The recent fall of major banks — including First Republic Bank yesterday — has caused concerns that the U.S. is on the brink of a financial catastrophe, one that could resemble the 2007-8 crisis that led to the Great Recession.
Three times this year, fearful bank customers and investors have rushed to withdraw their money, and the federal government has taken drastic action to prevent a broader panic that could knock down the rest of the financial system. Nobody knows for certain whether this third time will be the last.
For now, the situation has stabilized. The stock market held steady yesterday, and other banks seemed to be doing fine.
But a crisis has not necessarily been averted. History is filled with examples of leaders who believed they had stopped a disaster but later found they had underestimated the problem, including during the 2007-8 financial collapse. Some analysts worry that other banks may have as-yet undiscovered problems. And the Federal Reserve, America’s central bank, is likely to continue to raise interest rates — the very thing that catalyzed this year’s bank collapses.
So why does this matter to everyday Americans? A financial crisis can lead to less spending across the entire economy, suppressing jobs and wages. It can also hurt people’s investments, including retirement accounts and other savings.
Today’s newsletter will look at the bank collapses and their potential consequences to the broader economy.
Lost faith
Regulators seized First Republic Bank and sold it to the financial behemoth JPMorgan Chase yesterday. This deal — in which a bigger bank absorbs a struggling one — is typical during a crisis. What is less typical is the magnitude of this year’s failures. Combined, First Republic, Silicon Valley Bank and Signature Bank held more in inflation-adjusted assets than the 25 U.S. banks that collapsed in 2008.
The three banks, and their falls, had some important traits in common.
First, the banks’ investments were particularly exposed to the risk of rising interest rates. As the Federal Reserve increased interest rates over the past year, many of First Republic’s assets lost value because they were fixed at lower interest rates and, therefore, lower payouts to the bank. Meanwhile, First Republic had to pay now-higher interest rates on its customers’ deposits. The mix of lower revenue and higher costs toppled the bank’s balance sheet.
Second, the three banks had a large share of customers with deposits that surpassed federal insurance limits. These depositors are more likely to be cautious and ready to move their money, because they know that they could lose much of it if a bank goes under.
So when First Republic’s investment strategy began backfiring, depositors started to pull out their money in large numbers — a classic bank run. By last week, First Republic revealed that customers had withdrawn more than half of the bank’s deposits.
Last, the three banks’ fates were connected. “The failure of Silicon Valley Bank made Americans more concerned about the safety of their deposits,” my colleague Maureen Farrell, who covers finance, said. “And First Republic looked a lot like Silicon Valley Bank.” The threat of further contagion is what led regulators and the financial system to move to try to stabilize the situation.
The problems largely come down to mismanagement at the three banks, experts said. But regulators share some of the responsibility for failing to spot warnings and to act on them earlier. The Federal Reserve acknowledged as much last week, saying that regulatory changes and a “shift in culture” left regulators unprepared. The Fed also placed some of the blame on Congress, which in 2018 reduced the central bank’s oversight of so-called midsize banks like First Republic and Silicon Valley Bank. The Fed is now considering tougher rules.
Economic fallout
What happens next? Some analysts argue that the worst is over: Silicon Valley Bank, Signature and First Republic were all outliers, and their similarities made them unusually vulnerable to the current moment. So far, the government’s swift responses seem to have done a good job containing the potential contagion.
But things could get worse. Economists say that the Federal Reserve’s interest rate hikes take time — potentially more than a year — to work through the economy. It was only last year that the Fed began dramatically raising rates. The three banks’ collapses, then, could be the beginning. As higher interest rates warp the economy, other parts of the financial system could fall under the strain, too.
Regardless of which scenario plays out, the three bank failures could lead to an economic slowdown. As other banks and investors worry that they could meet a similar fate as First Republic, they may act more cautiously. That caution could translate to less money going to businesses and consumers, meaning less economic activity and growth overall.
More financial coverage
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To prevent future bank runs, the F.D.I.C. proposed protecting larger deposits than it now does.
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Executives at the major U.S. banks spent the weekend analyzing First Republic’s financials. Here’s how JPMorgan came out on top.
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