The advantage of banking in flyover country

Here are some of the things that have struck me about the banking industry since the closings of Silicon Valley Bank and Signature Bank.

What a non-event this is for community banks in the Midwest. When the news broke midday on Friday, March 10, that regulators had closed Silicon Valley Bank in California after a run on the bank, I think bankers everywhere went on alert. Many conducted meetings with staff over the weekend to discuss answers to questions they anticipated coming from customers on Monday morning. Others called key customers to assure them that everything was OK at their bank. I even heard of bankers who were in Hawaii for the ICBA convention who decided to cut short their meeting and fly home to be at the bank. But then Monday morning came, and there were no questions. No customers lined up when the doors were opened for business that morning. I talked to several bankers who said they heard from one or two people, but there was no onslaught of questions from desperate customers. Some bankers saw money leave their bank in the following week, but mostly I heard about bankers who said they gained deposits from customers who had big accounts elsewhere and decided to move the money around to stay under insurance limits.

How badly the press has represented this story. Many of the stories I read included speculation about the next bank to fail. And, as of this early April writing, no other banks failed. While the closing of two big specialty banks on opposite coasts is certainly an important story, it does not constitute a crisis. Yet, much of what I read tried to equate this with the financial crisis of 2008. This isn’t anywhere near as significant as the 2008 crisis. I think the story I found farthest off the mark ran in one of the local business journals where they listed all the banks in Minnesota ranked according to the amount of money they held in accounts with more than $250,000. I am not sure what the point was, except that perhaps they were trying to say something about the safety of those deposits. But of course, they completely missed the point. There was nothing in the article to gauge whether the money was protected by pledged assets. Many banks win the right to hold millions of dollars for hospitals, municipalities and school districts by pledging assets as collateral against those deposits. 

How tone-deaf the Treasury Secretary is. After the government said it would make good on all the deposits at the two failed banks, someone asked if depositors at smaller banks would be covered in the event of failure. Janet Yellen essentially said no, only money in a systemically important financial institution would be protected. Certainly, there was a more diplomatic way of saying that the government would protect deposits where it could. Yellen came out sounding like Uncle Sam only cares about wealthy people who don’t pay attention to their bank or the insurance rules. And at the ABA Washington Summit on March 21, someone asked whether a blanket deposit insurance guarantee would be applied to smaller banks. Her answer: “Similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.” Talk about double-speak! The answer sounded like “yes” but, in fact, means “no,” because almost no small bank failure could realistically instigate a contagion. This is a Treasury Secretary who needs some media training! 

A/L management is not new. There was no mystery about why SVB failed. It had too much money tied up in long-term bonds. When it needed to sell those bonds to respond to depositors who withdrew their money, the bank had to accept low prices as the bonds had lost value in a rising interest rate environment. The question really is, why did bank management buy those bonds in the first place? The answer may be that the deposits simply came in too fast, as the bank tripled in size since the end of 2019. Loan demand didn’t grow, so there wasn’t much to do with the money except buy bonds. Lulled by years of low interest rates, they bought long on the curve and got caught when the Fed started raising rates to fight the inflation the government caused by pumping so much money into the economy. 

Good bankers practice good A/L management. This is not new. The graduate schools of banking all have detailed courses in this. The bankers’ banks and trade associations have seminars. Did the folks at SVB miss that education? There is certainly judgment involved in the management of an investment portfolio, and sometimes people make poor judgments. The huge volume of uninsured deposits in both these banks, coupled with the clubby nature of the SVB customer base, upped the stakes significantly. Once the customers began encouraging each other to pull their money out, the banks were doomed.

I didn’t see any stories from reporters who wrote that banking simply doesn’t work that way in the Midwest. The banks don’t concentrate heavily in a single industry; deposits are either insured, pledged, or otherwise protected through reciprocal arrangements, and community bankers here know enough of their major customers to credibly reassure them if they get in a potential crisis situation.

Mark-to-market is not the answer: I have read a number of pundits who say the problem was the accounting for bonds in the held-to-maturity bucket. Their solution is to get rid of it and force bankers to mark everything to market. That is a terrible idea. If you hold a bond to maturity, you will get the agreed-upon rate regardless of interest rate moves while holding that bond. There is no reason to complicate a picture of the bank by viewing it through the unrelated gyrations of the market. The value of many banks would be wildly inaccurate if you got rid of the held-to-maturity portion of the securities portfolio. If you think SVB and Signature contributed to the volatility of the financial services industry, wait until you see the volatility of the industry under 100 percent mark-to-market. No, the problem at SVB was not accounting; it was simply bad management.

More regulation won’t help either. I couldn’t believe how quickly Sen. Elizabeth Warren blamed the 2018 change in the SIFI threshold for the failures. (Actually, I can believe it.) Does she honestly think that would have made a difference in the cases of SVB and Signature? The original Dodd-Frank threshold of $50 billion was absolutely too low. President Biden was close behind Sen. Warren with a call for more regulation on March 30. The 20-some banks with assets ranging from $100 billion to $250 billion are in his crosshairs. While the specifics of his proposal are not known as of this writing, he is likely seeking tighter regs around capital and liquidity. I don’t know why the Administration felt it needed to move so quickly, before the Fed or the FDIC completed investigations and really got a chance to assess what regulatory changes might be helpful. 

Deposit insurance is back on the table. Dodd-Frank moved the deposit insurance coverage limit to $250,000 from $100,000 and was supposed to end too-big-to-fail, so I thought the discussion about the appropriate level of deposit insurance coverage was over. But government officials re-opened that discussion when they decided to protect all of the deposits at the two banks. I am still not clear why they did that. They say it was to prevent runs at other banks, but I think they could have accomplished more if they had only covered 80 percent of the deposits. With 20 percent of the deposits over the cap exposed at all banks, there wouldn’t have been anywhere safer to put the money and there wouldn’t have been any runs. Former FDIC chair Bill Isaac wrote in a Wall Street Journal essay that they should have only covered 80 percent, which is what he did in many cases in the 1980s when banks failed. 

Of course, there is a cost to covering all those deposits, and it looks like any special assessment may spare community banks, which seems altogether appropriate. There is no way to justify socking community banks with any portion of the bill for protecting all deposits at SVB and Signature.

Now there are proposals being floated to expand deposit insurance to all deposits, or to lift the cap to some higher level. I am not sure that the deposit insurance limits, or rules, need to change. We should not cover all deposits. Covering all the deposits at SVB and Signature completely turned the system upside down. FDIC insurance was created in the 1930s and has always been a system for the little guy. It was a way to keep families from losing all their money in the event of a bank failure. The corporations and super rich who needed to keep more than the limit at the bank were on their own. It was assumed they had the resources to work with the bank to arrange for other forms of protection or to find other places for their money. But in the case of SVB and Signature, the government said we are going to protect the customer with $100 million in the bank, and then they said they had no intention of covering deposits in excess of the cap if it was at a small bank, that is, one that is not systemically important. So the person with $100 million gets all their money back and the one with $300,000 loses $50,000. That is just bad policy.