The guest commentary below was written by written by Mike O'Rourke. This piece does not necessarily reflect the opinions of Hedgeye.

Instantaneous (Mis)Information Era - Italian bank cartoon

It should be clear that after more than a week into the banking panic, and two interventions organized by the authorities, this problem is not going away. Quite the contrary, it has gone global.

The reports that UBS is acquiring Credit Suisse will likely magnify Credit Suisse's problems by moving them to UBS, making a $500 billion problem a $1.8 trillion problem. The prime concern of every bank for the immediate future is preventing deposit flight. It should be clear that the most expedient and effective solution to this crisis is an expansion and modernization of the FDIC deposit insurance regime. It has become vastly apparent that the banking industry and its regulators were not prepared for a banking crisis in the instantaneous information era. This is an era where the network effect of social media carries information and misinformation to hundreds of million if not billions at the click of a button. Another click of a button allows depositors to instantaneously move funds. Banking is a "spread business" where bankers borrow short through deposits and lend long through loans, mortgages and investment securities. The spread between the two are the banker's profits. The public would not place their deposits in a bank if they believed there was a risk of loss in exchange for a paltry interest rate. If banks are at risk of losing funding through deposit flight, there is no point in pursuing the lending long half of the equation by originating loans and extending credit. Thus, it is up to the authorities to restore confidence in the system.

The massive wave of monetary and fiscal stimulus due to the pandemic resulted in a stunning 35% growth in bank deposits from $14.5 trillion to $19.7 trillion in 2020 and 2021. The amount of FDIC insured deposits to FDIC total deposits hit its lowest level in four decades.

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The past year of monetary policy tightening to combat inflation has resulted in notable unrealized mark to market losses throughout the banking industry. Over the course of the past year, these losses were disclosed in plain sight in regulatory filings to both investors and regulators. There were some bankers who have made mistakes. It is unfathomable that they can call themselves "bankers" while failing to understand the concept of interest rate risk. Furthermore, the Federal Reserve could not have been more lucid or given more notice in clearly communicating plans to raise interest rates. For those who failed to manage this risk, there is no excuse. Institutions such as this deserve to fail, but the depositors deserve incrementally more protection.

The instantaneous information era of social media also means misinformation proliferates. One only need look at the meme mania in 2021 to know that the overwhelming majority of market-related tweets are falsehoods, but still create powerful reactions. Healthy institutions are just as susceptible to a bank run irrespective of the truth. Forget about rate hikes slowing the economy, the last thing any banker in this country is considering right now is making new loans and expanding credit. The economy will slow. The FDIC deposit insurance level should be tied to the size of the economy or deposits, or some other metric that grows with the economy. The current $250,000 deposit insurance threshold is woefully low relative to the size of Nominal GDP (deposits are in nominal dollars) when compared to FDIC’s historic increase levels. Simplistically explained, the current $250,000 insurance level was set in 2008, when Nominal GDP was $14.6 trillion. Today's Nominal GDP is $26.1 trillion. If you adjusted the deposit insurance level for 2022 GDP, it would be $447,000. There have been six times since 1950 that the FDIC insured deposit level was raised. If you averaged the FDIC deposit level to Nominal GDP, you would get $628,000 as a deposit insurance level. Or the deposit insurance level could be tied to the amount of deposits in the FDIC system. FDIC deposits have more than doubled since 2008. Thus, if it was adjusted to the 2008 level, the deposit insurance level would be $532,000. These examples are simply meant to illustrate the distortions in the system that are relatively easily solved.

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The post global financial crisis policy environment fostered this crisis. The Federal Reserve's 15 years of zero and near zero interest rate policy encouraged bankers to "reach for yield." Although the Fed Reserve repeatedly warned against reaching, it never took action. Then consider the pandemic deposit influx fueling additional reaching. Since 2013, the Federal Reserve has had the ability to raise the Countercyclical Capital Buffer (CCYB) for the purpose of requiring banks to hold excess capital when financial conditions make the risk of loss high. Unsurprisingly, the Federal Reserve never raised them. The 35% increase in deposits over two years may have been a sign of the easy financial conditions. The Fed's financial repression through QE prevented markets from functioning properly and giving signals that risk factors were growing. Investor complacency has exploded as the public has placed its investing on autopilot by sending a tidal wave of flows into passive strategies. The Fed's infatuation with creating inflation in a price stability environment prompted a decade and a half of exceptionally accommodative policy that ruined its credibility. The Federal Reserve's lack of credibility means some banks did not believe the FOMC would follow through on its tightening policy, which was a perilous mistake.

Bank solvency should come into doubt because of bad credit and underwriting decisions. SVB made poor investment/hedging decisions that should have been handled better as part of its typical banking business. While we are sure there are some other banks out there that have made bad decisions of every sort, we are more confident it is not every bank (as the stock market would have one believe). If banks risk failure because of mania and herd mentality of depositors receiving instant information (whether true or false) on mark to market moves, it makes it near impossible to extend credit. This has the potential to be the greatest threat to the banking system in a generation, but it is also something the government can quickly remedy. One only need recall 2009 and FASB relaxing of mark to market for banks to know that when the rules threaten the system, the government changes the rules.


This is a Hedgeye Guest Contributor piece written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.