AFMC - Perspective On The Bank Crisis
2023-05-16 16:30:00 ET
Summary
- Federal Reserve tightening cycles, without exception, have been associated with financial crises.
- Tightening lending standards, which has historically led to an economic downturn, is raising the likelihood of a recession.
- The bank failures may mark the end of market downturns and the beginning of a new market cycle, as they did in the past.
Originally posted on May 2, 2023
By Brian Levitt, Global Market Strategist
While the failures of Silicon Valley Bank (SIVBQ), Signature Bank ( SBNY ), and First Republic ( FRCB ), and problems at Credit Suisse ( CS ) were unnerving and led to market volatility, they weren’t necessarily unexpected. Fed tightening cycles, without exception, have been associated with financial crises. Here are a few key things to keep in mind about bank crises past and present.
Financial crises are a part of tightening cycles
Most of the past crises didn’t result in systemic bank failure
Despite all the “financial accidents” that occurred across each of the Fed tightening cycles, there have only been three instances in modern US history of systemic bank failure — the 1930s, the late 1980s, and the late 2000s, according to the Federal Deposit Insurance Corporation.
Banks appear to be healthier than during the Global Financial Crisis
The health of bank balance sheets is a fundamental difference between 2008 and today. Bank balance sheets appear to be sound as they are heavily comprised of high-quality and liquid assets, such as US Treasury bonds and cash. 1 A central feature of the 2008 Global Financial Crisis was that many of the nation’s largest and most interconnected banks had levered exposure to the US housing market. Assets were worth far less than stated, and the leverage was significantly greater than had been claimed. The banks failed because of bad loans and poor credit underwriting.
But as banks tighten lending standards, recession risks are elevated
Banks were already tightening lending standards prior to the recent bank failures. It’s expected that lending standards will tighten further, which raises the likelihood of a US recession. Historically, a tightening in lending standards has led to higher corporate borrowing costs as well as a downturn in US economic activity.
Banks are tightening lending standards, which raises likelihood of a recession
Sources: US Federal Reserve, 1/31/23 (latest data available) and Bloomberg L.P., 4/30/23. Investment-grade corporate bonds are represented by the Bloomberg US Corporate Bond Index. The option-adjusted spread (OAS) is the measurement of the spread of a fixed income security rate and the risk-free rate of return, which is then adjusted to account for an embedded option, such as calling back or redeeming the issue early. The Senior Loan Officer Opinion Survey on Banking Lending Practices is a survey of up to 80 large domestic banks and 24 US branches and agencies of foreign banks. Indexes cannot be purchased directly by investors. Past performance does not guarantee future results.
Banking crises may represent the beginning of new market cycles
Bank failures could potentially mark the end of market downturns and the beginning of new market cycles. That was the case in 1984 with the Continental Illinois failure as well as in the early 1990s following the Savings and Loan Crisis. The Global Financial Crisis is an outlier and represents a tail risk to an optimistic view. The 2008 crisis, however, engulfed banks with assets representing roughly 7% of the US gross domestic product ((GDP)). The current crisis has thus far impacted fewer and smaller banks than in 2008 and may better resemble the crises in 1984 and 1990.
Past crises that have led to new market cycles
Sources: US Federal Reserve, US Bureau of Labor Statistics, Bloomberg, L.P., 3/28/23. The S&P 500 Index is a market-capitalization-weighted index of the 500 largest domestic US stocks. Indexes cannot be purchased directly by investors. Past performance does not guarantee future results. GDP is gross domestic product, the total value of goods and services produced in a year.
Footnotes
1 - US Federal Reserve, 4/19/23. Latest data available.
Important information
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The S&P 500® Index is a capitalization-weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the US economy.
The Bloomberg US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility, and financial issuers.
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Perspective On The Bank Crisis