facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog external search brokercheck brokercheck Play Pause
Is This the Start of a New Financial Crisis?  Thumbnail

Is This the Start of a New Financial Crisis?



What started it all?

The first bank to fail was cryptocurrency focused Silvergate Bank, which announced it would wind down on March 8th due to losses suffered in its loan portfolio.  But its failure was attributed to the problems being experienced in the crypto market, and therefore was not considered a harbinger of bigger problems.

Shortly thereafter, two mid-size U.S. banks failed -- Silicon Valley Bank and Signature Bank.  A third, San Francisco-based First Republic Bank, would likely have failed if it had not been for a bailout organized by Wall Street's biggest banks.

What went wrong?

The Federal Reserve’s decision to abruptly hike interest rates at a record pace provided the match that lit the fuse.  

Silicon Valley Bank, Signature Bank, and First Republic Bank all specialized in providing banking services to technology-focused businesses.  Rising rates have hit the tech sector particularly hard because they often rely heavily on borrowed funds to get their business models up and running profitably.  As rising borrowing costs cut into profit margins, tech companies were forced to withdraw funds from their bank accounts.

Making matters worse was the negative impact rising rates had on the market value on bonds.  Banks typically invest their customers’ deposits in government bonds for safety, but rising interest rates have depressed the value of banks’ fixed-income investments, and a sudden surge in customer withdrawals has forced them to sell them at a loss.

Finally, a large share of the deposits at SVB exceeded the $250,000, which is the limit that is insured by the FDIC.  As a result, when word got out that the banks were in trouble, corporate customers rushed to withdraw their uninsured deposits.

It was an old-fashioned bank run, but with a new high-tech twist: fears spread across social media combined with digital banking combined to accelerate the speed and scope of panic.  As Federal Reserve Chair Jerome Powell said after the SVB’s collapse, "The speed of the run...is very different from what we've seen in the past."

How big is the problem? 

While the decline in market value of bonds due to the Fed’s tight money policies has impacted the whole banking sector, smaller banks are the most vulnerable.  But other financial institutions are also feeling the sting.   For example, unrealized losses on long-dated bonds held by mega-brokerage firm Charles Schwab & Company, which also owns a bank, topped $29 billion last year.

The Fed lifted the $250,000 insurance cap on deposits at SMB and First Republic in an effort to limit the spread of the problem.  It has also hinted it is prepared do the same for other troubled banks, if need be. 

In addition, the Federal Reserve separately announced a program whereby U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets will be valued at their maturity value, as opposed to their market value, when offered as collateral by banks and other financial institutions for loans from the U.S. government.

While these measures appear to have lessened the risk of a major bank crisis, it is probably too soon to issue the all-clear signal as signs of disruption remain.  The Federal Reserve has said it plans to continue hiking rates if needed to crush inflation, notwithstanding the surge in emergency lending to U.S. banks.  And, mobile apps that allow bank customers to transfer account assets with a few clicks of a button, make the Fed’s job all that more difficult.

Is my money at risk?

At this point there does not seem to be a system-wide problem such as the one that existed in 2008, when banks around the world suddenly discovered that they were heavily invested in worthless home mortgages due to lax lending policies.  Stringent stress tests adopted after the 2007-2009 financial crisis have helped ensure that most banks are sufficiently capitalized, although smaller banks are exempt from some of those regulations because of concerns that the high cost of compliance could drive them out of business. 

That said, there are measures you can take to further safeguard your savings.  First and foremost is to keep the amount you have in any single bank account or money market account at or below the FDIC coverage limit of $250,000 per account, or $500,000 if the account is owned jointly.

Alternatively, you can get up to $250,000 ($500,000 in the case of joint accounts) in coverage for multiple accounts at the same bank so long as each account falls in a different ownership category.  You can find a list of ownership categories here.

By comparison, money market funds (as opposed to money market accounts) are not insured by the federal government.  Rather, money market funds are only as safe as the institution that issues the fund, and the investments the fund holds.  However, you can gain added safety by investing in government money market funds, which are money defined as market funds that must invest 99.5% or more of their total government securities.  Note that such funds may offer slightly less interest as compared to unrestricted money market funds.

A third way to safely invest your savings is to buy U.S. Treasury securities, such as Treasury bills, Treasury notes, Treasury bonds, and Treasury inflation-protected securities (TIPS).  You can buy Treasuries directly from the government at TreasuryDirect.Gov.  But keep in mind that you could lose some of your principal if you sell such a security before it matures, since their market values fluctuate as interest rates rise and fall.