The great uncertainty of the banking crisis
The banking crisis resembles the COVID crisis in that one of its scariest aspects in these early days is that we just don't know how bad it is.
Why it matters: There's something incredibly unsettling about being in a liminal state. That's one reason why so many people rushed to believe the idea that Silicon Valley Bank and Signature Bank were sui generis outliers and that no other banks were in danger.
- A similar whiff of wishful thinking can be detected in the confident assertions — from JPMorgan CEO Jamie Dimon, Fed chair Jay Powell, and others — that First Republic's failure will be the last of the crisis.
- That might be true — but it's hard to see where the confidence comes from.
By the numbers: A recent Stanford paper found that SVB was far from being an outlier in terms of solvency — in fact, it calculated that a whopping 2,315 U.S. banks are insolvent on a mark-to-market basis.
Be smart: The solvency worries that caused SVB's demise were raised not because SVB was sitting on a particularly toxic set of assets, but rather because the assets under scrutiny were bonds that were very easy to mark to market.
- In the case of FRB, the weakness in the balance sheet took longer to materialize because the assets falling in value were bespoke mortgages.
The big picture: Being insolvent on a mark-to-market basis should not in itself consign a bank to failure. If you were always going to hold an asset to maturity anyway, it shouldn't really matter how much it was worth along the way, especially if there are no real questions about credit risk.
- Low-yielding assets, however, make it hard for banks to make money when their cost of funds is high thanks to 5% interest rates.
- And if deposits do start flowing out, either through fear of a bank failure or because there are more attractive yields elsewhere, that can force assets to get sold — and mark-to-market losses to be realized.
How it works: As Bloomberg's Matt Levine once wrote, "A bank is a collection of reasonable guesses about valuation ... There is no objective reality."
- As a result, it's literally impossible, especially in the present environment, to look at any bank's balance sheet and be entirely reassured as to its solvency.
Where it stands: PacWest's statement on Thursday that its cash reserves are much greater than its uninsured deposits — the deposits most prone to flight — would be reassuring in normal times.
- Right now, however, all eyes are on the bank's $44 billion of assets — a number more than 100 times greater than its $0.4 billion market capitalization. And what those assets are "really worth" has become an almost metaphysical question.
The bottom line: In 2020, we found ourselves in a new reality in which almost none of the facts we most urgently wanted to know about the world were known by anyone at all.
- That's a feeling bank balance sheets analysts know extremely well.