
Image

And probably a similar number during the Long Depression of 1873-1894.
So they kept all demand deposits at the Fed or in short T-bills rather than mismatching maturities?
How did they fail then?
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Re: [Bank failure discussion mega-thread]

Post by ClassII »

CuriousTacos wrote: Fri Mar 24, 2023 11:39 pm As a follow up...

While Basel III contains some stricter requirements in direct response to 2008, the bias towards government securities means that banks are doing even less to lend to businesses that can generate wealth.

I'd much rather have a bank take term deposits and loan a good portion out to local businesses, than take demand deposits and use almost all of them to buy long dated government-backed securities. But the regulations encourage the latter much more than the former.
I suppose the question to ask is if this is a problem or not. Is it particularly difficult to get a small business loan these days? If banks had to reach for yield on private loans we're back to 2008 but instead of just mortgages it would be loose lending to all manner of small businesses. Keep in mind a ton of those fail regularly too.
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Re: [Bank failure discussion mega-thread]

Post by exodusing »

ClassII wrote: Sat Mar 25, 2023 9:52 am
CuriousTacos wrote: Fri Mar 24, 2023 11:39 pm As a follow up...

While Basel III contains some stricter requirements in direct response to 2008, the bias towards government securities means that banks are doing even less to lend to businesses that can generate wealth.

I'd much rather have a bank take term deposits and loan a good portion out to local businesses, than take demand deposits and use almost all of them to buy long dated government-backed securities. But the regulations encourage the latter much more than the former.
I suppose the question to ask is if this is a problem or not. Is it particularly difficult to get a small business loan these days? If banks had to reach for yield on private loans we're back to 2008 but instead of just mortgages it would be loose lending to all manner of small businesses. Keep in mind a ton of those fail regularly too.
"Companies Big and Small Lose Access to Credit Amid Bank Stress" https://www.wsj.com/articles/companies- ... s-53df944e
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Re: [Bank failure discussion mega-thread]

Post by alex_686 »

CuriousTacos wrote: Sat Mar 25, 2023 9:35 am Those were all fractional reserve banks with government fiat. The ones in the great depression were even after the creation of the Federal Reserve.
US was on the gold standard. A nice safe hard currency which causes help exaggerator the problem.

To extend, Plato argued that money is a special type of bond created by a social contract. As such, all money is fiat money. I support this idea.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

exodusing wrote: Sat Mar 25, 2023 10:37 am
ClassII wrote: Sat Mar 25, 2023 9:52 am
CuriousTacos wrote: Fri Mar 24, 2023 11:39 pm As a follow up...

While Basel III contains some stricter requirements in direct response to 2008, the bias towards government securities means that banks are doing even less to lend to businesses that can generate wealth.

I'd much rather have a bank take term deposits and loan a good portion out to local businesses, than take demand deposits and use almost all of them to buy long dated government-backed securities. But the regulations encourage the latter much more than the former.
I suppose the question to ask is if this is a problem or not. Is it particularly difficult to get a small business loan these days? If banks had to reach for yield on private loans we're back to 2008 but instead of just mortgages it would be loose lending to all manner of small businesses. Keep in mind a ton of those fail regularly too.
"Companies Big and Small Lose Access to Credit Amid Bank Stress" https://www.wsj.com/articles/companies- ... s-53df944e
The proper equilibrium of business loans is not humanly knowable. Fractional reserves and government manipulation of credit/money often lead to a boom/bust cycle, so the tightening of credit may simply be the necessary unwinding of businesses that only got this far due to easy money. Unfortunately some good businesses can get swept away with this too, which is just one more reason why this cycle is bad for the economy (not to mention the capital wasted during the boom).

ClassII- my point was to show the irony of the argument that the fractional reserve system is necessary to support sufficient business lending, since the result is a system so unstable that regulators ultimately decide they need to limit such activity anyway. And then government-backed bonds still blow up some banks.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

alex_686 wrote: Sat Mar 25, 2023 11:05 am
CuriousTacos wrote: Sat Mar 25, 2023 9:35 am Those were all fractional reserve banks with government fiat. The ones in the great depression were even after the creation of the Federal Reserve.
US was on the gold standard. A nice safe hard currency which causes help exaggerator the problem.

To extend, Plato argued that money is a special type of bond created by a social contract. As such, all money is fiat money. I support this idea.
Right, I shouldn't have referred to that as pure fiat. My original statement you replied to was about fraction reserves, and all those examples were under a fractional reserve system, and even had a lender of last resort during the depression.
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Re: [Bank failure discussion mega-thread]

Post by alex_686 »

CuriousTacos wrote: Fri Mar 24, 2023 11:39 pm As a follow up...

While Basel III contains some stricter requirements in direct response to 2008, the bias towards government securities means that banks are doing even less to lend to businesses that can generate wealth.

I'd much rather have a bank take term deposits and loan a good portion out to local businesses, than take demand deposits and use almost all of them to buy long dated government-backed securities. But the regulations encourage the latter much more than the former.
I am going to be throwing out lots of high level concepts. Let me know if you want me to dig deeper into any of them.

For a little context, this is kind of my day job and my undergrade was in Economic History of the US and the History of 19th Century US Thought (i.e., the development of ideas). A good chunk of my day is spent breaking in newly minted grad students on how to actually apply the theory they learned in school to real risk management.

First, as I have already mentioned, the Platonic concept of money. i.e., a social contract. i.e., if it waddles like a duck and quakes like a duck it is a duck. That means anything that acts like money is money. So just not government sanctioned money but all of that near-money which is floating out there in the shadow banking system. Lots of good examples here over the past 200 years where failures have caused economic collapse. As such, as a social contract, it is a ever evolving thing.

Conclusion: Money will be continuously created and destroyed. As such, banks and fractional reserves are inevitable.

Second, there is the Minsky Instability Hypothesis, which I believe in. In summary, the seeds of tomorrow's failures is today's stability. You don't get a asset bubble unless you cheap capital. You only get cheap capital if you are in a low-risk environment. If you have a truly stable asset then the logical thing to do is leverage that asset all the way up. Cash is a special type of bond. As a example I will point out the AAA CDO's issued prior to the GFC 2008 were effectively cash because they were considered risk free, which leveraged up the system.

Conclusion: You are never going to have a passive stable currency and banking supply. The system is dynamic and as such risk management should be dynamic.

To extend, I would contest that Basel III favors government debt. Basel I & II favored investing in the local economy. Banks had to hold the same reserve requirements if they invested in low yielding government debt or medium yielding mortgage debt, or high yield sub-prime lending. As such the logical answer for banks was to leverage up their portfolio (see Minsky above). i.e., a strong preference for risk stuff over boring stuff. This of course led to bubbles in agricultural lending (see the farm crisis of 1987), sub-prime lending.

Conclusion, people are cleaver. No matter how you set up the game, people will figure out how to optimize the system. Since the system is dynamic any regulations will always be a step behind.

Which is why I kind of like Basel III. It is less about regulations and more about setting out principles. Under Basel III the risk weighting of assets should be adjusted to reflect the risks of those assets. Government bonds are relative safe and liquid so low reserves, other assets have higher reserves, to be adjusted as situations change.
Last edited by alex_686 on Sat Mar 25, 2023 12:06 pm, edited 1 time in total.
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Re: [Bank failure discussion mega-thread]

Post by alex_686 »

CuriousTacos wrote: Sat Mar 25, 2023 11:34 am Right, I shouldn't have referred to that as pure fiat. My original statement you replied to was about fraction reserves, and all those examples were under a fractional reserve system, and even had a lender of last resort during the depression.
The Fed really wasn't a lender of last resort until the banking act of 1935.
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

alex_686 wrote: Sat Mar 25, 2023 12:03 pm
CuriousTacos wrote: Sat Mar 25, 2023 11:34 am Right, I shouldn't have referred to that as pure fiat. My original statement you replied to was about fraction reserves, and all those examples were under a fractional reserve system, and even had a lender of last resort during the depression.
The Fed really wasn't a lender of last resort until the banking act of 1935.
Wikipedia:
The Federal Reserve Act [1913] created the Federal Reserve System, consisting of twelve regional Federal Reserve Banks jointly responsible for managing the country's money supply, making loans and providing oversight to banks, and serving as a lender of last resort.
I'm sure the 1935 act consolidated these powers, but they began in 1913.

Note: what existed prior to that in 1912 had its own issues. I'm not aware of a time that had meaningful restrictions on fractional reserve banking. I'll respond to your longer post when I have more time
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Re: [Bank failure discussion mega-thread]

Post by alex_686 »

CuriousTacos wrote: Sat Mar 25, 2023 12:53 pm
alex_686 wrote: Sat Mar 25, 2023 12:03 pm
CuriousTacos wrote: Sat Mar 25, 2023 11:34 am Right, I shouldn't have referred to that as pure fiat. My original statement you replied to was about fraction reserves, and all those examples were under a fractional reserve system, and even had a lender of last resort during the depression.
The Fed really wasn't a lender of last resort until the banking act of 1935.
Wikipedia:
The Federal Reserve Act [1913] created the Federal Reserve System, consisting of twelve regional Federal Reserve Banks jointly responsible for managing the country's money supply, making loans and providing oversight to banks, and serving as a lender of last resort.
I'm sure the 1935 act consolidated these powers, but they began in 1913.

Note: what existed prior to that in 1912 had its own issues. I'm not aware of a time that had meaningful restrictions on fractional reserve banking. I'll respond to your longer post when I have more time
The wiki source simplifies too much. Prior to the Great Depression Americans like their government small and toothless. JP Morgan was actually the lender of last resort back then.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
CuriousTacos
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Re: [Bank failure discussion mega-thread]

Post by CuriousTacos »

alex_686 wrote: Sat Mar 25, 2023 1:41 pm The wiki source simplifies too much. Prior to the Great Depression Americans like their government small and toothless. JP Morgan was actually the lender of last resort back then.
JP Morgan was active in that capacity through 1907. JP Sr died in 1913, and his son wasn't nearly as active or successful in doing so.

As for the Fed's role, it's certainly a matter of degrees:
https://www.federalreservehistory.org/essays/feds-formative-years wrote:Perhaps the most important benefit of becoming a member of the Federal Reserve System was access to the Fed’s “discount window.” Member banks could obtain additional reserves or Federal Reserve notes by “rediscounting” short-term commercial and agricultural paper (bank loans) with their Reserve Bank.3 The Fed’s founders expected that the ability of member banks to rediscount eligible paper at the Fed’s discount window would provide the flexibility or “elasticity” to the nation’s money supply needed to end the problem of banking panics.
Regardless, while it's interesting to discuss these nuances, we've gotten off track from your original statement: "creation of safe and stable risk-less money is littered by failure." I'd like to hear your examples of such attempts.
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UncleLeo
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Re: [Bank failure discussion mega-thread]

Post by UncleLeo »

Just saw that First Republic's stock lost 90% of its value since the beginning of the month and hasn't recovered at all even after SVBs bailout and the treasury secretary's remarks.
Can someone explain what problems FRB is facing? Similar to SVB? Credit Suisse? something else?
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Re: [Bank failure discussion mega-thread]

Post by technovelist »

UncleLeo wrote: Sun Mar 26, 2023 5:37 am Just saw that First Republic's stock lost 90% of its value since the beginning of the month and hasn't recovered at all even after SVBs bailout and the treasury secretary's remarks.
Can someone explain what problems FRB is facing? Similar to SVB? Credit Suisse? something else?
I believe (but don't quote me) that they have a similar maturity mismatch to SVB.
But it doesn't really matter; no "normal" bank can sustain a run.
In theory, theory and practice are identical. In practice, they often differ.
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Re: [Bank failure discussion mega-thread]

Post by MKP »

technovelist wrote: Sun Mar 26, 2023 7:55 am
UncleLeo wrote: Sun Mar 26, 2023 5:37 am Just saw that First Republic's stock lost 90% of its value since the beginning of the month and hasn't recovered at all even after SVBs bailout and the treasury secretary's remarks.
Can someone explain what problems FRB is facing? Similar to SVB? Credit Suisse? something else?
I believe (but don't quote me) that they have a similar maturity mismatch to SVB.
But it doesn't really matter; no "normal" bank can sustain a run.
This. They got grouped in with SVB because they are headquartered in SFO. They originate high quality mortgages to people who can (in actuality) pay. As a result these (high net worth) individuals keep a significant amount of cash in the bank (often as collateral) for these mortgages. The problem is, that to earn interest on the customer deposits, they put the money in gov. backed securities. In normal times this portfolio would roll with rates, but now the fed has raised rates so fast that the portfolio has gotten slaughtered, just like any bondholder portfolio for the past year. All if would take is someone to start a confidence crisis to cause people to pull their deposits, and when the investments are no longer worth even close to the deposits, we wind up with a liquidity crunch. First republic has done nothing different in the past 5 years than they have in the past 40 for better for worse, the FED basically caused this entire situation with them because they printed trillions during Covid and now need to go rate crazy to stop the inflation that they caused. Maybe that is why they and the other banks are playing nice with First Republic.
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Re: [Bank failure discussion mega-thread]

Post by coachd50 »

I do find it interesting how much buzz this has gotten. As nisiprius stated in another thread, 500 banks have failed in the last 15 years. Unfortunately, the BUZZ greatly exacerbates the panic and the problem.
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Re: [Bank failure discussion mega-thread]

Post by ScubaHogg »

alex_686 wrote: Sat Mar 25, 2023 12:00 pm Conclusion, people are cleaver. No matter how you set up the game, people will figure out how to optimize the system. Since the system is dynamic any regulations will always be a step behind.
A solid argument for a system where banks could fail and it wouldn’t matter anymore than if a local restaurant failed. Run-proof if you will

https://papers.ssrn.com/sol3/papers.cfm ... id=2425883
“Conventional Treasury rates are risk free only in the sense that they guarantee nominal principal. But their real rate of return is uncertain until after the fact.” -Risk Less and Prosper
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Re: [Bank failure discussion mega-thread]

Post by coachd50 »

ScubaHogg wrote: Sun Mar 26, 2023 8:46 pm
alex_686 wrote: Sat Mar 25, 2023 12:00 pm Conclusion, people are cleaver. No matter how you set up the game, people will figure out how to optimize the system. Since the system is dynamic any regulations will always be a step behind.
A solid argument for a system where banks could fail and it wouldn’t matter anymore than if a local restaurant failed. Run-proof if you will

https://papers.ssrn.com/sol3/papers.cfm ... id=2425883
Isn't that generally the case? How many banks have such a high concentration of uninsured deposits?
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