The first quarter was frightening for investors who remember the years 2008 and 2009. The headlines detailed the failure of three banks – two of which were among the largest bank failures on record. Such news sent shock waves across the financial markets. Many worried that we would relive the horrors of the Financial Crisis, which is still fresh in our minds. However, The Ross Group believes the recent bank collapses are distinct, and the failures do not pose a systematic threat to the remainder of the financial ecosystem.
The circumstances of these bank failures are unique for three different reasons. First off, most of the deposits at these institutions were not insured by the FDIC – a government sponsored insurance program for deposits $250k or less. This meant that customers, at any sign of stress, were more likely to pull their money for fear that they might never see it again. Hence, we watched in awe at the alarming speed at which these failures occurred almost overnight. Next, the management of these banks did an abysmal job managing their deposits. They had a fickle deposit base due to the uninsured deposits, and instead of taking as minimal risk as possible, they decided to invest the deposits in long dated securities with greater inherent risk. Their actions are akin to an investor who needs funds in three months for a home purchase and who subsequently purchases a 30-year bond to match the outflow. When the funds are needed, the bond must be sold at a significant loss to fund the outflow. These banks took too much risk and were burned. Lastly, some of these banks did business with an industry that many have questioned – the cryptocurrency community. When banks do business with characters and companies deemed to be suspect, customers and depositors get nervous quickly. These business dealings removed confidence in these banks and in turn helped lead to their demise. In short, the failures of these banks were caused by their own specific business decisions that do not necessarily permeate the entire financial system.
We believe there will be continued fallout from these failures such as new regulations on the banking system and a tightening of credit conditions (i.e., harder to get loans). But our team does not foresee the unrest that resulted from the Financial Crisis. Warren Buffett said the following about the banking industry: “In the end banking is a very good business unless you do dumb things. You get your money extraordinarily cheap, and you don’t have to do dumb things. But periodically banks do it.” Our team would argue that these specific banks did some dumb things. However, that does not mean every bank falls into that same category. As always, The Ross Group will look for opportunities in those businesses which continue to be prudent managers of their capital.