by Robert Romano
The Federal Deposit Insurance Corporation (FDIC) and the California Department of Financial Protection and Innovation put the $229.1 billion California-based First Republic Bank into receivership today on May 1, while the FDIC also entered into a “purchase and assumption agreement” with JP Morgan-Chase Bank for the nation’s largest bank to assume First Republic’s assets as well as its $103.9 billion of deposits.
Another one bites the dust.
Under the agreement, “All depositors of First Republic Bank will become depositors of JPMorgan Chase Bank, National Association, and will have full access to all of their deposits,” according to the FDIC.
Since early February, First Republic’s stock has tanked from a recent high of $147 a share to now just $1.90 as of this writing and falling, losing more than 98 percent of its value, as the bank’s failure follows that of Silicon Valley Bank and Signature Bank in March.
Once again, like Silicon Valley and Signature, the bank was caught upside down on interest rates — it bought treasuries and mortgages when interest rates were much lower, which when rates rose drove down the value of the paper they were printed on due to the inverse relationship between interest rates and bond values — causing a run on uninsured bank deposits of more than $100 billion in March.
As a result of the run on these regional banks — the second, third and fourth largest bank failures in American history — the SPDR S&P Regional Banking ETF has dropped a whopping 34 percent since the beginning of February, from $64.72 a share down to $42.66 in a flight of capital away from bank stocks, especially regional ones.
This followed Wall Street’s panicked rush in March to recapitalize First Republic with a reported $30 billion infusion by putting deposits into the bank — but notably not purchasing shares in the bank — which failed to save the bank as regulators finally stepped in.
The unusual move in March for the failed deposit infusion was due to the conditions of putting Silicon Valley Bank and Signature Bank into receivership and being deemed “too big to fail” by the Treasury, Federal Reserve and the FDIC, per the department and agencies’ joint statement: “Shareholders and certain unsecured debtholders will not be protected.”
This was a provision of Dodd-Frank, 12 U.S. Code Section 5390(a)(1)(M) which states “The Corporation shall ensure that shareholders and unsecured creditors bear losses, consistent with the priority of claims provisions under this section.”
As a result, there was zero incentive for any larger financial institutions to step in and purchase First Republic outright, even for pennies on the dollar — until after the bank had been seized by regulators.
And, with large deposits at the bank being well in excess of the $250,000 statutory FDIC limit for insurance, as First Republic became undercapitalized, it could not possibly withstand the bank run, leading to the $100 billion withdrawal.
Now with the assets and liabilities of these smaller regional banks being transferred to the Wall Street super banks, the further consolidation of the nation’s financial system continues.
Although, to be fair, no private bank, no matter how well capitalized, can possibly withstand bank runs of these magnitudes, a quick look at capital ratios of major financial institutions shows. For example, JP Morgan had a capital ratio of just under 12.2 percent as of the second quarter of 2022. Bank of America was at 10.5 percent. Wells Fargo at 10.4 percent. And so forth.
The implication is that if more than 13 percent of bank customers were to go to withdraw their funds at any of these banks, they would all fail. In the case of First Republic, deposits fell by almost half.
For now, the implicit backing of the federal government and the perception of “too big to fail” — plus perhaps the sneaking suspicion that there’s no where better to put one’s money — seems to be what is generally keeping the system together.
But long term, the incentive is for even more consolidation going forward, especially when one considers the nation’s fiscal and debt outlook over the next decade, with the $31.4 trillion national debt set to rise $50.7 trillion by 2033 according to the White House Office of Management and Budget. Truth be told, with the debt growing more than 8 percent a year on average since 1980, it could be much higher than that, say, $69 trillion or more.
So, who’s going to buy all those treasuries? Foreign central banks have been reducing their overall share of the national debt: In the Dec. 2008, foreign central banks and financial institutions owned $3 trillion out of the $9.9 trillion national debt, or 30.8 percent. In Jan. 2023, they owned $7.4 trillion out of the $31.4 trillion debt, or 23.5 percent.
In response, the Federal Reserve increased its share of the debt from $790 billion in Aug. 2007 when the global financial crisis began, or 8.8 percent of the then $8.9 trillion national debt, to $5.28 trillion out of the $31.4 trillion debt as of April 2023, or 16.8 percent.
Meanwhile, the current $6.7 trillion of debt held by the Social Security, Medicare and other trust funds is also a dwindling share of the debt, from $4.3 trillion out of $9.9 trillion in Dec. 2008, or 43 percent, to $6.8 trillion out of $31.4 trillion, down to 21.6 percent as the trust funds are set to be exhausted over the next decade.
That leaves U.S. financial institutions, retirement funds, hedge funds, mutual funds and the like to buy the rest of the treasuries, rising from about 17 percent in 2008, or $1.7 trillion, to a massive $11.9 trillion, or 38 percent today — the largest single holder of the debt.
But depending on how bad inflation is will determine how bad interest rates are, and potentially how upside down the financial system is on interest rates next time. And yet, the financing we obviously need will have to come from there with ever larger banks in the U.S., meaning likely more regulation, more capital controls (i.e. digital currency), higher insurance premiums and fees, and much larger asset prices to keep the financial system solvent.
The price will likely be less liberty.
Already, the Federal Reserve’s new Bank Term Funding Program —“ renting” treasuries from banks at 100 pennies on the dollar — has risen from $11 billion in March to more than $81 billion today, and the worst could be yet to come, as banks are said to be sitting on some $600 billion of unrealized losses due to rising interest rates resulting in underwater securities.
In addition, FDIC reported about a $13 billion loss will be assessed to the Federal Deposit Insurance Fund as a result of the transactions: “The FDIC estimates that the cost to the Deposit Insurance Fund will be about $13 billion. This is an estimate and the final cost will be determined when the FDIC terminates the receivership.”
So, far three major bank runs have occurred in the span of a little more than a month. This thing could just be clearing its throat even as worried investors hope the worst is past us. I guess we’ll see? These are uncharted waters. Hang tight.
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Robert Romano is the Vice President of Public Policy at Americans for Limited Government Foundation.
Photo “First Republic Bank” by Tdorante10. CC BY-SA 4.0.