Trust FDIC (not your bank)

In brief:

Trust the FDIC, not your bank

FDIC has successfully insured bank deposits for 90 years

No need to panic but limit your bank deposits to $250,000 (FDIC’s limit)

There are better options for cash today, including US Govt backed T-bills

Inflation is still too high eroding your purchasing power

Congress contributed to this banking crisis (again)

This is not 2008 but recession risk is heightened

We are investing in companies that we believe can weather a potential recession

The labor market remains strong, unemployment is below 4%

First quarter economic growth is estimated at 1.5%

The Federal Reserve is most likely done hiking interest rates (due to the banking crisis)

Trust the FDIC (not your bank)

You know that feeling of security you have right now about your bank? That’s the same feeling customers had about Silicon Valley (and Signature) bank before they suddenly imploded, igniting today’s new banking crisis. There is no need to panic. Why? Because once again, federal government agencies (not congress) quickly engaged to prevent the crisis from damaging our financial system. On March 10th the Federal Deposit Insurance Corporation (FDIC) stepped in to take over failing Silicon Valley bank. On the day prior, Silicon Valley customers panicked and withdrew a reported $42 billion. The preferred bank of venture capitalists and the Technorati failed to innovate themselves out of an old-fashioned bank run. Several factors contributed to the bank failing, but poor risk management by corporate executives is at the top of the list. Just 48 hours after Silicon Valley became insolvent, the FDIC along with the Federal Reserve and United States Treasury, released a joint statement to reassure depositors that their money was safe. If it was not for this action on Sunday evening Marth12th, we may have witnessed several more bank runs and we’d likely be in a recession by now. In light of recent bank failures, and out of an abundance of caution, we recommend clients limit cash balances to $250,000 (FDIC’s insurance limit) per institution. Since it’s founding in 1933, the FDIC has successfully protected depositors from countless bank failures. 

Profits Over People

Banks have no one to blame but themselves for the massive outflows they are experiencing today as customers move to attain a respectable rate of return on their money. As interest rates rose, banks continued to pay a pittance on our cash. Understand that a significant portion of a bank’s earnings are derived from the difference (or spread) on the interest rate they earn on loans, versus the measly interest rate they pay depositors. For instance, many banks are still paying less than 1% on cash deposits, but they’re earning over 6% on 30-year mortgages today, or a spread greater than 5%. In 2022, the spread banks earned on loans versus what they paid to depositors amounted to $637 billion!  Talk about easy money. We essentially ‘loan’ them our money so they can pocket billions. Friendly reminder: publicly traded financial institutions (including banks, brokerage firms) prioritize quarterly earnings to please Wall Street analysts and their  shareholders. They don’t give a $hit about you. 

Don’t Get Fooled Again

Loathe them or hate ‘em, banks are necessary. They provide loans for consumers to buy cars, homes, expand businesses, etc. However, they don’t stick your money in a vault. They loan it to consumers and businesses, and they also buy safe government guaranteed bonds.  So why not skip the middleman (banks) and buy bonds yourself? Due to the Federal Reserve’s fight on inflation, interest rates are significantly higher today. You can earn nearly 5% on 3 month Treasury bill guaranteed by the government. As a bonus, interest earned on Treasury bonds is free of state taxes. To stem the tidal wave of cash leaving banks, bankers are now actively promoting higher yielding money market funds, and confusing consumers in the process. Beware, if your bank convinced you to do this. Please understand that most money market funds are not protected under FDIC, as these are deemed as securities products. Your banker will say something to the effect of ‘these money market funds are safe because they invest in government bonds.’ This may be true but it’s likely they do not qualify for FDIC protection. Ask your banker point blank, is this fund protected by FDIC?  You may need to remind them that it’s a simple yes or no question.

Be an Owner, not a Loaner

We all need liquid cash but how much? Our resident Certified Financial Planner, Jerry Newman (CFP) recommends at least 6 months’ to one year worth of expenses. Again, short term T-bills are an excellent alternative to cash.  However, we believe, anything in excess of one’s liquidity needs, should be invested long term. It’s very easy to get discouraged after enduring a brutal bear market. Last year stocks fell 19% and the bond market, failed to ease the pain in stocks, fell 13%, its worst year on record. But pull your lens back. Over the past 5 years the stock market (S&P 500) is up 57%, and over the past decade, it’s up 120%. Stocks are a proven hedge to inflation, which is still running too high at 6%. If your bank is paying you 4% in a taxable money market fund, assuming the highest tax bracket, your after tax return is approximately 2%. After you account for 6% inflation, your net return is a negative 4% (2% minus 6%). For every $100,000 earning 4% at the bank, you are losing approximately $4,000 in purchasing power. Owning pieces of profitable businesses (stocks) is a far superior way to building wealth than ‘loaning’ money to your bank.

Regulate, Repeal, Rescue, Rinse & Repeat

Recognize a familiar pattern? In response to a crisis, congress passes regulations to prevent a future crisis. Congress receives millions in campaign contributions from banking lobbyists. Then under the guise of ‘free market capitalism’ congress weakens regulations. Eventually, banks seeking ever higher profits forget about risk management, and we find ourselves in a new crisis. The Federal Reserve is then forced to rescue the financial system. Rinse & repeat. In recent weeks we have seen the second and third largest bank failures in US history. But fortunately, today’s big banks are well capitalized, in large part due to Dodd-Frank regulations enacted in the wake of the Great Financial Crisis (GFC). Thus, even if today’s banking crisis leads to a recession, I do not expect anything resembling the GFC of 2007-2009.  The GFC was the worst economic downturn our country had endured since the Great Depression. The unemployment rate spiked to 10% as 9 million jobs were lost (today’s unemployment rate is 3.6%). Ten million Americans lost their homes to foreclosure.  In order to prevent another Great Depression, congress passed a $700 billion emergency massive bank bailout. On October 28, 2008, 6 weeks after Lehman Brothers went bankrupt, U.S taxpayers forked over billions to Wall Street banks:

Wells Fargo, $25,000,000,000

JP Morgan, $25,000,000,000

Citigroup, $25,000,000,000

Bank of America, $15,000,000,000

Morgan Stanley, $10,000,000,000

Goldman Sachs, $10,000,000,000

Merrill Lynch, $10,000,000,000

Note: Schwab did not take government bailout money in 2008

Oh Crapo!

Unfortunately, in 2018, congress passed the bi-partisan Crapo bill (named after the congressman who wrote it) which rolled back some of the Dodd-Frank regulations on smaller banks. This allowed banks with less than $250 billion in assets (like Silicon and Signature) to avoid mandatory stress tests, that are designed to gage the financial soundness of banks under very challenging scenarios (like the GFC). Silicon Valley was not subject to all Dodd-Frank restrictions. Just as in 2008, today’s banking crisis can partly be blamed on deregulation by congress.

I don’t know if we’re out of the woods with respect to the banking crisis. We may see more smaller banks fail or get taken over by bigger banks. Once highly reputable First Republic needed to be rescued. I suppose there will be others. But I do believe that our greater financial system is sound due to regulations and the government agencies that oversee them. I suspect many regional banks are in the process of shoring up their balance sheets, instead of pursuing growth (loans). And if banks reduce lending, economic growth will slow. I believe this crisis among smaller banks will act as a 'deflationary shock' to our economy. Less demand for dollars (loans) means less inflation. The silver lining is that the Federal Reserve is likely done hiking interest rates. We have not jumped on the ‘recession is imminent’ bandwagon but thanks to the banking crisis, recession risk has increased due to the change in mood and sentiment. We are managing portfolios accordingly and investing in companies and sectors that we believe can weather a potential recession (think big, dominant, profitable). Fortunately, our labor market remains strong with an  unemployment rate below 4%. And first quarter economic growth is estimated at 1.5%, down from above 3% just a few weeks ago. The slowdown is a byproduct of the Federal Reserve’s fight to reduce inflation. Since Silicon Valley bank collapsed on March 10th, the stock market (S&P 500) is up over 6%. You can thank the FDIC. 

Hamilton Wealth is not beholden to quarterly earnings, shareholders, and Wall Street analysts. We are fiduciary advisors that represent you. 

Lets discuss further.

Thank you!

-randy