Bears Banking on Credit Crunch

The Ghosts of the 2008 mortgage meltdown and Great Financial Crisis (GFC) are memories indelibly imprinted upon Central Bankers and provide a guide for future panic prevention.  In late 2008 after unemployment was surging higher, our Fed printed a Trillion dollars to quiet a major run on the banks and allow companies to meet payrolls. When Covid arrived in 2020 the Fed added $3 Trillion over 3 months to stabilize an economy during a mandated lockdown. Over the ensuing 2 years they created another $2 Trillion in pretend money long after the economy and inflation were growing rapidly. In March, after a year of tapping the brakes to fight inflation, the Fed had drained $600 Billion from the banking system and hiked the interbank Federal Funds overnight lending rate from zero to 4.75%.  However, just 3 weeks ago, these rate hikes caught several poorly managed banks with bond duration imbalances that triggered a bank run and forced the Fed to quickly add almost $400 Billion dollars back into the system over the past 2 weeks. The Fed made it clear that depositors would be made whole and unlimited credit would be made available to failing banks.

List of largest bank failures in the United States

Bank City State Year Assets at time of failure
Nominal Inflation-adjusted (2021)
Washington Mutual Seattle Washington 2008 $307 billion
Silicon Valley Bank Santa Clara California 2023 $209 billion
Signature Bank New York New York 2023 $118 billion

 The 3 major US bankruptcies and Credit Suisse in Europe were all preventable and not typical deposit banks that would raise alarm bells of a systemic global banking crisis like the 2008 GFC. The bad news is that the 3 banks that failed this month accounted for over $380 Billion in assets, even larger than the top 3 bank failures in 2008 that created 358 billion in losses (although in 2008 the $350 Billion devaluation of Bear Stearns assets ahead of its sale to JPMorgan was not accounted for). During the 2008 – 2014 GFC there were almost 450 banks that failed in the US as well as a 10% unemployment rate. Unlike 2008, the shock of the current banking scare appears to be isolated bankruptcies of just a few nonretail oriented banks while the economy remains at full employment. More minor bankruptcies, bailouts and buyouts are likely this year, but Central Banks are at the ready with unlimited imaginary currency to backstop any panic within hours.

The fear of contagion spreading to Europe arose last week when long troubled Credit Suisse required a $108 Billion bailout to facilitate a UBS bargain basement buyout. Banking stocks remain severely depressed during the recent rally in stocks from their March 13th low. If the mega cap banks like JP Morgan and Bank America recover half of their panic decline from March, then the broader stock market will feel a strong tail wind pushing it higher as financial fears subside.

Our contention is that even though we live in the Matrix regarding the reality of our financial system, Central Banks have the tools to maintain confidence in our banks and they are learning to respond quickly. While they have yet to “explicitly” guarantee all deposits above the FDIC insured $250,000 per account cap, we think they will continue bailing out depositors to prevent a systemic loss of confidence. After all, the only thing backing the modern fiat currency system is faith in the Government to guarantee obligations and prevent panic. If a bank run is allowed to fester, it will destroy Government trust and commerce and wreak havoc on the social fabric around the globe. However, what Western democracies can’t control are the actions of other non-Western Governments. While China’s aging demographics are falling apart faster than our Western democracies, they are also making a risky financial gamble to achieve global dominance economically and militarily. They have recently secured alliances with former US partners in the Middle East, Central Asia, Africa and now Latin America. However, their risky public and private lending is almost 300% of their economic output (GDP), far higher than the US and Europe. With $100’s of billions in lending to distressed emerging market countries, China is now asking the World and International banking entities backed by the US and Europe, to forgive loans, lend more bailout money and raise credit ratings to alleviate China’s debt obligations. China’s financial risk to the global network is worth monitoring, but timing an implosion of this long-term bubble and potential contagion would be hyperbolic speculation at this time. 

What’s important for investors to observe is the resiliency that permeates investment markets today.  After a year of ever-tightening credit conditions, we are at full employment with near record job openings. In the last 3 weeks we learned that service sector inflation (CPI) remains at 40-year highs, 68% of economists expect recession this year, and we have had record bank failures in the US and Europe this month. In a Bear market environment, a 10 to 20% downside panic in stocks would be a normal stock market response. When Lehman Brothers declared bankruptcy on September 15, 2008, the SP 500 Index fell almost 30% in less than 2 weeks. Two weeks after the current banking panic stocks are actually higher than when the initial selling began. That’s a resilient market. With inflation likley to remain above the Fed’s target for another year and ever tightening credit conditions, we don’t see the ingredients for a new Bull market, but we also are skeptical that the economy will experience a deep earnings recession due to fiscal stimulus and well capitalized consumers and companies. Our short-term forecast calling for a mid-February top and mid-March low followed by another rally into at least mid-April appears to be precisely on track. For a couple of months we have identified a low for stocks between March 13 and 23rd. The 1st quarter correction low did arrive on March 13th with a higher low on the 23rd. However, this is a trading range market that does not warrant being fully invested, thus if our expected rebound continues into mid to late April, we will use that time period to reduce recently added long positions once again.


 

 

 

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