By Tim Courtney, Chief Investment Officer

After the collapse of Silicon Valley Bank (SVB), Silvergate Capital and Signature Bank, the market experienced a mini panic and fell 5% in five days. Investors flocked to safety in treasuries, gold, and larger growth companies amid mounting concerns over the stability of the financial sector and¹ intensifying market volatility. ² In addition, people started questioning their own banking relationships, particularly those who bank with smaller or regional institutions.

Despite the initial shock, the market showed us it’s still singing the same interest rate tune. Most areas of the market moved higher after the week of declines, and the Nasdaq jumped 7% and touched its highs for the year.³ Why? Because we’re still in a cycle where the market views bad news as good news. Banks failing is bad news, but that is good since the market assumes that future interest rate hikes may now be blunted.

Overall, this means we’re still in a period of rebalancing. The market and our financial system is working to recalibrate from the Federal Reserve’s (Fed) decision to hike rates from near zero to 4.5% at a historic pace.⁴ As the market continues to readjust to a more normal interest rate environment, we may experience more consequences along the way.

If we compare our current environment to the Great Financial Crisis in 2008, there are notable differences. For one, banks on the whole are better capitalized than they were 15 years ago. They no longer have large weights in holdings such as mortgage-backed securities filled with borrowers of questionable quality backed by an oversupply of real estate.⁵ In addition, the accounting rule known as “mark-to-market” eventually caused banks in 2008 to buckle as debt markets froze.⁶ Markets began recovering in 2009 when this rule was rescinded.⁷ The Fed appears to be acknowledging this today as they roll out the Bank Term Funding Program (BTFP), which allows banks to receive loans for their qualifying assets at par value rather than market value. ⁸

The Fed’s latest decision to raise interest rates by 25 basis points⁹ may indicate the start of a slowdown in rate hikes. The market has stabilized for now, but we may see more banks coming under pressure from the rate hikes. While this is a risk, a larger risk may be brewing. Over the last several weeks depositors have been pulling money out of smaller and regional banks and moving it to larger national ones because of the perceived extra protections afforded to larger banks. Local lending to smaller borrowers is often done by the regional banks. This lending will almost certainly be curtailed and cause economic slowing. That may end up being the larger cost to this current bank panic. If you have any questions, please contact your Exencial advisor.

Sources:

1. CNBC (3/13/23) — Investors rush into bonds, gold in flight to safety after SVB rescue
2. The Wall Street Journal (3/14/23) — Investor anxiety hits a fever pitch after Silicon Valley Bank collapse
3. Bloomberg (3/13/23) — U.S. stocks shake off markets jitters; Bonds fall: Markets wrap
4. The New York Times (3/7/23) — Fed Chair opens door to faster rate moves and a higher peak
5. Federal Deposit Insurance Corporation — Crisis and response: An FDIC history
6. Harvard Business Review (11/09) — Is it fair to blame fair value accounting for the financial crisis?
7. Forbes (7/28/09) – Suspend Mark-To-Market Now
8. Investopedia (3/21/23) — What is the bank term funding project?
9. CNBC (3/22/23) — Live Fed updates: Watch Powell speak about the interest rate hike, banking turmoil

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