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Who is Top Dog?

I sat down to right this and thought of how the markets continued to sell off this week in the face of further bank closures.  So, it came as a bit of a surprise when I looked to see what the indices did this week only to discover that both the S&P 500 and Nasdaq are up for the week.  Based on the steady flow of negative news, and my internalizing of said news, I assumed things had gone much worse.  Only the Dow Jones Industrial Average is down this week and only a small amount at that.  This goes to show that the news does influence us for better or worse.  Had I not looked for myself, you couldn’t have convinced me two of the three major averages were up this week.  The moral of the story is, don’t let the news get you down.

Speaking of news, the big story this week was not one but two bank collapses.  Fear of contagion took hold this week as both First Republic Bank and then Credit Suisse began to falter.  In both cases, they were rescued, but not before a lot of speculation could take hold.  By the end of the week, First Republic was bailed out not by taxpayers, but instead by other banks.  In a move that one must assume the Federal Reserve orchestrated behind closed doors, eleven of the largest banks agreed to pony up $30 billion to shore up First Republic’s balance sheet.  As for the later, Credit Suisse received a $54 billion bailout by the Swiss central bank.  To provide a backstop for depositors, the Federal Reserve created a new bank term funding program to allow banks to borrow against their treasuries and mortgage-backed securities at par.  In its first week, $12B was borrowed using this facility.  It has not been reported which bank or banks have required a capital infusion.  Additionally, another $153 billion was borrowed from the Fed’s discount window this week by banks fearing depositors may come for their deposits too.  Are we out of the woods yet?  Probably not as far as investors are concerned, but it does appear financial structures are now in place that could lessen the impact and hopefully quell depositor fears.

Let me quickly address the elephant in the room.  The actions this week once again have righted the ship, but do not fix the underlying problems.  While no one is keen to apply regulations in a free market, there are circumstances which warrant such actions.  In this case, taxpayer money was not used to bailout these banks, but the bailout itself creates a moral hazard in that banks will continue to do business as usual.  And by usual, I mean maximize shareholder profits using sometimes reckless means.  It would not have been out of the ordinary for SVB or First Republic to hedge its interest rate risk.  But in both cases, they made tragic errors of judgement, and possibly profit maximizing decisions, which would come back to haunt them.  I suggest if you have more than $250,000 with one bank, you should consider opening accounts at another bank to get under the $250,000 FDIC insurance limit.  While the Fed bailed out depositors above $250K this time, there is no guarantee they will do so again.

Recent events have compelled me to think about how our financial services industry is structured.  While I was a teenager during the savings and loan crisis in the early 1980’s, this week made me consider if history does in fact repeat.  While the two events are not exactly the same, the parallels are remarkable.  From 1980 to 1994, nearly 1,300 smaller, home loan-focused banks failed.  In retrospect, they failed because high inflation prompted the Federal Reserve to significantly increase interest rates.  The S&Ls were in the mortgage business, and when they made these loans they held them on their books.  As rates rose, those mortgages were worth less and less – a sort of corollary to the mortgage-backed and government securities sitting on SVB’s books.  One might say, history doesn’t repeat, but it does rhyme.  Regarding interest rates, the FOMC meets next week and will decide on Wednesday whether to raise rates again.  The odds are on a 0.25% hike, but at this point it is just as likely they pause given the turmoil with the banks.

In closing, I want to turn to something non-financial.  Let’s talk about something warm and fury.  I learned this week that for the first time in three decades, the U.S. has a new favorite dog breed, according to the American Kennel Club.  Adorable in some eyes, deplorable in others, the French bulldog became the nation’s most prevalent purebred dog last year, ousting the Labrador retriever which had held the top spot for 31 years.  The Frenchie has a distinctive look which has been bred for its pushed-face and perky ears.  For those who have one or know a Frenchie, it won’t come as a surprise that there is contentious debate regarding the breeding of these dogs and whether more exaggerated traits are causing unnecessary health problems for the breed.  However, there is something endearing about these animals which draw people to them.  If you’re looking for a purebred and want the latest new thing I think you’ve found it.  However, I’d be remiss if I didn’t suggest everyone consider adopting a dog (or cat) from their local animal shelter or Humane Society.  We’ve personally had great luck over the years with pets we’ve adopted from animal shelters.  Now you know. 

Bruce J. Mason, MBA