The Federal Deposit Insurance Corporation (FDIC) this week announced the winner of its auction for the loans and deposits of the failed Silicon Valley Bank: First Citizens BancShares (Nasdaq:FCNCA), a North Carolina outfit with no obvious synergy with SVB’s customer base or tech know-how. Given First Citizens’ capital base of only $14.1 billion ($9.7 billion of which is stockholders’ equity) compared to the $72 billion of SVB loans it took on, there must be some chance of a cascade of bank failures. For those who think this unduly pessimistic, I have a tale to tell you – from 1973.
For those readers decades younger than me – and even I did not see the shows live – the Clampetts were a family of hillbillies from the Ozarks (yes, I KNOW the Ozarks are not in North Carolina!) who struck oil on their land, moved to Beverley Hills, the swanky suburb of Los Angeles, and became from 1962-71 the “Beverley Hillbillies” with appropriate farcical special effects. We are told that First Clampetts – sorry, First Citizens – is a North Carolina bank controlled by the Holding family, the current patriarch of which Frank Holding is – gasp – a Wharton graduate. So not Clampett-like at all, really.
More seriously, my problem with the deal is that the $110 billion of assets transferred to First Citizens more than doubles its size, taking it to $219 billion in assets, when its asset base as recently as December 2019 was under $40 billion and its capital base last December was $14.1 billion. Now banking is not tech; if there is one maxim ingrained in me since my first days in the industry, it is that banks cannot both grow very rapidly and maintain asset quality, particularly if they do so in a period of easy money, such as the U.S. experienced from 2009-2022. Combine that rapid growth with an assets to shareholders’ equity ratio of more than 20 to 1 and a period of rapidly rising interest rates and you are asking for trouble. (Rising interest rates endanger banks by reducing the value of their fixed-rate assets; they can also endanger banks by sapping the soundness of their loan books, since many customers in businesses such as real estate and tech cannot deal with the cash flow difficulties those rate rises bring.)
The media are fixated on the possibility of this crisis becoming a major banking crash, like that of 2008. As a historian of that event (in Kevin Dowd’s and my “Alchemists of Loss” © Wiley, 2010) I can state with considerable confidence that the exact pattern of that downturn will not be repeated. There is no retail housing bubble waiting to burst, with its attendant tsunami of subprime mortgage-backed securities; although the housing market became overblown recently due to excessive monetary expansion, it did not do so until 2021-22, and even then the bubble was concentrated in higher-price properties, which will cause losses but are unlikely to produce the complete meltdown of a market, as did the 2006-07 house market crash. The home ownership percentage remained well below its peak of 2006, and thus there will not be the direct financial pain among poorer people that the 2008 crash caused.
From the viewpoint of a benign deity, that is fair; the poorer elements in society did not benefit much from the absurd bubble in all kinds of asset prices in 2010-22, so it is fair they should suffer relatively less than usual in the asset price and financial collapse to come. Less to the taste of that benign deity, the banking behemoths are in little danger this time; deposits are migrating rapidly towards them, and there has been less game-playing in derivatives this time around. The banking industry will thus continue its unattractive and economically damaging concentration and closeness to government.
There is however another precedent, covered briefly in “Alchemists of Loss” but not well remembered in the United States, or indeed anywhere among people under 70, and that is the British secondary banking crisis of 1973-75. This was my introduction to the finance industry; there is little detailed information on it on the Internet, which did not exist at the time. By the 1990s, when the Internet appeared, the institutions involved had mostly either gone bankrupt in the 1970s or been bought out by foreign behemoths in the takeover frenzy that followed Lady Thatcher’s misguided 1986 Financial Services Act.
The secondary banking crisis resulted from a bad British government, that of Edward Heath, confronted with a novel international financial situation: the abandonment of the Bretton Woods semi-fixed exchange rate system in December 1971, and its replacement by a floating-exchange-rate world. A British government of even moderate competence would have greeted this event with the immediate abandonment of the exchange controls that had bedeviled British investors since 1939, preventing them from investing abroad without paying a “dollar premium” of 50% or more. (This was eventually done by Lady Thatcher in 1979; an early sign reassuring observers that she had more basic common sense than her predecessors.)
Instead, Heath and his Chancellor of the Exchequer Tony Barber decided to expand the money supply in a “dash for growth” since they could now do so without sterling weakness immediately slamming them against the constraints of Bretton Woods, thereby forcing them to reverse course. (The Bank of England was a passive observer of this folly; it had not been allowed any say in monetary policy since Montagu Norman’s 1931 triumph in timing the (by then inevitable) abandonment of the Gold Standard so as to eliminate the feeble Ramsay Macdonald Labor government and replace it with the National Government, with the admirable Neville Chamberlain guiding economic policy. “They never told us we could do that” said Sidney Webb, an especially foolish member of Macdonald’s Cabinet. Quite right, too!)
Naturally, with a huge surge of money sloshing into the finite domestic British economic puddle, the result was a massive surge in property prices, which the Heath government stimulated still further by embarking on banking reform, allowing “secondary banks” to proliferate. Share dealers appear to have seen trouble coming – the market peaked as early as May 1972 – but every shyster, crook and chancer set up a secondary bank and attempted to finance commercial property (also high-end houses in general, but not ordinary housing, which was subject to draconian planning restrictions – too boring!)
The fun only lasted about 18 months, presumably because the small, rickety and closed British market could not sustain it, though the quadrupling of oil prices by OPEC in September-October 1973 would anyway have had a serious deflationary effect. The first bank to fail was London and County Securities, quite a large operation that had only been set up in 1968. The Bank of England immediately arranged its sale to a larger and better regarded secondary bank, First National Finance Corporation and sat back, congratulating itself on a good weekend’s work.
Imagine the Bank’s horror a month later, when First National Finance came to it rather shame-faced and announced that it, too, was about to fail to meet its obligations. A “lifeboat” was put together led by Britain’s largest bank National Westminster, thought to be impregnable (though in the event it very nearly wasn’t impregnable, although its final collapse, following a merger, did not occur until 2008.) Economically, the crash was a disaster for Britain; the stock market fell to a lower real level in January 1975 than after the fall of France in June 1940, while inflation soared to 25% in 1975. The one disaster that did not happen was in housing; inflation was so high in 1973-77 that house prices, by remaining approximately flat, were able to halve in real terms, thereby clearing the market and preventing more than a modest surge in home mortgage defaults.
Britain’s 1973-74 situation looks very similar to that in the global economy today; the recent excesses in artificial monetary policy were worse and far more prolonged than those of Heath and Barber, but they have been applied to the gigantic pool of the global economy rather than the stagnant puddle of the 1973 British one. Like the London and County bankruptcy, that of SVB has taken everyone by surprise; indeed if prizes are to be given for appalling management, the wokies of SVB must beat the Cockney wide-boys of London and County – SVB managed to go bust without its loan book even being looked at.
The forced rescue of Credit Suisse, however, shows that the problem extends far beyond the woes of one medium-sized California bank. All kinds of assets are worth far less in a 4.75%-5% interest rate environment (the current Federal Funds rate) than they were in a zero interest rate environment. Whereas the British secondary banking crisis was due almost entirely to speculative real estate lending – the British are an unimaginative lot – the current U.S. and global generation has found a much broader range of ways to lose money. There are still problems with real estate – indeed Signature Bank, SVB’s partner in bankruptcy, seems to have serious difficulties in New York rent-controlled apartments, as well as office and retail properties, in both of which sectors genuine lifestyle changes are causing much obsolescence of existing assets. However, the tech sector, with its plethora of companies making losses for the first few decades of their existence, is another danger sector. Thus there is a likelihood of a cascade of bankruptcies, very probably including the enthusiastically expanding First Citizens, over the next year or so, with only the giant size and open nature of the U.S. and global economy making it happen more slowly than in 1973.
While the secondary banking crisis was exploding, I congratulated myself on being safe in the junior ranks of one of London’s prestigious and solidest merchant banks. Of course, it turned out that a decade of appalling economic polices and high inflation, followed by an utterly misguided “deregulation” favoring foreigners and riff-raff, would account for those too. It is to be hoped that in the U.S. today, better policies will prevent the total devastation that hit the London finance sector in 1973-86. However, given the track record of the last decade, particularly in monetary policy, I wouldn’t bet on it.
My new book on the Industrial Revolution ‘Forging Modernity: Why and How Britain Developed the Industrial Revolution’ has just released on Hardcover.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)