Savings and loans move in cycles

Over the years bank deposits have accelerated each time fiscal welfare has been provided in response to a recession, a banking crisis or some kind of health major event/pandemic/dislocation.

Here’s a chart that shows what I mean.

After COVID, liquidity increased materially. Treasury dropped money down chimneys and banks printed more into existence.

The money tsunami stimulated both savings and loans. Deposits skyrocketed. Banks borrowed short and lent long, all the while stacking up dry powder at almost zero cost. Woohoo.

Then about a year ago the U.S. Fed pivoted from loose to tight monetary policy (to arrest inflation).

Even that didn’t drain deposits nor stop lending.

And that’s because U.S. households were (and are) still very strong and unemployment extremely low.

While credit card debt is not starting to push the envelope, mortgage debt is well anchored due to long term favourable structures in the U.S.

But then came a perfect shitstorm of skyrocketing bank deposits, over-investment of those deposits in bonds that would lose money when interest rates finally went up, and bank runs enabled by fintech platforms converged.

That turkey dinner convergence created duration mismatches that barbequed both SVB and Signature Bank that each had insufficient value in their investments to halt prolonged runs. Since then, First Republic also collapsed. See here for a refresher.

So what?

Well, in light of that, I’ve been keeping track of what’s been happening with deposits (have they rushed out?) and loans (are the banks still lending?), and the answer is that not a lot has changed.

It’s partly due to the Deposit Put from Biden and the Treasury/Fed. What that means is that the government has got American depositors covered with the BTFP as well as sending a clear message that the discount window, which is a mechanism that allows banks to borrow direct from the Fed) is open (see here for a refresher).

The White House + Treasury + the Fed have guided the market into a ‘nothing to see here’ scenario which (a) incentivises depositors to stick with their current bank (avoiding more bank runs) and (b) leaves the Fed free to continue with restrictive monetary policy.

But is everything really OK under the hood?

Let’s look at the charts:

• Bank deposits were $13.2 trillion before COVID and peaked at $18.1 trillion.

• That makes for a $5 trillion (or 38%) increase in under 2 years!

• Deposits had decreased to $17.6 trillion 2 days before SVB collapsed.

• Today, deposits sit at $17.1 trillion, a $0.5 trillion decline from before SVB collapsed.

This tells us deposits have only decreased 2.7% since SVB, and only 20% of the COVID largesse that ended up in deposits has been taken out since Easter 2022 - almost precisely one month after interest rates started to go up in March 2022.

While this shows up on the radar blip meter, it’s really not that big a deal.

In other words, deposits are not rushing out of banks and that means sentiment is relatively calm.

And loans haven’t really moved, i.e., they totalled $12 trillion 2 days before SVB collapsed and last week they stood at $12.1 trillion. Literally the same, albeit that means hardly any loan growth which is net deflationary and should assist the Fed in fighting inflation.

This basically means that the key reduction in deposits is mainly a reaction to interest rate policy (depositors chasing yield in money market accounts and short bonds that pay more than bank deposit rates) and not a lot to do with mismanaged banks and fintech platforms. In fact, the bigger/safer the bank, the lower the bank deposit rate.

And the flatter lending trajectory is not unexpected, given the fast pace of interest rate increases and also because bank lending criteria have tightened and there is some conjecture over the health of the commercial real estate sector and household credit card use.

The net of that is that so far, we are yet to see a savings and loan crisis like in the 1980s.

What now?

We keep one eye on the trajectory of savings and loans. And even if there is a crisis, we know the Fed will use its canon to stimulate - something that was not used back in the 1980s, but has become the playbook following the GFC.

We keep the other eye on the debt ceiling and yield curve (here’s a refresher). The debt ceiling will most likely resolve itself after being used as a political deckchair restacking exercise, but in the meantime sentiment over it and the spiking yield curve will cause more volatility in markets.

And we keep a third eye on whether interest rates rise again on June 14 and a few more banks have to be put to the canon (a bit of spring cleaning plus a cheap way to grow for JP Morgan and the big banks).

Even then, ‘not a problem’ because there are multiple canons at the ready to counteract the next crisis.

It might feel uncertain, but now is a great time for companies and investors to position themselves for the next epoch - more treasury issuance, more spending, more canons/Puts.

See you in the market.

Mike