money What’s Wrong With the Banking System?
O ne bank fails and then another. Will 2023 be a repeat of the financial crisis of 2007–2008? Despite similarities, there are enough differences that I think we’ll avoid the worst of those years. Banks are generally in much better shape than in 2007. They have higher levels of capital, and their lending standards are generally better than in the past. Unfortunately, credit risk is not the only kind of risk. The current prob- lems stem from banks’ holdings of government securities, including US Treasury, agency, and agency-backed mortgage securities. Instead of default risk, the problem is that the value of bank investments fell as interest rates rose in 2022. After the last financial crisis, regula- tors began ranking bank investments
and loans according to credit risk. The greater the risk, the more capital the bank was required to maintain. But as the Federal Reserve drove inter- est rates downward, banks found that the payoff from lending money to businesses was low, while govern- ment securities required less capital to be set aside. So, banks increased holdings of government securities. Many banks bought long-term securi- ties, which are more sensitive to inter- est rate changes than are short-term securities. In 2022, these longer-term securities fell in value. While some of the losses were recognized by banks, rules state that if a bank intends to hold an investment to maturity, it doesn’t have to recognize the losses in the interim. It is estimated that in the United States, banks had unrec-
ognized losses of about $620 billion at year-end. When depositors withdrew funds faster than expected, some banks, including the infamous Silicon Valley Bank (SVB), were forced to sell these investments at a loss. The losses caused a panic among depositors. As deposits left the bank, SVB couldn’t sell its investments fast enough. The bank collapsed. So, is this problem pervasive, and are we headed into a repeat of 2007–2008? In that former period, as banks sold bad investments, they drove the price of those investments down. The remaining investments held fell as well, and their financial condition deteriorated further. In 2023, as the crisis centered around SVB accelerated, investors flocked to
26 • AMAC Magazine
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