Updated Mar 10, 2023, 05:06pm EST
The sudden collapse of startup lender Silicon Valley Bank—which has culminated in the biggest bank failure since the Great Recession—has wreaked havoc on stocks and sparked fears of a potentially systemic conundrum, and though experts say the fears are largely overblown, they also warn the related effects of the Federal Reserve’s interest rate hikes will continue to ripple through the economy for quite some time.
Contagion fears have gripped the market this week as the financial sector led a broader stock plunge following crypto bank Silvergate’s shutdown on Wednesday and SVB’s similarly sudden closure on Friday, when it was shuttered by a California regulator in the biggest bank failure since the Great Recession.
The broad selloff was “undoubtedly an unwelcome reminder” of the 2008 financial crisis, says Sevens Report analyst Tom Essaye, noting SVB scrambled and ultimately failed to stay afloat after it was forced to sell a bond portfolio at a $1.8 billion loss because higher interest rates pushed bond prices “far below” where they were when purchased.
Though “ominous” and “extremely negative,” Silvergate and SVB’s funding problems shouldn’t be “extrapolated out [to] punish the entire industry,” says Essaye, noting both banks operated in markets that are more vulnerable to the economic stress sparked by higher interest rates—cryptocurrencies, startups and venture capital.
Nevertheless, the difficulties also highlight challenges facing the entire banking sector—namely, the cost of deposits (and therefore, banking) has “risen substantially” due to higher rates, all while bond holdings face lower market values, meaning that “some banks may not be as capitalized as they think they are,” says Essaye.
In a Friday note to clients, Bank of America analyst Ebrahim Poonawala largely agreed, saying the panic is “likely overdone,” as investors stress over “idiosyncratic issues at individual banks,” but he also noted the sector will continue to struggle until inflation concerns finally abate—a prospect with a highly uncertain time line.
“In [this new] interest rate environment, business models matter, profits matter and unrealistic projections of profitability five to ten years down the road won’t cut it,” says Chris Zaccarelli, chief investment officer for Independent Advisor Alliance. “There are a lot of companies and speculative bubbles that aren’t coming back from this round of Fed intervention.”
What We Don’’t Know
It’s still very unclear how Fed officials will react to the banking sector’s struggles; however, Fed Chair Jerome Powell may be forced to respond to the turmoil at the conclusion of the central bank’s next policy meeting, on March 22. Testifying before lawmakers this week, the chair reiterated that hikes slow the economy down “with long and variable lags” that hit some sectors and companies more than others, adding: “It will take time . . . for the full effects of monetary restraint to be realized.”
Two of the biggest questions for economists are when the Fed will slow or stop its rate increases–and what, if not significantly lower inflation, could force the ultimate pause. A growing number of experts believe it could take a large financial market disruption, but it’s unclear just what kind. As yields on the 30-year Treasury leaped late last year, Bank of America credit strategist Yuri Seliger told clients policymakers could be getting more concerned about poor liquidity in the Treasury market. Additionally, a potentially large drop in housing prices could potentially result in too much tightening in the housing sector, a key part of the U.S. economy.
SVB Shut Down By California Regulator (Forbes)
SVB Shares Halted After Stock Crash—VCs Tell Firms To Withdraw Funds (Forbes)
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I’m an associate editor at Forbes reporting on markets and finance. I graduated from the University of North Carolina at Chapel Hill, where I double-majored in business journalism and economics while working for UNC’s Kenan-Flagler Business School as a marketing and communications assistant. Before Forbes, I spent a summer reporting on the L.A. private sector for Los Angeles Business Journal and wrote about publicly traded North Carolina companies for NC Business News Wire. Reach out at firstname.lastname@example.org. And follow me on Twitter @Jon_Ponciano
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original source: Biggest bank failure since Great Recession sparks ‘exaggerated’ fears of contagion, but big lingering risks remain