Bank Failures Shine Light on Interest Rate Risks

Financial markets reacted turbulently to the collapse of Silicon Valley Bank (SVB) on March 10, 2023, followed two days later by the failure of Signature Bank of New York. With $209 billion in assets and $175 billion in deposits, SVB was the nation’s 16th largest bank and the second largest to fail in U.S. history.^1-2

This news was alarming to savers who worried their own bank accounts could be at risk and investors who feared a wider financial crisis. To help restore confidence in the U.S. financial system, the federal government pledged to make all depositors whole and to support other banks that might face liquidity issues stemming from the rapid rise in interest rates.³

These events have drawn new attention to how banks operate and the risks they take to earn money on customer deposits, as well as the government’s role in regulating and supervising bank activities.

What is the FDIC?

The Federal Deposit Insurance Corporation (FDIC) is an independent agency backed by the full faith and credit of the U.S. government. FDIC insurance is intended to reassure depositors and offer protection in case an insured bank becomes insolvent, is liquidated, or experiences other financial difficulties. Most banks in the United States are insured by the FDIC, which protects deposits up to $250,000 (per person, bank, and account category).

When a member bank fails, the FDIC issues payments to depositors (typically up to the limits provided by law) and takes over the administration of the bank’s assets and liabilities. Generally, the FDIC will try to arrange for a healthy bank to take over the deposits of a failed bank. If no bank assumes that role, the FDIC taps a fund that is financed by premiums paid by insured banks.

Why are banks under pressure?

In its quest to bring down inflation, the Federal Reserve has raised the benchmark federal funds rate from near zero to more than 4.5% over the past year.⁴

Banks earn money by investing customer deposits, often in relatively safe long-term Treasuries and other government-backed bonds. U.S. Treasury securities are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. But as interest rates rise, bonds lose value on the secondary market, which becomes a problem if banks must sell bonds before they mature. At the end of 2022, U.S. banks had booked about $300 billion in unrealized losses on bonds they planned to hold to maturity.⁵

At SVB, poor balance-sheet management also came into play. A California bank that catered to technology start-ups, SVB was highly — and knowingly — exposed to weakness in that volatile sector. As start-up valuations fell and venture capital funds dwindled, withdrawals increased and forced the bank to sell $21 billion in securities at a $1.8 billion loss. More than 90% of customer deposits at SVB were uninsured, which made depositors more likely to panic and pull their money once the bank’s losses came to light.⁶

Signature Bank’s challenges were similar in that a large share of customer deposits were uninsured — and it was a primary servicer of high-risk cryptocurrency businesses.⁷

What actions did the government take?

In a joint statement, the U.S. Treasury, the Federal Reserve, and the FDIC guaranteed that depositors of SVB and Signature Bank would have access to all their money. Concluding that the failures posed a risk to the financial system gave the FDIC greater flexibility to return funds that exceed the $250,000 cap. Any resulting FDIC insurance fund losses will be recovered through a special assessment charged to banks. The banks’ shareholders and unsecured bondholders did not receive any government support.⁸

In addition, the Federal Reserve will help ensure that all banks have enough liquidity to meet depositors’ needs — without selling bonds prematurely — through a new facility called the Bank Term Funding Program (BTFP). The BTFP allows banks to use their government bonds as collateral for one-year loans. Fragile U.S. banks borrowed $164.8 billion combined from the new BTFP and the Federal Reserve discount window, a pre-existing liquidity backstop, during the week ended March 15, breaking a record from the 2008 financial crisis.⁹

How will other banks be affected?

Moody’s Investors Service cut its outlook for the entire banking sector from stable to negative, due to the “rapidly deteriorating operating environment.” Lower credit ratings could push up borrowing costs and cut into earnings. First Republic Bank (FRB) was one of five banks that were put on review for ratings downgrades due to substantial unrealized losses and exposure to the risk of outflows by uninsured depositors.¹⁰ FRB’s credit rating was later cut to junk status despite a $30 billion rescue package from a coalition of the nation’s largest banks.¹¹

The current situation is fluid, and it’s too soon to know if more distressed banks will buckle. Regulators emphasized that the U.S. financial system remains resilient and has a solid foundation, in part due to safeguards put in place during the last financial crisis.¹²

The Federal Reserve launched an internal review to determine what went wrong and whether regulators missed signs of trouble. This may cause officials to refocus attention on smaller institutions and strengthen those regulatory requirements accordingly.¹³

Are your savings protected?

If you have multiple accounts at one bank, you might check to see who is listed as the owner(s) of each account, what category it falls into, and whether it overlaps with other categories that might affect the amount that’s covered. Ownership categories consist of individual accounts, joint accounts, retirement accounts, trust accounts, and business accounts, among others.

You can’t increase your coverage by owning different product types (a checking account, savings account, or CDs, for example) within the same ownership category. A tool on the FDIC’s website (FDIC.gov) can help you estimate the total FDIC coverage on your deposit accounts.

If your assets aren’t fully insured, you might consider shifting them to increase your coverage. If you are married, for example, you could expand your total coverage up to $1 million at one bank by opening two separate individual accounts in addition to a joint account. If you have personal or business account balances that regularly exceed $250,000, you might consider diversifying your holdings between multiple financial institutions — or possibly rethink your cash-management strategy altogether.

All investing involves risk, including the possible loss of principal.

1) Reuters, March 13, 20232) Federal Deposit Insurance Corporation, March 12, 20133-4, 8, 12) Federal Reserve, March 12, 20235-6) Bloomberg, March 12, 20237) The Wall Street Journal, March 14, 20239) Bloomberg, March 16, 202310) CNBC, March 14, 202311) Reuters, March 19, 202313) The Wall Street Journal, March 14, 2023

IMPORTANT DISCLOSURES FF Global Capital does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright © 2024
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Annuities – Duplicate – [#14354]

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March 6, 2023

An annuity is a contract between you (the purchaser or owner) and the issuer (usually an insurance company). In its simplest form, you pay money to the annuity issuer, the issuer invests the money for you, and then the issuer pays out the principal and earnings back to you or to a named beneficiary.

Annuity Contract

Annuities

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September 28, 2022

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Retirement

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September 22, 2022

If you choose to work after retirement, you should be aware of the effect it will have on your Social Security benefits.

New Cancellation for Federal Student Loans and Delayed Repayment to 2023

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September 15, 2022

The new plan will cancel $10,000 in federal student loan debt for individual borrowers whose income is below $125,000 in 2020 or 2021.

Inflation Reduction Act - Tax Benefits

Inflation Reduction Act: What You Should Know

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September 7, 2022

The Inflation Reduction Act, signed into law on August 16, 2022, includes health-care and energy-related provisions, a new corporate alternative minimum tax, and an excise tax on certain corporate stock buybacks.

Is the U.S. Economy in a Recession?

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August 10, 2022

In an early July poll, 58% of Americans said they thought the U.S. economy was in a recession, up from 53% in June and 48% in May.

Top 30 Global Ideas for 2022

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July 5, 2022

In this note, we present our Top 30 Global Ideas for Q3 2022. This list remains one of high-conviction, long-term ideas, with quarterly updates that enable dynamic changes into names that we think offer higher- conviction upside potential.

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Despite Concerns, Retirement Confidence Remains Steady

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May 27, 2022

In the 2022 Retirement Confidence Survey, more retirees reported higher-than-expected expenses overall compared to 2021, with notable jumps in the housing and travel, entertainment, and leisure categories.

Person counting money

What Do Rising Interest Rates Mean for Your Money?

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May 15, 2022

On March 16, 2022, the Federal Open Market Committee (FOMC) of the Federal Reserve raised the benchmark federal funds rate by 0.25% to a target range of 0.25% to 0.50%.

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Retirement Plans for Small Businesses

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May 5, 2022

As a business owner, you should carefully consider the advantages of establishing an employer-sponsored retirement plan. Generally, you’re allowed certain tax benefits for establishing an employer-sponsored retirement plan, including a tax credit for establishing the plan and a deduction for contributions you make.

Is the U.S. Economy in a Recession?

In an early July poll, 58% of Americans said they thought the U.S. economy was in a recession, up from 53% in June and 48% in May.¹ Yet many economic indicators, notably employment, remain strong. The current situation is unusual, and there is little consensus among economists as to whether a recession has begun or may be coming soon.²

Considering the high level of public concern, it may be helpful to look at how a recession is officially determined and some current indicators that suggest strength or weakness in the U.S. economy.

Business Cycle Dating

U.S. recessions and expansions are officially measured and declared by the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER), a private nonpartisan organization that began dating business cycles in 1929. The committee, which was formed in 1978, includes eight economists who specialize in macroeconomic and business cycle research.³

The NBER defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” The committee looks at the big picture and makes exceptions as appropriate. For example, the economic decline of March and April 2020 was so extreme that it was declared a recession even though it lasted only two months.⁴

To determine peaks and troughs of economic activity, the committee studies a range of monthly economic data, with special emphasis on six indicators: personal income, consumer spending, wholesale-retail sales, industrial production, and two measures of employment. Because official data is typically reported with a delay of a month or two — and patterns may be clear only in hindsight — it generally takes some time before the committee can identify a peak or trough. Some short recessions (including the 2020 downturn) were over by the time they were officially announced.⁵

Strong Employment

Over the last few months, economic data has been mixed. Consumer spending declined in May when adjusted for inflation, but bounced back in June.⁶ Retail sales were strong in June, but manufacturing output dropped for a second month.⁷The strongest and most consistent data has been employment. The economy added 372,000 jobs in June, the third consecutive month of gains in that range. Total nonfarm employment is now just 0.3% below the pre-pandemic level, and private-sector employment is actually higher (offset by losses in government employment).⁸

The unemployment rate has been 3.6% for four straight months, essentially the same as before the pandemic (3.5%), which was the lowest rate since 1969.⁹ Initial unemployment claims ticked up slightly in mid-July but remained near historic lows.¹⁰ In the 12 recessions since World War II, the unemployment rate has always risen, with a median increase of 3.5 percentage points.¹¹

Negative GDP Growth

One common definition of a recession is a decrease in real gross domestic product (GDP) for two consecutive quarters, and the current situation meets that criterion. Real (inflation-adjusted) GDP dropped at an annual rate of 1.6% in the first quarter of 2022 and by 0.9% in the second quarter.¹² Because GDP is reported on a quarterly basis, the NBER committee cannot use it to measure monthly economic activity, but the committee does look at it for defining recessions more broadly.

Since 1948, the U.S. economy has never experienced two consecutive quarters of negative GDP growth without a recession being declared. However, the current situation could be an exception, due to the strong employment market and some anomalies in the GDP data.¹³

Negative first-quarter GDP was largely due to a record U.S. trade deficit, as businesses and consumers bought more imported goods to satisfy demand. This was a sign of economic strength rather than weakness. Consumer spending and business investment — the two most important components of GDP — both increased for the quarter.¹⁴

Initial second-quarter GDP data showed a strong positive trade balance but slower growth in consumer spending, with an increase in spending on services and a decrease in spending on goods. The biggest negative factors were a slowdown in residential construction and a substantial cutback in growth of business inventories.¹⁵ Although inventory reductions can precede a recession, it’s too early to tell whether they signal trouble or are simply a return to more appropriate levels.¹⁶Economists may not know whether the economy is contracting until there is additional monthly data.

The Inflation Factor

With employment at such high levels, it may be questionable to characterize the current economic situation as a recession. However, the employment market could change, and recessions can be driven by fear as well as by fundamental economic weakness.

The fear factor is inflation, which ran at an annual rate of 9.1% in June, the highest since 1981.¹⁷ Wages have increased, but not enough to make up for the erosion of spending power, making many consumers more cautious despite the strong job market.¹⁸ If consumer spending slows significantly, a recession is certainly possible, even if it is not already under way.

Inflation has forced the Federal Reserve to raise interest rates aggressively, with a 0.50% increase in the benchmark federal funds rate in May, followed by 0.75% increases in June and July.¹⁹ It takes time for the effect of higher rates to filter through the economy, and it remains to be seen whether there will be a “soft landing” or a more jarring stop that throws the economy into a recession.

No one has a crystal ball, and economists’ projections range widely, from a remote chance of a recession to an imminent downturn with a moderate recession in 2023.²⁰ If that turns out to be the case, or if a recession arrives sooner, it’s important to remember that recessions are generally short-lived, lasting an average of just 10 months since World War II. By contrast, economic expansions have lasted 64 months.²¹

To put it simply: The good times typically last longer than the bad. Projections are based on current conditions, are subject to change, and may not come to pass.

1) Investor’s Business Daily, July 12, 2022

2) The Wall Street Journal, July 17, 2022

3–5) National Bureau of Economic Research, 2021

6, 12, 15, 21) U.S. Bureau of Economic Analysis, 2022

7) Reuters, July 15, 2022

8–9, 17–18) U.S. Bureau of Labor Statistics, 2022

10) The Wall Street Journal, July 14, 2022

11) The Wall Street Journal, July 4, 2022

13–14) MarketWatch, July 5, 2022

16) The Wall Street Journal, July 28, 2022

19) Federal Reserve, 2022

20) The New York Times, July 1, 2022