April 10, 2023 The relief from losses continued to flow in the first quarter right up until the banking crisis hit. The S&P 500 rose 7.5% and the Aggregate Bond Index rose 3%. The rebound was widespread with NASDAQ, one of 2022’s worst performers gaining 16.8%. Large foreign developed market companies bested their US counterparts, rising
8.3%. Generally larger companies did the best. The Russell 2000 small company index rose 2.7% while the Emerging Markets Index rose 3.4%. Things were going well relative to last year and inflation continued to decline.
The Fed had said they expected to raise the Fed Funds rate by .25% three times in early 2023. In February and in March they raised by 0.25%. There had been talk of a .50% increase when inflation and economic growth were not playing according to the Fed’s script which is to get inflation back to 2%. This talk disappeared by March 12 when a third US bank failed, and their attention turned to the stability of the financial system.
In five days early in March three banks failed, two of which were the second and third largest bank failures in the US. This all started with Silvergate a relatively small bank closed due to loan losses related to Crypto assets. They were holding deposits for the failed crypto exchange, FTX which was Sam Bankman Fried’s main operating company. Next Silicon Valley Bank (SVB) and Signature Bank experienced bank runs. Both banks had over 80% of their deposits uninsured when the run started. Both banks had significant clients who were venture backed corporations or venture funds themselves. These two banks invested a sizeable portion of their deposits in Government bonds, which as you know suffered large losses last year on paper. The bank did not write down these assets as they were being held as long-term investments, which is the correct accounting. The problem arose when someone looking at the balance sheet noted the large unrealized loss and pointed out that if realized it could cause the bank to fail. Now everyone wanted their uninsured deposits out, and it was the end of both institutions.
You might think the Fed and the Treasury were aware of this duration risk. Jamie Dimon, in his letter to Shareholders of JP Morgan, said “Most of the risks were hiding in plain sight.” In recent years the Bank Stress Tests have not included a rising interest rate scenario. These last two bank failures are collateral damage from the steep rise in interest rates and a failure to understand that uninsured depositors could head for the doors suddenly. It’s surprising that the Fed, the Treasury and FDIC were not prepared for this eventuality. Republic Bank also came under similar pressure, but it was saved by an intervention by a group of large banks that deposited $30 Billion in the institution. Credit Suisse a large Swiss bank wasn’t so lucky it also failed and was merged into UBS, another large Swiss bank. Since then, things have calmed down, but small banks have lost significant deposits. All banks are increasing their lending standards and trying to increase their liquidity. This could be the beginning of a significant credit crunch which would help reduce GDP and inflation.
With the emergence of the bank failures, it has become clear that the Fed and Treasury were trapped between reducing inflation and maintaining the stability of the financial system, both goals work in opposition to one another leaving the government with a dilemma. It seems likely that volatility and the possibility of a recession will remain in place for this year. Whether that recession results in a hard or soft landing remains
uncertain. Let’s all root for the Fed to navigate us to the latter!
This material has been prepared for informational and educational purposes for our clients and friends. This material does not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. Please consult your Fairhaven Wealth Management professional to discuss how this may impact your own financial plan and/or investment portfolio. This material is not intended to provide, and should not be relied upon for accounting, legal, tax advice or any other purposes. Information and views are as of the date indicated and such information and views are subject to change without notice. Fairhaven has no duty or obligation to update the information contained herein. Further, Fairhaven makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Wherever there is the potential for profit there is also the possibility of loss. Certain information contained herein is based on or derived from information provided by independent third-party sources. Fairhaven believes that such information is accurate and that the sources from which it has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy, completeness or the assumptions on which such information is based. Independent third-party sources cited in these materials make no representations or warranties regarding information
attributed to them and shall have no liability in connection with said information. Neither Fairhaven Wealth Management nor its subsidiaries nor its affiliates provide accounting, legal or tax advice. Please consult your tax advisor or attorney for such guidance. Fairhaven Wealth Management is an SEC registered investment advisor. For a copy of the firm’s ADV Part 2 disclosure document please direct your inquiry to admin@fairhavenw.com. © 2023 Fairhaven Wealth Management, LLC
Comments