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The above is a current article by Carolyn Said in The San Francisco Chronicle, lightly edited for brevity.How worried should the average person be about news that San Francisco’s First Republic Bank is teetering on the brink, following on the heels of Santa Clara’s Silicon Valley Bank, which imploded last week? The bigger issue is whether the bank crisis will continue to spread, and how it could ripple into the economy — for instance, by making it harder to get loans, spurring still more layoffs, and even tipping the country fully into a recession.
Most experts think that we’re still far from dire consequences, although there could be more short-term pain ahead.
“For the vast majority of people, this mini crisis is going to pass, and we’re all going to have many other things to worry about in our professional and personal lives,” said Ross Levine, a finance professor at the Haas School of Business at UC Berkeley. Still, he said, “This is a very uncertain time.”
Darrell Duffie, a Stanford finance professor, was also sanguine: “The most likely scenario is that the economy will be fine because there won’t be a major problem in the banking system,” he said. “There might be some mergers and some problems at other banks. But I think it’s most likely that after one or two more banks have had to be rescued, whether by merger or similar treatment, it will stop there.”
Why? “Because the government will do its darndest to make sure this won’t lead to significant contagion,” Duffie said. “There’s every sign the government means business. The speed and size of its actions so far are commensurate with putting a stop to this.”
Those actions included the extraordinary steps of agreeing to backstop all Silicon Valley Bank deposits, even above the insured limits, and getting 11 big banks to deposit $30 billion into First Republic to signal confidence and help keep it afloat. In addition, the Federal Reserve is ensuring that banks have plenty of funds on hand by making money available to them on “terrifically generous” terms, he said.
But not everyone was optimistic- John Lonski, former chief economist at Moody’s Investors Service and founder of the economic/market research firm Thru the Cycle, thinks that lots of smaller and regional banks could be consolidated or collapse, as happened in the savings and loan crisis, which triggered the failure of about 1,000 banks from 1986 to 1995.
He thinks cascading effects this time could include banks tightening credit — which could make it harder for people to get mortgages or credit cards, and for businesses to get loans. And that could lead to an even worse outcome.
“That credit crunch (could) finally push the U.S. economy into this long-expected recession,” he said. That would mean more layoffs, he said, particularly of middle-aged and older workers, who have higher salaries.
Anastassia Fedyk, an assistant professor of finance at Haas, weighed in midway between the upbeat and downbeat views: “We are in a contagion spiral, going from Silicon Valley Bank to First Republic,” she said. “It’s speculation at this point about how much more damage we’ll see spilling over to others.”
But, she cautioned, the domino effect could be real if investor confidence continues to sink. “We’re already on the second domino,” she said. “The regulatory responses were enough to stop some of the fallout from SVB, specifically. All those exposed deposits were protected, but not enough to quell fears that something similar might happen with similarly exposed banks like First Republic.”
Although she thinks a recession “is in the realm of feasibility,” it’s still early, and the government has a lot more tools at its disposal to stem the risk, she said.
All eyes are likely to be on the Federal Reserve next week as it meets to decide whether to continue raising interest rates to fight inflation, or press pause on its campaign, Levine said.
“They face an excruciatingly difficult decision,” he said. “They need to assess the vulnerabilities in the banking industry. If they assess there really are no systemic vulnerabilities, that this is just a few small banks, then they are likely to choose to continue with (raising rates). If they see other risks, risks they view as genuine or (that) could induce banks to restrict credit — even if the Fed views banking as very sound — then they might decide to pause the raising of interest rates.”
Duffie thinks the Fed is less likely to raise interest rates than it otherwise would have done. The banking events themselves could cause credit to tighten, thereby lowering inflation, he said. “It’s a shifting of probabilities from the Fed pushing on inflation and therefore taking a risk of recession to this brewing problem in the banking system having a similar effect on credit provision,” he said.
“Given the uncertainties, pausing for one meeting cycle could be very prudent,” Levine said. “Markets are obviously very sensitive on banks now. Waiting to tighten credit might give everything a chance to calm down.”
© 2015 Mutual Fund Observer. All rights reserved.
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Comments
The further tightening of lending standards that's likely to come from the banking sector will exacerbate the effects of Fed tightening. Smaller companies and office real estate are often mentioned. What others will feel the pressure? Perhaps not immediately, but with a lag.
No single bank failure should trigger a recession. The issues with banks run deep. (And SVB represents more than 1 failing.) The problems with banks are directly related to the speed with which the Fed raised rates. For a body which prides itself on “transparency”, to shift almost overnight from “transient” inflation and accompanying very low overnight lending rates (below 2%) into full crisis mode with rates now approaching 5% is “remarkable”. And it helps explain how some banks’ investment managers came to be caught flat-footed and leaning the wrong way.
ISTM there will be some type of recession in the next year or two. Recessions are a normal part of the economic cycle. The question should be: how deep and how long lasting?. How all this relates to investing is a different animal. Stocks, from my understanding, tend to fall leading into a recession but begin recovering prior to a recession’s end. Also, provided stocks were bought at reasonable value in the first place, they should appreciate over time along with inflation.
But I do think there is a high probability of a recession within the next year or so.
We've had the worst bout of inflation since 1981.
The Fed has aggressively hiked rates over the past year.
History suggests the Fed will be unable to engineer a "soft landing."
Lending conditions will continue to deteriorate, many businesses will cut back,
and consumers (currently in decent shape after pandemic stimulus) will eventually decrease spending.
Numerous pundits have predicted a shallow recession.
We'll see what happens...
https://schwab.com/learn/story/market-snapshot
Always found her to very effective in getting to the point with charts. Enjoy.
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
https://mutualfundobserver.com/discuss/discussion/58534/wealthtrack-weekly-investment-show/p8 Nancy thinks we are entering a recession in the next 12 months, even with conflicting data on strong employment numbers, high wages, decent earning reporting and an inverted curve.
I too think a 25 bps rate hike is likely this week.
Yes, I thought Nancy Lazar was very good.