In Case Of Bank Crashes, Airbags Are Deployed

A number of years ago, COVID and a ZIRP (Zero Interest Rate Policy) caused an out-of-control inflationary spiral that caused the economy to turn in the wrong direction, resulting in the resulting recession. Last year, however, the Federal Reserve, headed by Jerome Powell, imposed the most aggressive interest rate hike policy in over four decades, slamming the brakes on inflation.

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There was no change in interest rates (the Federal Funds Rate target) year-on-year beginning in January, but today, the benchmark (i.e. the interest rate determined by the Federal Reserve) is at 5.0%, which is a significant increase from last year's 3.0%.

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In March, we saw the second and third largest bank failures in American history as a result of an unprecedented spike in interest rates. This spike in interest rates contributed to these failures. Fortunately, last month the Federal Reserve and banking regulators (the Treasury and FDIC – Federal Deposit Insurance Corporation) took some measures to implement safety airbags. As a result of the bank failure, the Fed, FDIC, and Treasury announced that all deposits at SVB would be backed by the Federal Reserve, FDIC, and Treasury. There was also a more broadened emergency lending program announced by the Fed and Treasury to help meet withdrawal demands and to prevent further bank runs by allowing a wider swath of banks to access funds at no cost and to meet withdrawal demands.

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There was a general relief among investors after the government responded, and the financial markets responded accordingly. The S&P 500 index rose +3.5% last month, while the NASDAQ index rose even more (+6.7%). Nonetheless, not everyone was spared from the disaster. The KBW Bank Index suffered a -25.2% decline, and the small-cap and mid-cap stock indexes, on the other hand, also lost -5.6% (IJR) and -3.5% (IJH) respectively.

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Yet, as we mentioned earlier, it is important to remember that too hard a hand is applied to the economic brakes can lead to unintended consequences, for example, the failure of a bank or two. This is exactly what happened with Silicon Valley Bank (OTC:SIVBQ), which is the world’s second biggest bank failure, with assets of $209 billion, and Signature Bank (OTC:SIVBQ), which has assets of $110 billion, which is the third largest bank collapse ever.