Why is the U.S. Banking System Near Collapse, and facing multiple vulnerabilities and challenges? Because accumulating losses from loans on banks’ balance sheets will likely trigger another, more severe round of bank runs, which may inevitably result in the widespread collapse of U.S. banks.
In the worst-case scenario, the U.S. banking system may be hurtling toward a complete implosion. The confluence of factors, including regulatory dynamics, deposit surges, liquidity concerns, and loan portfolios heavily weighted toward real estate, presents a formidable threat. The risk of a U.S. banking system collapse is higher than at any point since the Great Depression!
The composition of the U.S. deposit base underwent a significant transformation over the past three years, particularly concerning easily withdrawable demand deposits, characterized by accounts that permit immediate withdrawals without prior notice. What fueled this astronomical surge in demand deposits between 2020 and 2022? It was primarily driven by a combination of COVID-19 lockdowns, government stimulus checks, and the Federal Reserve’s massive monetary stimulus.
When the U.S. economy experienced multiple lockdowns in 2020 and 2021, individuals had limited opportunities to spend their money, resulting in a considerable accumulation of unused funds in household accounts. Simultaneously, banks extended substantial loans to corporations.
Furthermore, the Fed executed its most extensive “money-printing” operation during the spring of 2020, causing its balance sheet to expand from around four trillion to over seven trillion USD in just four months. This exponential growth in the money supply escalated inflation. Consequently, when the economy finally reopened, the Fed was forced to embark on its most aggressive interest rate hike cycle in April 2022, elevating the Federal Funds Rate from 0.08% to over 5% in a little over a year. Naturally, U.S. Treasury yields followed suit.
For banks, the rapid escalation of Treasury yields had catastrophic consequences. A bond’s yield and price are inversely related. As yields surged, bond prices plummeted, inflicting heavy losses on banks that had acquired Treasuries at near-zero rates, when bond prices were much higher. These losses were termed “unrealized losses” because banks held Treasuries as held-to-maturity assets, intending to keep them until maturity, at which point the principal and interest would be returned. These losses only became “actual losses” if banks were forced to sell Treasuries before maturity, which is precisely what transpired.
Beginning in the summer of 2022, the U.S. experienced a “silent” bank run as depositors began withdrawing funds, redirecting them, for example, to retail money market funds offering higher yields than traditional bank accounts. In March, this situation escalated into a full-blown crisis. The outflow of deposits rapidly depleted the cash and easily liquidated assets held by many banks, forcing them to sell Treasuries at significant losses. Word spread that Silicon Valley Bank (SVB) had incurred substantial losses from these sales, prompting panic. It was estimated that by the end of 2022, U.S. banks were grappling with nearly $2 trillion in unrealized losses. The massive volume of these unrealized losses was a key factor in the contagion effect during the SVB crisis, prompting U.S. authorities to intervene decisively.
The SVB crisis commenced on Friday, March 10, 2023, and by Sunday, March 12th, U.S. authorities recognized the potential for a nationwide bank run. To avert this crisis, they devised an extraordinary three-step strategy. First, a joint statement from the Treasury, the Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve was issued, guaranteeing all depositor funds, including uninsured deposits, at SVB and Signature Bank. Secondly, the Federal Reserve injected $300 billion in liquidity into the system and announced plans to make “additional funds” accessible through a Bank Term Funding Program (BTFP) to all banks. Thirdly, in an unprecedented move, President Biden appeared on national television to reassure the public that deposits in U.S. banks remained secure. This sequence of swift and extraordinary actions effectively confirmed that the U.S. was on the brink of a nationwide bank run.
In Europe, banking challenges materialized with the Credit Suisse failure. The forced “merger” between Credit Suisse and another Swiss banking giant, UBS, orchestrated by Swiss authorities, helped quell tensions in Europe temporarily. However, the crisis resurfaced at the end of April with the collapse of another U.S. regional lender, First Republic Bank. The unfortunate fate of First Republic Bank provides crucial insights into the direction of the crisis.
Small regional banks in the U.S. currently hold a vast majority, approximately $2 trillion, of real estate loans. These loans in regional banks have surged by 36% since the beginning of 2020 and a staggering 149% since reaching their lowest point in the final week of 2011. As we are well aware, many U.S. cities are grappling with a “retail apocalypse,” a situation likely to worsen when the next recession arrives (which may not be far off). As we saw with First Republic Bank`s collapse, banks cannot liquidate these loans, except under highly restrictive conditions at the Federal Reserve’s discount window.
The urgency of this issue cannot be overstated. For instance, First Republic Bank’s loan portfolio consisted of 80% real estate loans. It suffered losses from its loan portfolio and possessed a limited liquidity buffer to offset the outflow of deposits, ultimately leading to its demise. Numerous U.S. banks have a higher proportion of real estate loans in their portfolios than First Republic Bank held. Moreover, thousands of U.S. banks would need to be equipped to handle a deposit run.
The accumulating losses from loans on banks’ balance sheets can trigger another, more severe round of bank runs, potentially resulting in a widespread collapse of U.S. banks. Any way you slice it, the U.S. banking system collapse, where Americans keep their hard-earned life savings, is in jeopardy!
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