VGSH - The Impact Of Bank Failures And Disintermediation On The FDIC And The Federal Reserve

2023-03-22 02:30:00 ET

Summary

• Early signs of economic unravelling are starting to appear.
• The Federal corporation that insures bank deposits is woefully underfunded.
• The Federal Reserve is under pressure to pivot away from its inflation control efforts.

Warren Buffett famously observed, “There’s never just one cockroach.” Let’s review what we know so far, with an eye toward what might happen next. The following topics are today’s headlines.

Bank Failures

Silicon Valley Bank (SIVB) and Credit Suisse (CS) have failed, due in large part to losses in their bond investments caused by rising interest rates. This combines with last year’s stock market loss to put pressure on the Fed to pivot. See the section below on the Federal Reserve.

Disintermediation

Fears appear to have calmed, so bank withdrawals caused by fear have subsided. But greed is another reason for withdrawals. Treasury bonds and bills pay more than 4%, more than twice bank savings with interest below 2%.

The Federal Deposit Insurance Corporation (FDIC)

The public is being calmed by insurance that covers depositors in failed banks. But the insurance company that provides this coverage could easily fail.

Some very interesting, but perhaps scary, facts about the FDIC (from Steve DeVito, Ryan ALM's head bond trader):

As of Q4 2022, the FDIC reported having a reserve of around $126 billion. But considering there are around $9.9 trillion in insured deposits in the US, $126 billion covers only about 1.26% of total deposits.

The FDIC fund doesn’t come close to meeting the minimum legal reserve requirement of 2%.

The FDIC admits this amount needs to double to exceed “the minimum level needed to withstand future crises of the magnitude of past crises.” The FDIC invests that $128 billion in US government bonds! As Steve points out, there are $9.9 trillion in insured deposits. It would take many additional trillions in US dollars to insure the entire banking system's deposits. Talk about the potential inflationary impact if the US has to inject resources to a greater extent. They've already injected >$164 billion!

The Federal Reserve

The Fed is “tapering” to fight inflation. It’s “tapering” its zero interest rate policy (ZIRP) to cool the economy. When the Fed tapered in 2013, it caused a “taper tantrum” that forced it to reverse its rate hikes - it pivoted.

Most believe the Fed will pivot again because rising interest rates hurt stock prices and weaken banks. But unlike 2013, when inflation was negligible, current inflation is quite high. Pivoting will fuel inflation this time.

Either course - pivot or taper - is not pretty. These are indeed scary times.

Conclusion

There are more cockroaches. We just don’t see them yet. Please see my previous article on protecting your investments: " When Stocks And Bonds Won't Do ".

For further details see: