Will We Continue To Pay The Price?

If you keep tempting fate eventually it nips you in the butt. That’s what happened late last week and over the weekend with two bank failures. It’s more complicated than simply just that and don’t expect me to explain it all in under 1000 words but continue reading and you will learn.

The result was that on Friday federal authorities closed Silicon Valley Bank and on Sunday closed Signature Bank. The seeds of these disasters were sown years ago. Let’s explore how we got here.

Back in March of 1933, during the first week of his administration, Franklin Delano Roosevelt closed the banks to avoid a total financial meltdown. That, along with a plethora of other measured worked in an era of in person, during business hours banking. Today, with internet transactions – ATMs are only useful for smaller amounts – banking is a 24/7 affair.

In June of 1933 FDR signed the Glass-Steagall Act into law. It effectively separated fiscally conservative commercial from risking investment banking. It also created the Federal Deposit Insurance Corporation (FDIC). The “wall” that FDR successfully built in banking restored the people’s faith in the institutions.

In 1999 Bill Clinton signed into law the partial repeal of Glass-Steagall. That was one of his few huge mistakes. Fortunately for his legacy we survived that and at least some of the blame can legitimately be laid elsewhere for the 2008 financial disaster and the ensuing Great Recession.

In July of 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as Dodd-Frank was signed into law by President Obama. Among its other provisions it partially restored the “wall” between commercial and investment banking. My first real job was in banking and although I never climbed past very low management, I still have some theories on banking. I firmly believe that managing widows’ and orphans’ money – what the people who hired me and trained me in commercial banking taught me my job was – is very, very different from taking fliers in pursuit of possible huge rewards. Yes, you missed the next Microsoft but in the process the widows and orphans were able to keep a roof over their heads and food on the table.

In 2018 the “financial genius” Donald Trump rolled back Dodd-Frank setting the stage for where we found ourselves last weekend. In response to a question Trump blamed the bank failures on, “Woke,” Board members. The implication was that if all the Board members had been old, straight, white guys there would never have been a problem. I don’t know for a fact but I doubt Herbert Hoover (another Republican -do you detect a pattern?) had much other than old, straight (or at least not out of the closet), white guys advising him. If you had to blame the Great Depression on a single president it clearly would be Hoover. (I’d lump Calvin Coolidge into the mix.)

To add insult to injury, on Friday just hours before their bank was closed down by federal authorities, executives and upper managers at Silicon Valley Bank were receiving substantial bonus checks. Let’s just say they weren’t the equivalent of $100 gift cards to Walmart. With purposefully focused accounting the bank’s books looked good to the compensation committees. Let’s just say that bad banking practices work well for the executives until they don’t. This is another case of privatizing the profits (even the phantom profits) but socializing the losses.

As of this writing the depositors are to be made whole. Unlike in prior government bank bailouts the stockholders and other investors are not being bailed out. Let’s explore that for a bit.

I think I’m pretty much in the mainstream when it comes to who a bank bailout should protect – the innocent depositors. Currently the FDIC protects accounts up to $250,000 per person (that’s $500,000 for your joint account). That’s a lot of money but simply may be inadequate in today’s America. We should explore raising the ceiling.

Some, but certainly not all, business accounts should have much higher or no ceilings on protection. Examples are attorneys escrow accounts. In many metro areas (DC for example) most middle-class homes cost significantly more than $500,000. Payroll accounts are another example that jumps to mind. A large corporation’s payroll, especially those who pay their top people on a monthly basis, often need high six or seven figures to cover their payroll.

Among the regulations these banks successfully lobbied to free themselves from were so-called stress tests that would have reveled their vulnerabilities before the tragedy set in. Two of the weakness these institutions had was that they were too dependent on a single sector of the economy and had vulnerable to interest rate rises. (I’m barley giving you a “thumbnail” here.) These bankers either knew they were engaging in risky financial behavior or were totally financially braindead. Diversification in the avoidance of risk is a bedrock principle of investing and whether they want to admit it or not that was exactly the kind of speculative financial behavior they were involved in.

Especially of late I have been a frequent critic of Fed Chair Jerome Powell who incidentally is pro loose bank regulation. What effect this will have on future (in my opinion unnecessary) rate increases will be interesting to see.

What is crystal clear is that we are paying for sins of the past. The question is will we learn from this episode.

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