The Sixteenth Largest US Bank Failed Last Week Together with Yet Another Crypto-Linked institution.
Markets sold off last week. Two factors were at work. First, employment figures were stronger than expected, feeding into the bearish argument that interest rates must move higher to slow excess demand and inflation. And second, a regional bank with $200 billion in assets failed. While it may not be obvious, I think these events are connected.
My focus is on the consumer, whose spending drives the economy. But sometimes the credit cycle drives the consumer. Normally, the most important factor for consumer spending is employment. When U.S. consumers have jobs, they spend. The level of spending is influenced by many factors but the propensity to spend is so strong that consumers will even rush to make up on lost spending following periods of hesitation. I would not bet against the U.S. consumer.
That said, consumers need access to credit (loans from banks) for important transactions like homes and autos. Businesses need access to capital to make investments and hire more workers. During periods of external shock, such as during the Covid panic or in the wake of the 2007-2009 financial crisis, banks reacted to uncertainty by pulling back on lending. The below chart clearly shows caution around lending during those events and also, of more concern, today.
Ultimately, the Fed stepped in during the financial crisis to support banks and get lending going again. This was considered a success. The Fed and the administration were following the same playbook during the Covid panic, but unfortunately overdid it. Ultra-low interest rates, direct payments to individuals, the suspension of loan and other payments, and other bank actions flooded the system and created excess demand. One result has been higher prices for food and services (inflation). Another result was distortion in financial markets. Flourishing crypto fraud, meme-stock mania, and crazy valuations for unprofitable tech stocks were all spawned in the toxic cocktail of stimulus checks, greed, and the lack of risk aversion that comes with free money.
Crypto-banks should fail and meme stock investors need to be zeroed out, unfortunately. The Fed’s year-long campaign to raise interest rates is directly intended to put an end to the excesses that are behind rising prices for goods and services. Lower stock market, home and other asset prices are a part of this plan. There is no debate about whether the Fed will win in its effort to destroy excess demand. The debate is whether the Fed can achieve this result without throwing the economy into a deep recession. On the one side are the optimistic “soft-landers”. The soft-landers look at current consumer and economic activity as a sign that the economy will keep going even with the impact of higher rates. Meanwhile, the skeptics fill up my LinkedIn feed with posts written in all caps and warning that Powell’s efforts are yet to be fully seen will “break something”. I call the bearish camp the “apocalyptic chartists” for their propensity to post scary charts (like the above).
Is the failure of Silicon Valley Bank tangible evidence of a broader, more systemic problem stemming from rising interest rates? Will its failure wreck confidence among investors in other banks, or cause banks to reduce risk by cutting lending to consumers and businesses? I’m not a bank analyst or expert but this event certainly does not seem positive for lending.
Here’s my guess: If efforts over the weekend to purchase all or part of Silicon Valley Bank are successful and the majority of depositors are made fully or mostly whole, then crisis will be averted. Calm may be restored. Nevertheless, risks to the system from the efforts to slow the economy and fight inflation have become more apparent. Expect the apocalyptic chartists to get louder.
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John Zolidis
President & Founder
Quo Vadis Capital, Inc.
John.zolidis@quovadiscapital.com
Mr. Zolidis founded Quo Vadis Capital, Inc., a Registered Investment Advisor (RIA) and research consultancy, in 2017. He started his career in finance in 1996 following degree studies in Philosophy at Kenyon College and the University of Oxford. He has followed U.S. consumer companies as a senior analyst since 1999, mostly on the sell-side, writing research for institutional investor clients. He also managed money in a buy-side role at a long-short equity fund over 2013-2014. He was named in the Wall Street Journal’s Best on the Street list in 2005. Mr. Zolidis and works from New York, NY and Paris, France or wherever he has his laptop.
Travel update: Heading Austin & Houston at the close of March and early April. I concluded last month’s travels with a guest lecture at Columbia Business School. The topic was how to know when to sell a security. I recorded a condensed (12 minute) version, which I uploaded to youtube. Email me if you’d like the full slide deck. At the end of this month, I will fly to Texas to visit my brother, a playwright living in Austin and my nephews. My excuse is two days of analyst meetings and presentations with Academy Sports + Outdoors (ASO), a sporting goods retailer that I follow and write about for my professional investor clients.
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