During the first quarter of 2023 and over the course of several days, we experienced two bank failures in the United States. Many are asking what do these events mean, and what, if anything, should you do differently?
First, Do No Harm
The investment climate has changed dramatically over the past year. Thanks to aggressive moves by the Federal Reserve, interest rates have gone from almost zero to about 5%. That’s a little like going from 0 to 100 mph in a supercar in a few seconds…it is not normal. And now we’re seeing some repercussions.
So it is crucial to make sure you’re invested right. But first, be careful to not overreact. Emotional responses can be more damaging to wealth than almost any actual event.
Instead, let’s look at what we know, and don’t know, about the landscape, so you can determine if any adjustments make sense.
What Do the Banking Woes Mean?
Events with Silicon Valley and Signature Bank have raised questions about the stability of our banking system. Fortunately, these issues seem to be relatively isolated for now. But what actually happened?
First, let’s quickly review how modern-day banking works in the United States. Today’s banks run off a system called Fractional Reserve Banking. That means when they take in deposits, they don’t just put it all in a vault.[i] Instead, today’s banks aim to make cash available for lending.
So instead of holding your money, they are only required to maintain a fractional amount on hand. Then they are permitted to lend the rest.
The Reserve Requirement was previously zero, 3% or 10% depending on bank size. [ii] As of March 2020, however, the Federal Reserve lowered the reserve requirement on all depository institutions to zero.[iii] Instead, it made holding reserves voluntary.
Regardless, this has tended to work well, with one exception: that’s when a bank run occurs.
Bank Runs in Today’s Online World
A “bank run” is when many people rush to get their money out of the bank at once. Bank runs occurred during the Great Depression. At that time, you had to rush out and physically get in line to pull your money from the bank.[iv]
The recent bank runs seemed less dramatic. That’s because you can withdraw cash online with a few keystrokes using today’s online banking platforms.
But what caused the rush to the exits?
With the Federal Reserve aggressively raising rates, businesses and consumers have a new choice they haven’t had for a while, and that’s earning a high interest rate on deposits. With the federal government offering nearly 5% on treasury debt and the banks only offering a fraction of that, many people chose to move their money. At the same time, discussions on social media played this option up. So more people and businesses started moving their cash. At that point, the bank had to raise capital to meet depositor withdrawals. This news worried bank depositors and drove even more people to withdraw money, quickly exceeding the bank’s reserves.
Once the withdrawals could not be met by SVB, the bank failed. The process was similar for Signature Bank. In these cases, the government stepped in to insure deposits for customers.
One crucial factor was that these banks had invested most of the money in long-term treasury bonds, which are considered risk-free investments. With interest rates rising, however, those bonds fell in value. Now, these were not speculative investments; if held to maturity, there would be no losses. This was just an unfortunate timing issue with a mismatch of maturities.
What Should I Do?
We should take this seriously, but formulating a plan and not just reacting is essential. Fortunately, there are steps you can take to help minimize your exposure to these types of events.
First, this is not a repeat of the 2008 Global Financial Crisis, when a massive bailout was needed to save U.S. banks. The banks went on a lending spree at that time, granting no-money-down mortgages with lax lending standards. Today, bank lending standards are stringent, so bad loans are not as common. It’s just that the fast-paced interest rate increases have made their conservative investments lose money in the short term (but not if held to maturity).
Second, we always advocate that you stay diversified. This is a prime example of why—we cannot always control all the variables or see what’s coming. With diversification, you don’t have all your eggs in one basket, so a problem with one investment won’t cause you as much harm.
Third, you should get familiar with Federal Deposit Insurance Corporation (FDIC) coverage. You can review this insurance on the FDIC website. [v]
This government agency insures your deposits up to a certain amount, generally $250,000 per person per account. Here are some things to know about FDIC coverage
- Coverage is based on a per depositor per insured bank category for each account ownership category. So if you have your money at multiple banks, you are covered at each of them up to the applicable limit (usually $250,000).
- Some accounts get multiple layers of coverage. For example, if a revocable trust owns an account, each beneficiary gets FDIC coverage of $250,000. Amounts over $1,250,000 have a more complicated coverage formula, but accounts with multiple beneficiaries may have even more coverage. [vi]
- One common recommendation we give our clients is to put their cash into a brokerage account and purchase multiple CDs from various banks. That gives you broad FDIC coverage with the simplicity of a single account.
- You can also sidestep FDIC altogether by purchasing treasury bills, notes or bonds. These are debt instruments backed by the full faith and credit of the U.S. Government, so these are even safer than relying on FDIC. Currently, these pay attractive yields, making them a good choice for many.
- You can also opt for treasury-backed money market funds to provide similar protections.
Key Takeaway
One silver lining of the 2023 banking crisis is that it has reminded us to always pay close attention to our investments. And it has brought home the importance of staying invested but always staying diversified (even with cash). This is all part of good risk management, which is more important than ever in turbulent times.
Wondering what moves you should make to keep your money safe?
Contact us today to set up a time to talk. We’ll review your financial plan and investments to help make sure you’re prepared for whatever the future brings.
[i] https://fredblog.stlouisfed.org/2018/12/how-much-cash-do-banks-keep-in-the-vault/
[ii] https://www.investopedia.com/terms/f/fractionalreservebanking.asp#citation-1
[iii] https://www.federalreserve.gov/monetarypolicy/reservereq.htm
[iv] https://www.history.com/topics/great-depression/bank-run
[v] https://www.fdic.gov/resources/deposit-insurance/faq/#:~:text=The%20standard%20deposit%20insurance%20coverage,held%20at%20the%20same%20bank.
[vi] https://www.fdic.gov/deposit/diguidebankers/documents/revocable.pdf