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Quarterly Letter to Clients

April, 2023

Indices at quarter-end (March 31, 2022):

Dow Jones Industrials: 33,274.15 1Q'23 +0.38% YTD +0.38%

Standard & Poor's 500: 4,109.31 1Q'23 +7.03% YTD +7.03%

Both stocks and bonds were slightly higher this past quarter. Bank stocks, large and small, were predictably under pressure (see below), but rebounded a bit as things settled down. Tech stocks, even in the face of large layoffs in that industry, were where the action was, with the NASDAQ index outpacing the Dow and the S&P by a wide margin.

Inflation may well ease because the price of oil has dropped, but that is yet to be seen, with the latest readings still in the area of 6%. The Fed, undaunted by problems in regional banks, raised rates by a minimal one-quarter of one percent. That action, and their accompanying commentary, was not greeted favorably by the market, though still probably necessary. The move was the least that they could do to show that they are still concerned.

In a cartoon, a man is reading a paper headlined, "Banking Reform." He says to his wife, "The same people who didn't see it coming the last time want to protect us again." I guess that we need a small shock to the system once in a while to keep us on our toes.

This shock wasn't war, or inflation, or interest rates; it was the banks. Two weeks after its audit was completed, Silicon Valley Bank (SVB) collapsed, followed three days later by Signature Bank; both were taken over by the government. First Republic was next, saved by a $30 billion injection from a few of our giant banks. In Europe, the long-suffering Credit Suisse was saved, bought by UBS.

Domestically, the pain seems centered in regional, small-to-mid-size banks, precisely the companies that were relieved of stringent requirements by legislation passed in 2018. The current bailouts were an effort to prevent a domino effect.

Normally, bank deposits are insured by the FDIC to a maximum of $250,000 per separate account name (e.g., one account for you, one for your spouse, and one joint account, all in the same bank, for a total of $750,000 insured; more than that, go to a second bank). But businesses need high levels of cash to meet their payrolls. Around 90% of SVBs accounts were over the maximum insured level. If those companies couldn't make payrolls, the panic would have snowballed.

That's when the cavalry rode in, in the form of the Federal Reserve, which guaranteed all deposits, even those in excess of $250,000. This was unusual, but to my mind, necessary. After all, do we expect depositors to be required to judge the soundness of individual banks? If a company keeps large deposits that it intends to use to pay salaries, how can it avoid going over the maximum insured amount?

Some will argue with me, saying that true capitalism calls for the weaker entities to fall, and the stronger to survive and thrive. But this is not our grandparent's banking system, where the local bank wrote your mortgage and then held on to that loan for the next thirty years. Today's banking system is tightly interdependent; banks do not stand alone, they exist in a symbiotic, system-wide relationship. One bank failure leads to another. And no bank can withstand a run by its depositors.

(I could be a little sarcastic here and point out that allowing SVB et al to fail might have helped the Fed in its fight against inflation.)

We have a system of stress-testing our major banks to ensure that they remain viable in challenging times. And our banking giants certainly appear to be safe. Protecting us from a systemic collapse of our banks and our currency is perhaps one of the main roles of our government. The nation, the world, depends upon the soundness of our currency and our banking system. Our entire economic system relies on trust and faith, and this rescue, and those of 2008, bolstered that faith and trust.

Still, if you have more than $250,000 in any single bank account, you should open another account.

Jim Pappas