Despite the recent bank runs, we’re not in for a 2008 disaster, but that doesn’t mean the economy is in great shape by any means.
The recent news of two banks, Silicon Valley Bank and Signature Bank, collapsing has sparked concerns about the possibility of another 2008-like financial crisis. While it is true that these bank failures could have far-reaching consequences, it is important to note that the current situation is different from that of 2008.
Firstly, the root causes of the current bank failures are different from those of 2008. In 2008, the financial crisis was triggered by a credit crisis, which led to widespread defaults on subprime mortgages. This, in turn, led to a chain reaction of bank failures and credit freezes. The current bank failures, however, are not caused by any such external event. Instead, they are a result of the banks’ aggressive growth approach coupled with historic rate hikes in a short period of time.
Secondly, the regulatory environment has changed significantly since 2008. In response to the financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in 2010. This act introduced a number of measures aimed at improving financial stability and preventing bank failures, such as stress tests and increased capital requirements. While these measures are not foolproof, they have helped to mitigate some of the risks associated with banking.
Despite these differences, it is important to note that the economy does show fracturing in several key areas and usually where we see one bank failure, another several will follow behind. The COVID-19 pandemic has led to significant economic disruption, with many businesses struggling to stay afloat. In addition, inflation is on the rise, which could further strain the economy.
Silicon Valley Bank and Signature Bank, the two banks that recently collapsed, have both been criticized for their risky lending practices. Silicon Valley Bank, in particular, had been lending aggressively to startups in the tech space, many of which were high-risk ventures. This strategy coupled with requiring these companies to place all of their deposits with the bank had paid off in the past, with the bank posting strong profits, but it ultimately led to its downfall.
Signature Bank, on the other hand, had been heavily involved in the real estate market. The bank had lent large sums of money to real estate developers, many of whom were struggling to repay their loans. When the pandemic hit and the real estate market collapsed, Signature Bank was left with a large number of non-performing loans, which ultimately led to its bank failure.
The collapse of these two banks is unlikely to cause a 2008-like financial crisis, but it could have far-reaching consequences for the economy. Firstly, the collapse of these banks could lead to a tightening of credit, as other banks become more cautious about lending. This could make it harder for businesses to access the capital they need to grow and expand.
Secondly, the collapse of these banks could lead to a loss of confidence in the banking system. This, in turn, could lead to bank runs and further bank failures. While it is unlikely that we will see a repeat of the widespread bank runs that occurred in the 1930s, there is still a risk that customers of these banks could lose their savings. However, the FDIC has stepped in as of late to cover all deposits above $250,000 for any depositors within these banks.
The Federal Reserve faces a catch-22 situation when it comes to dealing with the aftermath of these bank failures. On the one hand, the Fed needs to ensure that the banking system remains stable and that customers’ savings are protected. On the other hand, the Fed needs to avoid creating a moral hazard, where banks are encouraged to take excessive risks because they know the Fed will bail them out if they fail.
To navigate this dilemma, the Fed will likely take a cautious approach. It may provide some support to the banking system to ensure that it remains stable, but it is unlikely to provide a full bailout.