April 29, 2023
“You Don’t Know Who is Swimming Naked, Until the Tide Goes Out” ____Warren Buffett, CEO of Berkshire Hathaway
This week saw the final collapse of another major bank, First Republic, FRC which the Banking industry tried to save several weeks ago with a $30 Billion Dollar loan from a group of other banks, to replace fleeing deposits.
Again it seems that this bank, like many other banks, made the basic financial mistake of using short term deposits to buy long term bonds during a period of low interest rates. The Bank also grew its asset base, by catering to wealthy clients, by offering “super size” interest only mortgages. This provided their wealthy clients with maximum tax deductions and therefore were very popular, but risky loans.
These investments turned out to be very risky when Federal Reserve started their inflation fighting program by increasing interest rates last year.
Again, we must remind readers, that the belief that hi quality long term bonds are “safe” because they can be held to maturity is a fiction, for several reasons. The most obvious one is the current problem that Long Term Bonds, lose current market value when interest rates rise.
Now people are told by their investment advisors, that it is only a “paper loss” because when the bond matures in 10-20 years it will be repaid at face value. So, that ignores the fact that if you need the money for any reason, in the interim period, you will not get back the face value, but the market value.
Also, if if you were able to hold these bonds until their maturity date, the money you get back will have substantially less “purchasing value” because of inflation. Even if inflation was at the Fed’s wishful thinking level of 2% per year, a dollar in 10 years could buy less than .80 cents of groceries. With inflation at 5% your dollar could buy less than .50 cents of groceries, at the time of maturity.
Another problem is that over time, as we have found, the credit rating of companies can change dramatically, usually for the worse. Many times what you will get back at maturity is not cash, but another bond with repayment years in the future.
This is the problem facing many banks today. As depositors flee seeking alternative investments with higher yields, the Bank’s ability to repay these borrowers, is forcing them to sell these assets at market value, not face value.
Why this was not picked up by regulators years ago, during Stress Tests, is beyone my understanding.
This current bank disaster is in many ways similar to the Savings and Loan crisis of the 1970’s. For those readers interested in learning more about that subject, I would recommend the book, “Inside Job” the looting of America’s Savings and Loans, by Stephen Pizzo, Mary Fricker and Paul Muolo.
Need I remind my readers, that deregulation of the Savings and Loan industry was the handiwork of the Ronald Reagan crowd who told the public that regulations were stifling the industry.
Some Billion Dollar questions for all investors to consider: Which Bank is Next? and, How much longer with the stock market ignore what is going on in the Banking Sector?