March 20, 2023
🤝 Yeesh, what a wild weekend. The Swiss government raced to pull off the biggest banking deal since the financial crisis: Banking giant UBS is buying its beleaguered rival Credit Suisse, for very little money — as Felix explains below.
- Now all eyes are on the U.S. markets for the reaction.
Today's newsletter is 1,211 words, 5 minutes. Let's go!
1 big thing: An unavoidably messy bank failure
Credit Suisse failed this weekend — or at least it would have, were it not too big to fail. Instead, Switzerland's banking regulators cobbled together an emergency solution that leaves nobody happy — but at least prevents a catastrophe for the global financial system, Axios' Felix Salmon writes.
Why it matters: The 30 G-SIBs — global systemically important banks — are the financial institutions that global regulators have determined are too big to fail. As such, they operate under stricter capital standards and regulatory scrutiny than anybody else. Nevertheless, as Credit Suisse shows, they can still end up being worth a negative amount of money.
By the numbers: UBS is buying Credit Suisse for roughly negative $14 billion. It's paying $3.2 billion to Credit Suisse shareholders, but only because Swiss regulators are wiping out $17.2 billion of the bank's liabilities, leaving those bondholders with nothing.
Between the lines: In the normal world of mergers and acquisitions, that wouldn't be possible. Bondholders are senior to shareholders, meaning that they get paid out first, and only once they're paid out in full do shareholders get anything.
- In the real world of rescuing a too-big-to-fail bank, however, such niceties can end up being sacrificed for the sake of managing to get a deal done.
The intrigue: UBS management and shareholders didn't particularly want to buy Credit Suisse, while Credit Suisse management and shareholders certainly didn't want their bank to be sold for peanuts. It's unlikely this deal would receive shareholder approval from either side — which is one reason why Swiss authorities changed the law to enable the deal.
- The interests of international financial stability ended up overriding the interests of shareholders.
Where it stands: Swiss regulators forced the two banks together, threw Credit Suisse shareholders a $3.2 billion bone, and zeroed out a tranche of junior contingent convertible (CoCo) bonds that are supposed to convert into equity when a bank gets into trouble.
The big picture: Credit Suisse shareholders ended up losing about $17 billion in equity value over the past year. At that point, there wasn't another $17 billion left to lose — so the next tier up had to take a hit.
- In the interests of expedience, it was easier to just zero out the CoCos and leave shareholders with $3.2 billion than it would have been to convert the CoCos to equity and then pay them out at pennies on the dollar. Just finding a conversion price would have been incredibly fraught.
The bottom line: Banks are a huge pile of assets offsetting another huge pile of liabilities. Shareholders only own the sliver between the two, which in the case of Credit Suisse was nonexistent. When a bank is failing, they generally have no say in what happens to it.
- CoCo bondholders have more reason to feel aggrieved. But they were going to lose most of their money anyway — and besides, CoCos are supposed to behave like equity in a crisis.
- In that sense, it shouldn't come as a complete surprise that they've been wiped out.
2. Catch up quick
3. The thin $250,000 line
The FDIC guarantees bank deposits of up to $250,000 — a figure most of us weren't thinking all that much about until a week ago, when regulators guaranteed all customer deposits, even those above a quarter-million dollars, at two failed banks, Emily writes.
Why it matters: Now lawmakers, academics, and some in the financial industry are debating whether the FDIC limit, which hasn't been raised since 2008, needs to be increased — or abolished altogether.
- Over the weekend, four different lawmakers involved in banking said they'd consider raising the limit, CNBC reports. Last week, Maxine Waters (D-Calif.), ranking member of the House Financial Services Committee, told the New York Times that raising the limit is something Congress should contemplate, in an interview.
- A coalition of midsize banks is asking the FDIC to insure all deposits for at least two years, Bloomberg reported.
The big picture: Regulators stirred up some murkiness when they decided to protect all depositors at Silicon Valley Bank and Signature Bank, with the aim of stemming a serious systemic risk to the financial system.
- On the one hand, their actions sent the message that if you deposit more than $250,000 at an important-enough bank, it's safe.
- On the other hand, no one has said exactly that. The limit still exists and uninsured deposits are still uninsured.
- And it's unclear what makes a bank important enough: First Republic Bank, SVB's similarly sized peer, continued to experience withdrawals of uninsured deposits after SVB's rescue.
So we're left with confusion. "At this point, the $250,000 cap is illusory," write Lev Menand and Morgan Ricks in a piece for the Washington Post. But the fact that the official cap remains in place means that “much of the nation’s money is unsound and unstable — an ever-present sword of Damocles hanging over the U.S. economy."
- Menand and Ricks argue the U.S. should scrap the limit.
Zoom out: The rationale behind the deposit limit is that everyday Americans are low-information lenders — we put our money into a bank, unsecured, without doing a deep dive into the bank's finances to make sure it's sound. Knowing that deposits are backed by the FDIC obviates the need for every person to become a bank analyst.
- But wealthier depositors, including the companies that place more than a quarter-million dollars in the bank, are supposed to be more sophisticated — and better able to handle the risk.
- What happened with Silicon Valley Bank throws that whole line of reasoning out the window.
- "Large depositors are both bad at monitoring banks and perfectly capable of engaging in destabilizing runs," per Menand and Ricks.
Why should all Americans care about the fate of wealthy depositors? Because their bank runs affect us, too. As we've seen this month, payrolls become imperiled and other banks start to teeter.
4. Savings accounts cling to the past
Deposits were starting to get interesting, even before their sudden flight from Silicon Valley Bank caused the biggest banking panic since 2008-09, Matt writes.
The big picture: The interest rate drought for savers ended in 2022, as the Fed's sharp increase in short-term rates prompted some banks to compete for deposits for the first time in quite a while.
- For depositors with significant sums — such as corporations — there's money to be made by shifting stockpiled cash into accounts that are paying more.
The intrigue: In textbook economics, depositors would be flocking to the accounts with the highest rates, and maximizing their returns.
- But check out the chart above: Even before this month's panic, the national average was still sitting near zero. For many savers, especially those with low dollar amounts in their accounts, inertia is strong.
- And since the panic: Money has poured into some of the country's biggest — and stingiest — banks in recent days, as fearful depositors flocked to put their money in banks deemed too big to fail.
The bottom line: During moments of financial stress, investors — that includes depositors — switch their focus from return on capital, to return of capital, meaning safety trumps all.
1 last FDIC thing: Before the creation of FDIC insurance, banks failed a lot. More than 9,000 banks failed in the four years before deposit insurance went into effect in 1934, according to a paper from the FDIC entitled "A Brief History of Deposit Insurance in the United States." (It's 76 pages.)
- The FDIC maximum has been raised only seven times in its 90-year existence, and the last two times were because of financial turmoil.
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✏️ Markets is edited by Kate Marino and copy edited by Mickey Meece.