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Regional Banks in Turmoil

Published on March 30, 2023

Peter Mallouk
President & CEO
Jonathan Clements Headshot

Jonathan Clements
Director of Financial Education

Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!

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Jonathan Clements:  Hello. This is Jonathan Clements, Director of Financial Education for Creative Planning. With me is Peter Mallouk, President of the firm, and we are down the middle.

On March 10, federal regulators took over Silicon Valley Bank. Since then, we’ve had a wild couple of weeks with Signature Bank also shuttered, major U.S. banks coming to the rescue of First Republic and Switzerland’s UBS taking over an ailing Credit Suisse. So Peter, what’s going on here? What’s the common thread among all these troubled banks and how do we get through this?

Peter Mallouk: This banking crisis, there’s banking crises every 10 or 15 years, but this one’s very different than the ’08-’09 one, which is a lot of people are fearful of. This is the beginning of contagion. In ’08-’09, you had Lehman Brothers fail and no one stepped in to save it, and because they were so interconnected with four or five other major banks, you had basically the circulatory of the system of the economy about to collapse. All of them were trading with each other and one failing had massive implications for the other.

Here, there seems to be a domino effect of one bank happening over the other, but we really have to segment this out into four different categories. So one, we have an issue with crypto banks. Well, that’s because most crypto, as we’ve been saying from the beginning, is totally worthless. Somewhere between 99% and 100% of all cryptocurrencies are going to zero, and as we started to see that unfold, we’ve seen so many of them go to zero or even the top 10, many of them go down 90%. Some of those banks are failing, some of them committed fraud. Some just have been trading in crypto themselves and suffered. So let’s put that in one category to the side.

Then we’ve got to look at Credit Suisse. Credit Suisse had its own issues going back for over a year where there was a lack of confidence in the bank and its balance sheet, and it really took hold on social media over a year ago, really having nothing to do with what was going on with interest rates and everything else. So then we get to Silicon Valley Bank, also pretty unique. Silicon Valley Bank has a very unique depositor base. Over half of it are technology companies. Many of them are backed by venture capital investors. They all tend to move in herds together and venture capital is suffering.

There’s not a lot of money going into it, which means they’re not putting money into the tech companies, which means those tech companies were spending down their deposits, which hurt Silicon Valley Bank, and at the same time, interest rates were going up and the bonds that Silicon Valley Bank have on their balance sheet we’re declining in value. You combine that with a lack of confidence and you had a classic bank run. That’s category three.

Category four is all the regional banks that are pretty much just fine suddenly in massive turmoil. Now, why are they in massive turmoil? Because when the Federal Reserve bailed out the depositors at Silicon Valley Bank, so they didn’t bail out the shareholders or the lenders. If you own stock in Silicon Valley Bank, it’s now worth zero. If you loan money to Silicon Valley Bank, it’s now worth zero, but if you’re just a business and you deposited money in Silicon Valley Bank, the Federal Reserve, the Treasury said, “Look, we know there are FDIC limits of 250,000. We’re ignoring those.” There was even a company that had 500 million in the bank. They said, “We’re going to make all of you whole,” and they did that to prevent there from being a run on other banks.

Now, what they then did is they testified before Congress and said publicly, “Hey, we are not bailing out all the banks. There’s FDIC limits. This isn’t ’08-’09. We’re not going to run around bailing everybody out.” So if you think about if you’re a CFO of a small business that has revenues of 10, 20 million, you’ve got a bank account and a regional bank that’s just fine, how can you in good conscious leave your money there?

As a fiduciary to the owner of your company or the shareholders of your company, you’re going to go down the hall, you’re going to tell the CEO, “Look, if we go to a really big bank, the federal government has said explicitly that some banks are too big to fail.” They’re too systemically important. So they basically said we will never let them go under, but they said explicitly we’re not going to do the same for all these other banks. So if you’ve got $2 million in your business in a regional bank and it’s not guaranteed, but if you move it over to one of the four or five largest banks in the country, the Federal Reserve is saying they’ll back them up.” That’s what we’re seeing happening now. So banks that are perfectly fine, we’re seeing money move.

Now just yesterday, we saw Yellen say hey, look, we’ll protect more banks, but it’s a very confusing message. There’s no explicit guarantee and there’s a lot of conflicting messaging. So it’s not really one bank domino falling on the other. These are different sets of facts impacting things in different ways. Ironically, banks are pretty healthy. Generally, they’re very healthy. So it’s really a run on the bank type situation where no one wants to be the last man standing, and that’s what we’re seeing here.

Jonathan: So is there a fix for this, Peter? I mean, if you per chance ended up in Washington, had to call the shots, what would you be doing?

Peter: Well, I think you have two strategies happening here. I think one, if we observe what the Fed and Yellen are doing is they don’t want to say, “We’re going to guarantee all the money in all of the banks,” because that’s a very big shift from where we are today. It’s a socialization of the banking system. So what they’re trying to do is say words that they think will cause people to quit doing this, quit pulling money out of one bank and moving it to a bigger bank, but they have a legit problem here is no one believes them and they don’t believe them because everything they’ve been saying has not been true, right? They said, “We don’t think that we’re going to have to raise rates a lot,” and then they did. Everything they’re saying, we really can’t count on it. I’m not saying they’re lying. They don’t know where the economy is heading more than anybody else. They’re just doing their best to control inflation and keep banks from failing.

So I think people look at it and say, “I don’t have total confidence in the soft words they’re using to make me feel good.” What they don’t want to do is have everybody move their money to four or five banks because then all of a sudden you have no competition. They could all charge more for mortgages and for everything else. They want there to be a healthy, diverse banking system. I think, ultimately, this probably isn’t just going to pass on its own, and there’s going to have to be some new policies around guaranteeing depositors to a higher extent so that a depositor doesn’t have to be a finance analyst to know which bank to put their money in. That’s not reasonable, right? It’s not reasonable to expect my mom and dad to do the research on a specific bank or, frankly, even most financial advisors to do the research on what bank is healthy and where they can leave their money.

People have to feel like, “If I put my money in the bank, it’s going to be there.” Shareholders should be wiped out when there’s a problem. People that lend money to bank should be wiped out if there was a problem. I think we’re heading towards a solution like that from the FDIC or the Fed somehow where they restore confidence in a more real way for the average American to go, “Look, if my money’s in a regional bank, I’m not going to wake up one day and see everything gone.”

Jonathan: So amazingly, amid all this turmoil in the banking industry, well, we’ve seen some turbulence in the financial market. It could have been a whole lot worse. As we talk today, the S&P 500 is right about where it was on March 9, the day before Silicon Valley Bank got closed. So why is it? Why has the stock market held up so well, Peter?

Peter: I think this is very fascinating because if you look at the regional bank index, it’s just gotten absolutely annihilated. I mean, severe, massive bloodbath bear market in that space. To your point, Jonathan, it’s isolated. You don’t really see that in the stock market. The stock market’s holding up just fine, and I think the stock market, well, I know the stock market is looking ahead, right? So it says, “Okay. Look, we don’t see the entire banking system collapsing.” The stock market in bond market don’t view this as an ’08-’09.

Interestingly, this is causing enough stress that the Federal Reserve is going to be reluctant to raise interest rates as aggressively. So the Federal Reserve was raising interest rates because that causes people to buy less homes and cars for higher prices. They’re trying to control inflation, and they were raising rates very fast, and the market doesn’t like that because when businesses have to pay more in interest, it hurts their profitability. If people have to pay more for homes, you wind up having a recession and so on, and the stock market was looking forward and saying, “Hey, we’re going on recession. I’m a little nervous.” You saw the stock market go down last year.

What Silicon Valley Bank and the banking crisis has done is it’s made it where the Fed wants to raise rates to slow down inflation, but they can’t raise them as fast because they don’t want to feed the banking problem. So the stock market looks at this, and now the stock and bond market are predicting that interest rates are going to come down the next four or five fed sessions. That was not the case a few weeks ago. The stock market and bond market assumed interest rates would continue to rise, which would impact profitability of companies.

Now it sees that it feels like a mild recession is going to happen sooner rather than later if we’re not already in it. The Federal Reserve to respond will say, “Hey, we think we’ve got inflation under control. We’re going to start to lower rates to make sure that recession’s not too severe,” which then reignites the economy. When you have lower rates, people are more likely to spend. So the stock market’s looking forward and it sees a path out of interest rates going up higher. It sees a path out of that towards a trend of interest rate stabilization or maybe even declines.

Jonathan: So if you’re an investor and you’re looking out to 2024 and beyond and you have your money in stocks, should you be optimistic at this point?

Peter: Overwhelmingly optimistic if you extend the period of time longer. So it is impossible to make a prediction in one year no matter what. It doesn’t matter what you’re looking at. You can never predict one or two years or three years even. Nobody had COVID on their Bingo card a couple years ago. Nobody had a banking crisis on their Bingo card today. Someday there will be a cyberattack and whatever. Something’s going to happen. Just stuff happens.

I think this is a classic lesson for investors. You have a crisis that’s impacting the market day-to-day a little bit now. That’s the banking crisis, and the market doesn’t expect contagion. It looks at that like one wave we’ve got to deal with. Then it looks at a bigger wave, and the bigger wave is interest rates matter a lot. If interest rates are higher, the economy tends to soften. If they’re lower, people spend money, the economy’s stronger, and it’s looking at that wave and saying, “Look, interest rates are going to come down, maybe we’ll have another bull market cycle.”

Then there’s the long term wave, and that’s the wave where I like to place my bets, and that is, do I believe that over 10 years the demographics are moving in my favor globally, that innovation is moving in my favor globally? Do I expect there to be inflation over the next 10 years? Do I think a candy bar, a can of Diet Coke or whatever it’s going to cost more 10 years from now? The answer to those three things is a resounding yes.

There’s 1.2 billion people coming out of poverty over the next decade all over the world, India, China, whatever. America might say, “Well, who cares? How does that affect me?” Well, McDonald’s is opening a restaurant overseas every day. It affects you if you own McDonald’s stock over a third of the earnings for the S&P 500 come from overseas. These billion people coming out of poverty, they’re going to buy phones, they’re going to buy candy bars, they’re going to want to buy American products and global products, and all of those affect the stock market. So the demographics are moving in our favor.

Second, technology, no rational person can look at the next decade and think that we’re not going to have massive advancements with technology. I actually believe thousands of years from now they’re going to look at this period of time, this emergence of 3D printing and artificial intelligence and everything that we’re seeing happening. They’re going to be studying this the way they’re studying fire and the invention of the internet. We’re in the middle of a huge boom of technology.

I think we’re going to see a lot of miracle cures over the next decade in biotech with healthcare and everything else. I don’t think anyone can think 10 years from now that we will not have advanced from a technology perspective. Look, if you’re around for a decade, you know prices tend to go up. Those three forces, those are very powerful forces. So yeah, we can look at the next 90 days and think about the banking crisis. We can look at the next year to two years and think about the interest rate issues, but the three things that matter in the long term, they look better today than they’ve ever looked.

So if you’ve got your short-term covered, if your portfolio has you covered in the short term with what you need to get through it, then the long term, I feel more confident today than at any point in my career about the outlook there.

Jonathan: All right, Peter. Well, thanks for the words of reassurance, and now, we’re at that time in the podcast. I need your financial wellness tip of the month. What have you got for me, Peter?

Peter: So a lot of people are worried about their bank and their FDIC insurance. You get $250,000, but you can expand that by changing your accounts. If you’re married, a husband can have $250,000 in their name, the wife can go put $250,000 in her name. If you’ve got a revocable trust and you’ve moved money into it, that makes you the grantor. Let’s say you’ve got three beneficiaries, then your insurance isn’t $250,000, it’s a million dollars because you would get to multiply it by four. So there are things you can do to expand that coverage, and you can talk to your wealth manager about that or I’ve obviously covered a little bit of it here. You can Google your way to the rest on the FDIC website, but there’s just ways to expand that coverage to make you feel better.

Jonathan: Should anybody have $250,000 sitting at a bank account?

Peter: I think if you’re an individual, you should never have more than that in the bank anyway. You can have your money and invest in a cash management account and get usually two to three times what the bank will pay you. So look, if you’re an individual with more than$250,000 in the bank, Jonathan, that’s a very good point, that’s a fundamental mistake. You want to get that into an investment account. It can be separated from your regular investment account and be a cash management account where it’s readily accessible to you and liquid, but you can get a better return and you can actually put yourself in things that are guaranteed in a cash management account as well. If you’re a business owner, it’s a different story, but then you’ve got whole other issues you can’t resolve with FDIC coverage.

Jonathan: All right, Peter, and for my tip of the month, if anybody’s making extra principal payments on their mortgage, I would really encourage them to rethink it. I made huge extra principal payments on my mortgage during the period of declining interest rates. It was a great way to essentially get a high return on your conservative money paying down your mortgage, but that is no longer the case. There are a ton of people out there who either took out mortgages at 3% or less or refinanced at those rates. If you’re making extra principal payments on that mortgage, it’s a losing proposition when you could turn around and buy bonds and cash investments that are yielding 4% or 5%. So as emotionally appealing as extra principal payments are and getting rid of that mortgage, if you go strictly on the math and you want to get a higher return on your money today, you shouldn’t be making those extra principal payments.

Peter: That’s great advice because it’s probably the first time in 10 or 15 years that advice is relevant. We’ve heard the opposite of that for so long. It takes a while for that to really sink in, but it’s very, very good tip of the month from you.

Jonathan: All right, Peter. Well, that’s it for this month. This is Jonathan Clements talking with Peter Mallouk, President of Creative Planning, and we are down the middle.

Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.

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