What I learnt from three banking crises

The FT’s star columnist, Gillian Tett, is in fine form in this long essay in which she describes her learning from the three big banking crises she has seen in her career: Japan 1997-98, Lehman-GFC 2007-08 and the latest crisis in 2023 (SVB, First Republic, Credit Suisse, etc) where people sitting in the comfort of their homes & offices pulled out their deposits before you could say ‘bank run’.

Her first big learning is that the level of transparency around the financial system has improved so radically now compared to Japan ’98 and GFC ’08 that the financial system has become more prone to contagion: “During the 1997-98 Japanese turmoil, I would meet government officials to swap notes, often over onigiri rice balls. But it was a fog: there was little hard information on the (then nascent) internet and the media community was in such an isolated bubble that the kisha (or press) club of Japanese journalists had different information from foreigners. To track the bank runs, I had to physically roam the pavements of Tokyo…

…CDS prices are now displayed online (which mattered enormously when Deutsche Bank wobbled). We can use YouTube on our phones, anywhere, to watch Jay Powell, chair of the US Federal Reserve, give a speech (which I recently did while driving through Colorado) or track fevered debates via social media about troubled lenders. Bank runs have become imbued with a tinge of reality TV.

This feels empowering for non-bankers. But it also fuels contagion risks. Take Silicon Valley Bank. One pivotal moment in its downfall occurred on Thursday 9 March when chief executive Greg Becker held a conference call with his biggest investors and depositors. “Greg told everyone we should not panic, because the bank will not fail if we all stick together,” one of SVB’s big depositors told me.

Similar conversations took place in Japan in 1997, physically, in smoke-filled rooms. But few customers knew. Not so in 2023: reports of Becker’s words leaked into the internet, fuelling a stampede. In a few hours, some $42bn — or a quarter of SVB’s funds — departed. Back in 1984, by way of comparison, it took depositors an entire week to withdraw half their funds from Continental Illinois — in person — when that giant lender failed.”

The bottomline Ms Tett says is that bank runs now happen breathtakingly fast i.e. in hours, not days and regulators (and even bankers) are simply not programmed to respond that fast: “Torsten Slok, an economist at Apollo, notes that “the share of [US] households using mobile banking or online banking increased from 39 per cent in 2013 to 66 per cent in 2021”.

Until now, the models used in finance do not seem to have taken account of the fact that consumer behaviour online might be different from that in the old-fashioned, physical banking world. But one striking feature about American banks, even before the March panic, was that consumers were moving money out of low-paying deposit accounts into better-yielding money market funds at a dramatically faster pace than at similar points before in history.”

The second big lesson Ms Tett says is that regulators and bankers need to shift their attention from credit risk (i.e. the risk of a borrower defaulting) to interest rate risk (i.e. the fact that AFTER a bank has made a fixed rate loan (or purchased a fixed coupon bond), interest rates rise and thereby render the loan (or bond) less valuable): “Take interest rate risks. These “flew under the supervisory system’s radar” in recent years, says Patrick Honohan, former central bank governor of Ireland; so much so that “the Fed’s recent bank stress tests used scenarios with little variation [and] none examined higher interest rates” — even amid a cycle of rising rates. Why? The events of 2008 left investors obsessively worried about credit risk, because of widespread mortgage defaults in that debacle. But interest rate risk was downplayed, probably because it had not caused problems since 1994.

The global financial crisis was similar: when I asked bankers at entities such as UBS in late 2008 why they had missed mortgage default risks in earlier years, they told me that their risk managers were too busy worrying about hedge funds and corporate loans instead. That was because a big hedge fund (Long-Term Capital Management) imploded in 1998 and the dotcom bubble burst in 2000, creating corporate loan losses. The past is not always a good guide to future risks.”

The third big less Ms Tett says is that whatever is considered the safest asset (note: NOT the sexiest asset) in a bull run is usually the likeliest trigger for the next banking crisis: “A third, associated, lesson is that items considered “safe” can be particularly dangerous because they seem easy to ignore. In the late 1990s, Japanese bankers told me that they made property loans because this seemed “safer” than corporate loans, because house prices always went up. Similarly, bankers…told me in 2008 that one reason why the dangers around repackaged subprime mortgage loans were ignored was that these instruments had supposedly safe triple-A credit ratings — so risk managers paid scant attention.

So, too, with SVB: its Achilles heel was its portfolio of long-term Treasury bonds that are supposed to be the safest asset of all; so much so that regulators have encouraged (if not forced) banks to buy them. Or as Jamie Dimon, head of JPMorgan, noted in his annual shareholders’ letter, “ironically banks were incented to own very safe government securities because they were considered highly liquid by regulators and carried very low capital requirements”. Rules to fix the last crisis — and create “safety” — sometimes create new risks.”

Ms Tett concludes by saying that the current bout of bank collapses has further to run given how profound the distortions created by 15 years of lax monetary policy have become.

If you want to read our other published material, please visit https://marcellus.in/blog/

Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.