The Banking Crisis: 3 Things Retirement Investors Need to Know
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Silicon Valley Bank was the 16th largest bank in the country, and two weeks ago on March 17th, they filed for bankruptcy. It was the second biggest bank failure in US history behind Washington Mutual. Signature Bank, headquartered in New York, collapsed shortly after and became the third largest bank failure on record. So what exactly happened here? Why did these banks fail? Whose fault is it? What can retirement savers learn from this debacle and what should they do in response?

Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm tackling these questions in addition to answering five important questions about our banking system. For the links and resources mentioned, just head over to youstaywealthy.com forward slash 184.

To understand what happened with Silicon Valley Bank and the current state of the banking system, we have to rewind a few years. In early 2020, the growing instability surrounding COVID-19 caused the global markets to collapse. As we all remember, in just four short weeks, the U.S. stock market dropped 34%. By April, the unemployment rate was skyrocketing and hit a high of 14.7%. And by the end of June, real GDP, i.e. the output of the U.S. economy, was cut by a third.

In response, and to prevent things from getting worse, the government stepped in and Congress-approved stimulus bills unleashed the largest flood of federal money into the U.S. economy in history. When it was all said and done, approximately 5% of the U.S. economy was in debt.

$5 trillion went to American households, small businesses, restaurants, airlines, hospitals, local governments, schools, and other institutions around the country. According to Louise Shiner, an economist with the Brookings Institution, the stimulus, quote, made sure that when we reopened, people had money to spend, their credit rating wasn't ruined, they weren't evicted, and kids weren't going hungry.

In addition to flooding the economy with money, the Federal Reserve cut interest rates twice, taking already historically low interest rates even lower. The Fed also began quantitative easing again and established new lending programs, including forgivable loans to businesses.

2020 ended up being the best year for household income in American history. In addition, total monthly debt payments as a share of income were the lowest in history and consumers now had $1 trillion more in checking accounts than one year prior. In other words, financially speaking, Americans were in a wildly better position at the end of 2020 than at the end of 2019.

Now, with interest rates at record low levels, consumers were incentivized to take their excess income and excess savings and go out and spend it and or invest it. As a result, from March 23rd, 2020 to December 31st, 2021, the S&P 500 was up about 120% as people piled money into the markets with renewed confidence in the economy.

And this is where this chain of very unique events begins to collide with banks like Silicon Valley Bank. Similar to consumers, venture capitalists were also incentivized to allocate their excess cash given record low interest rates. As a result, they invested hundreds of billions of dollars in tech startups, in many cases, tech startups that weren't even profitable.

In turn, those tech startups deposited their newly received venture capital money with banks like Silicon Valley Bank. In fact, Silicon Valley Bank's deposits tripled from $60 billion in early 2020 to $200 billion in early 2022.

And just like most banks, Silicon Valley Bank took those deposits and they bought safe US treasuries, the most secure assets on the planet. So what's the problem here? Well, while all this is going on, inflation is growing in the background, hitting 9.1% in June of 2022, the highest level we'd seen since the early 80s. So to combat inflation, the Fed determined that they needed to slow down the economy.

Consumer demand for goods and services far exceeded the supply. So to slow down the economy, they began, as we all know, raising interest rates. By the end of 2022, the Fed had raised rates seven times.

As I've talked about here before in the show, while the Fed doesn't control bond yields, it can influence them. And bond yields were certainly influenced by the Fed's new policy. We saw two-year treasury bond yields go from paying basically nothing to almost 5% in 18 months. And as we all know, when bond yields rise, bond prices fall in value. Even AAA-rated extra-safe treasury bonds, like the bonds that Silicon Valley Bank had purchased.

So now the economy begins to slow down due to the Fed's new interest rate policy. And with a slowing economy, those profitless tech startups, they need some of their money, that money that they had piled into checking accounts. In order to fulfill these withdrawal requests, Silicon Valley Bank had to sell some of their treasury bonds that they had previously purchased.

But as we now know, those investments were in the red due to the rapid spike in yields. So they're forced to sell investments, sell their treasury bonds at a loss, initially a $2 billion loss to meet the increasing number of withdrawal requests.

And as venture capitalists begin to put two and two together, recognizing the situation that Silicon Valley Bank was in, they begin urging their tech startups to get their money out ASAP. In fact, in a single day, $40 billion was withdrawn. In other words, there was a run on the bank, ultimately rendering them insolvent, leading them no choice but to file Chapter 11.

This, naturally spooked customers at other banks around the country, leading them to start withdrawing cash before their bank potentially followed suit. What we're seeing play out right now is what finance and economic nerds will call your traditional credit cycle. The cycle begins with economic expansion, followed by an uptick in inflation. Then, as we've seen recently, to combat inflation and slow the economy back down, the Fed steps in and begins to hike interest rates.

Consumers, you and me, as a result, we start to go out and borrow more money to make up for lost income in this newer, slower economy. In turn, lending standards begin to tighten, the economy contracts, and to complete the cycle, the Fed comes back in and begins to cut interest rates to avoid a prolonged economic downturn.

As you've likely picked up on with regard to the two bank failures, it's really hard to point the finger and assign blame to any one person or thing. From COVID to the Fed to Congress-approved stimulus bills to inflation to VC firms to tech startups to banks receiving hundreds of billions of dollars in new deposits.

I'm not trying to let anyone off the hook here, but we're staring at a very unique chain of events, a unique chain of events that may take years or even decades to fully understand the long-term impact. So instead of debating the nuances and trying to read between the lines of recent actions and commentary, I want to use the rest of our time today to answer three important questions about the current banking situation. Three common questions that I've been asked recently that relate directly to retirement investors.

So question number one, is this a repeat of 2008, 2009? Well, while I did mention Washington Mutual at the top of the show today, and I shared that these two recent bank failures are the second and third largest in history, the current situation and the current state of the banking system is much different than what we witnessed in 08, 09.

In addition to tighter lending standards, bank reserve requirements are much higher today than in the early 2000s. In other words, banks are required to hold on to a much larger sum of money that can't be used for things like lending out to other people. The reserve is intended to ensure that the bank can meet its liabilities in the case of sudden withdrawals.

In addition to higher reserve requirements, banks today are buying safe government bonds with some of those reserves. Whereas in 08-09, if you remember, banks were buying tranches of low-grade bonds that ultimately defaulted. So the problem with Silicon Valley Bank wasn't that they were financially unhealthy or that they made risky bets with their assets. The problem was their business was highly concentrated in one sector, the tech and the startup sector.

This concentration, coupled with the bank's mismanagement of interest rate and liquidity risk, ultimately led to the collapse. Rapidly rising interest rates and the series of events that we talked about today certainly fueled the fire, but plenty of other banks around the country are still holding up just fine. So no, it doesn't appear to be a repeat of the great financial crisis, but we're not totally out of the woods yet and may still see some new, similar events play out in the coming weeks, months, maybe years.

But thankfully, banks are in a much healthier position today than they were 15 years ago.

Which leads nicely into question number two, is your money safe? First, it's worth noting that not a single bank customer has lost their money in an FDIC insured bank since 1933, including money that was above FDIC limits. And so far, no depositors appear to be losing any money this time around either. Last week, the Fed stated, quote, no losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.

However, the Fed also went on to state, quote, bank shareholders and certain unsecured debt holders will not be protected. Senior management has also been removed. Any losses to the deposit insurance fund to support uninsured depositors will be recovered by a special assessment on banks as required by law.

In short, the Fed is not interested in protecting the bank's bad actors or shareholders, but is adamant about protecting consumer deposits, even deposits that exceed FDIC limits.

And they're largely doing this to maintain customer trust in banks around the country to prevent this situation from getting worse. The last thing we need is everyone racing to their local bank to pull everything out and stuff it under the mattress. And to be extra clear here, if you bank with an FDIC insured bank, you are insured for up to $250,000 worldwide.

per individual. So if it's a joint account with you and your spouse, your cash deposits in a checking account are insured for up to $500,000. Your small local FDIC insured bank could go out of business tomorrow and the deposit insurance fund would make sure that you get whole. And while the Fed is insuring dollars above and beyond the current limits, the current FDIC limits at Silicon Valley and Signature Bank,

It's not worth rolling the dice on what they might do next time this happens. And these recent events should serve as a good reminder to keep your cash under the insured limits.

If needed, hold cash at multiple banks or even use a service like Max My Interest, who we've had here on the show before, to make sure that your cash remains fully insured. You can also consider bank alternatives, such as treasury-backed money market funds. Which takes us to question number three. What about cash in your investment accounts? Is that cash safe from the current banking debacle?

The first thing to know here is that some brokerage firms do have a banking arm, and as a result, cash inside an investment account can, by default, be held in a bank deposit fund that's similar to that of a bank. So if your brokerage firm is maintaining your cash in a bank deposit fund, you would want to keep your cash balance under those FDIC limits.

But you would also want to talk to your brokerage firm or financial advisor about alternatives like U.S. Treasury money market funds. Instead of FDIC protecting your cash, it's the full faith and credit of the U.S. government. In short, unless the U.S. government goes out of business tomorrow, your cash is safe. And for that reason, there is no limit to the amount of cash that you can hold. Some investors will hold tens or even hundreds of millions of dollars in U.S. government money market funds.

For what it's worth, the fund that we use for our clients at my firm is the Fidelity Treasury Money Market Fund, FZFXX, which currently has a yield just over 4%. And I'll put a link to it in the show notes if you want to look into it further. Most brokerage firms have something similar, so I'm not advocating for this specific fund. But just take note of the underlying fees as they will directly reduce the yield.

Lastly, just to be sure we cover all of our bases here and prevent any confusion, if you have money invested in stocks, bonds, ETFs, mutual funds, etc., they are not impacted by any of the banking concepts that we discussed today. For example, if you own XYZ Mutual Fund at Charles Schwab and Charles Schwab goes out of business tomorrow, you still own your shares of XYZ Mutual Fund. The same can be said for other publicly traded securities.

You have ownership in those securities, in those companies or the underlying companies owned by the mutual fund. You don't have ownership in the brokerage firm that maintains custody of your investments.

Okay, I know today's topic was complex and wide-ranging, and there are many more pieces to the puzzle that I didn't get to, but I hope you found it helpful, and I hope it brought some clarity to this very unique situation. And if anything, I hope it served as a good wake-up call that cash management is important, and while most Americans don't have cash above and beyond these FDIC limits, it's important to know where our cash is held, how we're protected, and what we can do to optimize that asset class.

Once again, to grab the links and resources from today's episode, just head over to youstaywealthy.com forward slash 184. Thank you as always for listening, and I'll see you back here next week. This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.