— Preamble

— The Fed finally broke something 

— Prudence would argue for a less hawkish stance on the part of the Fed                      

— We’ve been this way before … scared/panicky, but not it is the end of the world

— So what? Now what?

Preamble

I composed the following piece late last night before the news broke of continuing-weak-sister Credit Suisse (CS), running into additional difficulties. I am certain that a resolution of this situation will be forthcoming versus a collapse of the world financial system. It could also put the brakes on Fed rhetoric and rate increases. As such, my opinions offered below stand.

The Fed Finally Broke Something

Silicon Valley Bank (SIVB), for some reason, had a significant portion of their investment portfolio in longer maturity securities when the Fed started its relentless march to higher rates last year. That should have set off alarm bells at both the federal and state regulators. It did not. Then they chose to keep that maturity schedule. Where were the regulators? The result … when calls came in to release deposits they had to sell bonds at a considerable loss, forcing them to be in the market looking for additional capital. News of this caused the death spiral run on the bank.

Why did this happen?

Immediately following passage of the “Dodd-Frank Wall Street Reform and Consumer Protection Act” in 2010 the banking industry went to work to soften its requirements. The act as written required banks with assets of $50 billion or more to be subject to the same rigorous requirements that were requisite of the top 25 systemically important banks. After 8 hard years of lobbying the  “Economic Growth, Regulatory Relief, and Consumer Protection Act” (5/24/2018) was signed into law. The asset ceiling for strong supervision was raised to $250 billion. You guessed it, Silicon Valley was only a $200 billion dollar bank, definitely flying under the radar. That sub-$250 asset group is where today’s problem banks are emerging. Obviously this regulatory relief needs a bit of tweaking.

Out of prudence the Fed needs to take a step back

At this point the Fed needs to be more in tune with Hippocrates-“First do not harm.” Many have suggested that their headlong charge into raising rates might kill the economy. That kind of  statement no longer rings with the same hyperbole has it as in the past. As the Fed’s rate moves may be causing problems in other segment of the banking and general economy, it would make sense that they do nothing with rates at the next FOMC meeting. They also need to tone down the hawkish rhetoric until the dust from this breakage settles … just in case there are other breaks waiting in the wings.

We have been this way before

I’m sure you have scary memories of 2008 and 2009. It was a disaster on a much larger scale in part because we did not act quickly to stanch the bleeding. It appears in this smaller iteration that no time has been wasted.

In 2008 the banks had spent the previous 10 year creating billions of dollar worth of “financial weapons of mass destruction” (Warren Buffett). These were bundles of mortgages made to unqualified buyers and speculators. They were hedged with toxic derivatives and sold all over the world as investment grade because of the worthless insurance they were wrapped with. Rates went up, housing prices fell (as they have today) and the bottom fell out. Bank capital levels were too low to cover the losses. The rest was history. It would also appear that this part of history bears no resemblance to the fundamentals today.

So what? Now what?

Actions taken by the Treasury in the last few days appear proper and warranted. If not, there are more tools that can be brought to bear on the problem. On the economy not much has changed. We continue to report strong employment numbers, despite the record uptick in the federal funds rate over the past year.  It looks to me that the system is holding up very well, regardless of those firms that have been caught ‘swimming naked as the tide has gone out'(Warren Buffett). This all is normal and not a change from what one would expect as the Fed has turned up the heat. We saw some real panicky trading last Friday.  The VIX (fear indicator/ CBOE Volatility Indicator) spiked up 24% (30.81) Monday morning, closing up about 7% (26.52). Tuesday the VIX was down another 2.79. Based on the fundamentals this seems not be the time to panic, and it may be presenting us with a great opportunity to buy stocks, even banking stocks, at very reasonable valuations. 

What’s your take?
 

More By This Author:

Another Trip To The Crossroads … We Are Not Holding Our Breath!
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