Jamie Dimon Is Correct: More Bank Failures Coming
J.P. Morgan CEO Jamie Dimon is making international headlines with his recent claim that the current U.S. banking crisis is “not yet over, and even when it is behind us, there will be repercussions from it for years to come.” With Congress’s ongoing excessive spending and the Federal Reserve’s continued monetary mischief, Dimon’s prediction seems pretty safe.
Following the collapse of Silicon Valley Bank (SVB), Signature Bank and Silvergate shut down shortly thereafter. Depositors with uninsured amounts above the Federal Deposit Insurance Corporation’s (FDIC) insured amount of $250,000 at both banks withdrew large sums, forcing the banks to sell assets that had lost significant value. Silvergate voluntarily liquidated itself, while bank regulators forcibly closed Signature Bank.
While the specific circumstances of SVB’s collapse may be unique, the factors contributing to its failure are not.
SVB, Signature, and countless other banks that have yet to make headlines invested in risky assets such as environmental, social, and governance (ESG) initiatives and less risky assets such as government securities. These actions were fueled by government interventions in the economy that pumped excess liquidity into the market, creating an artificial “boom.”
Since early 2020, Congress has added more than $7 trillion to the national debt, and the Federal Reserve helped keep interest rates artificially low. This resulted in a flood of liquidity that found its way into the banking system, which led to banks taking on those less profitable investments, particularly interest-rate-sensitive government bonds.
But banks weren’t prepared for the Fed to change its interest rate tune, raising its target for the federal funds rate from 0 percent to the latest range of 4.75 percent to 5 percent, and for those assets to lose significant value so quickly. This made these banks take a huge hit to their balance sheet when they marked-to-market those assets, and they didn’t have sufficient capital in a fractional reserve banking system to fund deposit withdrawals, hence bank runs.
Now, we’re witnessing the beginnings of the inevitable bust that follows a prolonged “boom” fueled by government actions that just redistributed resources while distorting markets.
Perhaps the worst part in all of this is that the Treasury, Fed, and FDIC are creating moral hazard for banks by insuring many deposits at big, “systemically important” banks. This has created a shift of deposits from smaller regional banks to bigger banks, given this guarantee for now. Therefore, there’s more reason for bigger banks to take on more risks with this backstop and flood of new deposits at the expense of smaller banks and the economy.
To make matters worst, the Fed recently added even more liquidity to the market. After reducing its balance sheet by about $700 billion from its peak of $9 trillion in April 2022, the Fed added $400 billion to provide loans to financial institutions. Its balance sheet is now down about $100 billion since then to $8.6 trillion, or only 4.4 percent below its record high last year, when it should be down substantially more to get ahold of inflation.
The Fed’s balance sheet provides a good indicator of inflation, which has started to improve, but including the aberrations in the Fed’s balance sheet and underlying inflationary indicators in the food and services sectors, inflation could easily stay elevated at a much higher rate than the Fed’s preferred 2 percent average for much longer.
Adding to the pressure on the banking sector includes how the Atlanta Fed’s GDPNow estimate for inflation-adjusted GDP in the first quarter of 2023 is only 2.5 percent (and Blue Chip consensus estimate is 1.5 percent) as of April 14. This is after less than 1 percent growth from the fourth quarter of 2021 to the fourth quarter of 2022, which is the slowest growth during a year of recovery in decades. This will exacerbate problems at banks if Americans can’t pay their bills.
And we’re likely to see even higher interest rates soon, even though the Fed expects to raise rates just one more time this year. Based on the well-respected Taylor rule, which calculates a federal funds rate target based on inflation and output gaps, the Cleveland Fed’s Taylor rule utility suggests at least a 6 percent federal funds rate target. This would further devalue the government securities on banks’ balance sheets.
So strap up, Americans, as we’re in for a bumpy ride in the banking sector and overall economy.
Only by allowing people to exchange freely with limited government interference that simply sets the rules of the game but is a referee thereafter, not a participant, can we better avoid these boom and bust cycles in the banking sector and across the economy that threaten our freedom and prosperity.
A big part of this will be to unleash the banking sector from excessive regulations like those imposed by Dodd-Frank after the financial crisis. There should also be an effort to not increase the FDIC’s insured amount by $250,000, as depositors should also take losses if they’re not doing their due diligence to research where they deposit their funds. And there should be support for increasing capital requirements by banks in the marketplace rather than policy avoiding some of the problems with fractional reserve banking.
Finally, the Fed should be led by a monetary rule, like the Taylor rule, and Congress by a fiscal rule, like the Responsible American Budget, to remove the discretion that plagues our economic activity and future. If not, there will be many more “booms” and busts and many more failures from government actions over time.
We must let free people succeed and fail, as failure is essential for us to learn lessons, or we will keep making the same mistakes. But we should be eliminating government failures by ultimately shrinking government and ending the Fed.
Vance Ginn, Ph.D., is founder and president of Ginn Economic Consulting, LLC, senior fellow at Young Americans for Liberty, and chief economist or senior fellow at multiple think tanks across the country. He previously served as the associate director for economic policy of the White House’s Office of Management and Budget, 2019-20. Follow him on Twitter @VanceGinn.
Apr 28 2023 at 4:58pm
Banks that took on long term _fixed rate_ investment with short term (variable rate) deposits face insolvency. End of story. Why regulators permitted this is still a myustery.
May 2 2023 at 5:10pm
I fail to see why regulators should have got involved.
Let insolvent banks fail. Problem solved, no need for regulators.
May 3 2023 at 11:34am
Be that as it may, regulators were regulating lots of other kinds of risk. Why did they not see this one?
Grand Rapids Mike
Apr 29 2023 at 4:11pm
Makes one wonder what the Risk Manager of the banks are doing along with the regulatory staff. The risk of high interest on banks capital invested in longer duration bonds should have been obvious. Interestingly the Risk Manager at SVB left last spring (2022) and cashed out her stock. It seems like the Risk to bank structure should be obvious to the Fed. but maybe not.
Apr 30 2023 at 6:17pm
re: “This has created a shift of deposits from smaller regional banks to bigger banks”
That’s how the system is designed. The lending capacity of the banks is determined by monetary policy. I.e., all deposits are the result of Reserve and commercial bank credit. As deposits grow, some funds are shifted into bank-held savings. This shift from demand to time deposits decreases the velocity of circulation, the circuit income velocity and transaction’s velocity of funds.
Banks compete for the deposits that the system already owns. There is just a redistribution of deposits among the banks. Banks must maintain a positive “balance of payments”. Their core deposits must be “sticky” or a stable source of funds (unlike “brokered deposits”). And the larger banks have economies of scale.
Banks, as a system, are losing money by paying interest on deposits.