March Madness

Fifteen years ago, in March 2008, a storied name in US banking failed. The government-backed sale of Bear Sterns to rival JP Morgan was seen at the time as putting a floor under the growing credit crunch and markets rallied.

As we now know, the orderly unwinding of Bear Sterns would be followed six months later by the chaotic collapse of Lehman Brothers and a scary new phase of the Global Financial Crisis.

The scars of this crisis largely informed how bank executives, investors and regulators have thought about things in subsequent years, right up to the recent wobbles. With that comes a tendency to fight the last war, comparing the current crisis with the past one. The good news is that current stress in the banking system is nothing at all like in 2008. But that doesn’t mean the current episode can’t end up causing damage. So, we need to ask ourselves four key questions, acknowledging that the situation is uncertain and fluid: To what extent are we dealing with a few bad apples versus a systemic problem? What is the likely spill-over to the broader financial system and economy? What does it mean for policy? And how can it affect the South African financial sector specifically?

Reckless safety
Firstly, banking crises are usually caused when the chickens of reckless lending come home to roost. Typically, though not always, there is a property boom, and banks overextend themselves lending to overextended households chasing house prices higher. When the music stops, there is trouble all around. This time, lending has been subdued and American household finances have generally been in good shape. Rather, Silicon Valley Bank and others got into trouble by putting too much money into safe, boring government bonds.

US bank deposits surged from $13 trillion to $18 trillion in 2020 and 2021 (they’ve declined somewhat since, as money market funds offer better yields). Banks needed to do something with all this cash, and with limited demand for loans, increased holdings of government securities that offered higher yields.

The problem is that those securities fell sharply as the Federal Reserve hiked interest rates. The same is true in other jurisdictions. This means that hundreds of billions of dollars in unrealised losses sit on balance sheets across the US banking sector. They don’t have to account for losses, however, if those bonds are held to maturity. But if a bank is a forced seller of those bonds to meet customer withdrawals, it must crystalise those losses and raise fresh capital. Across the banking system, customers have been withdrawing funds in favour of higher yielding options (deposit rates have not increased as much as Fed policy rates).

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