The Great Bank Panic of '23
Adapted from my letter sent to my private wealth management clients on March 16, 2023.
Bank Collapse Situation Report
The rapid collapse of Silicon Valley Bank (“SVB”), Silvergate Capital shutdown, takeover of Signature Bank, pressure on the banking system, and the government’s coordinated response with the Bank Term Funding Program to insure deposits and stabilize the financial situation have generated an avalanche of analysis, forecasts, and finger-pointing. Yesterday alone, I received dozens of emails and invitations to eight webinars on the subject!
Given the abundance of commentary on the matter, coupled with the fact that I’m not convinced that in this moment we know all that we will eventually know, I’m only going to offer comments on a couple pieces of the situation I am calling, with a nod to history, “The Great Bank Panic of ’23.”
Having professionally worked through several such events and avidly studied major historical financial incidents, details surrounding a situation such as this typically trickle out over time, and it’s not until years later, when “the dust has settled,” that we are able to fully ascertain the cause and effects. However, I do want to touch on:
Financial factors that led to the bank fall, and how we have chosen a different path.
How to avoid self-sabotage during times of financial crisis.
Action steps to consider.
1. Factors Leading to the Fall: Dangers of Concentration
SVB was heavily tied to and doing business in one sector: technology. Silvergate and Signature were concentrated in cryptocurrency. These concentrations are an obvious risk in any business environment; however, as I’ve said for some time now, the technology sector was dangerously over-valued for the past few years and cryptocurrency should be limited to speculative positions, if any. As discussed in my recent letter and previous communications, we have pulled back from technology stocks and tilted portfolios toward more reasonably-priced value stocks.
Concentration has the potential to build wealth and, as an example of dangerous “survivorship bias,” we can see public figures who have benefited greatly from concentrated holdings. Unfortunately, concentrated positions have proven to be a very poor way to protect and preserve wealth in the long-term, and people who lost everything due to a lack of diversification do not as often catch the media’s eye. A considerable focus of our financial planning is to ensure high-priority goals are not funded with low-probability concentrated positions.
In these pieces I’ve previously shared, the importance of proper diversification and dangers of concentration are clearly highlighted:
Investment Diversification: Age-Old Wisdom
Dangers of Concentrated Stock Positions
Bond Market Risks
In a very mechanical fashion, when interest rates rise, bond prices fall. For years, interest rates have been pinned to the ground, to a large extent by governmental actions. Interest rates were going to rise sooner or later, leading to a fall in bond prices. We knew it was important to fill near-term spending buckets with bonds that matured in the near-term (i.e., bonds that sat near the fulcrum of the interest rate and bond teeter-totter, where they would have less price volatility, versus longer-term bonds on the far end of the teeter totter, where prices would slam to the ground when interest rates or Fed support jumped off the other side). SVB, although holding what are considered the safest securities, U.S. Treasury bonds, did not do this. SVB decision makers chose to hold long-term bonds, and their asset values fell sharply with rising interest rates, which appear to have played a role in triggering the run on the bank.
2. Avoid Self Sabotage: Control What we can Control
In the endless parroting of “what happened” and “who’s to blame” in this current bank run, I’ve seen very little on how we should react and what we should do about it.
First, in any type of high-stress situation, it’s good to take a moment and reflect on how our physiology can affect our decision making, so we don’t make decisions detrimental to our financial success!
I recently shared a guest post from Dr. Elsa Zehndorfer on my blog (ScottOeth.com) about the science behind fear and how the cortisol in our body can affect our financial decision making:
“First, fear causes a cortisol release that can put us in fight or flight mode. Second, once the cortisol effect is triggered, it can be hard to stop. Constant exposure to financial news keeps it going. Third, if you realize you’re experiencing a cortisol effect, there are things you can do to shut it down.”
“Part of our stress response includes the switching off of all “non-essential” brain functions, and the switching on of our desire to take action—even if holding firm would be the best choice in that particular moment. Why? The brain is focused purely on protecting us from harm, rerouting resources to where they’re most vitally needed. This automatic response is extremely useful if we’re facing down an angry bear, as it triggers immediate, knee-jerk responses that will increase our chances of survival, such as fighting back or running fast.
But it’s far less helpful for an investor during a market sell-off, because the execution of all sophisticated cognitive thought processes isn’t immediately useful when threatened. Why? Thinking about self-control, memories, and analysis (all vital skills when it comes to investing) slows us down when we need to react fast. So, they swiftly shut down.”
I highly encourage you to take a moment to read Dr. Zehndorfer’s article, The Cortisol Effect and think about how you want to react in high-stress situations.
3. Action Steps: A Plan
After recognizing how you’re reacting to high-stress situations, what action steps are valuable to consider now?
a. Reassess Your Personal Risks & Revisit Your Financial Plan
This past Friday, I was on the road with a client and another financial analyst. While we were primarily discussing our mutual love of outdoor adventure, it was hard to avoid talking about the topic of the day: the collapse of SVB. After a few moments of quiet windshield time, my client, who works for a healthcare offering in the technology space simply said, “Will I have a job on Monday?”
While we’d been talking about high-level portfolio positioning and the mechanics of bank finance, here was a flesh and bone example of the immediate potential spill-off of the failure of SVB and the inability of its depositors to retrieve their assets. The client received a notice from his CEO indicating that the company did, indeed, bank with SVB, and that they “were working on alternative banking solutions.” He was greatly relieved when late Sunday I was able to share news of the government’s backing of SVB business deposits.
ACTION ITEM
Assess your employment situation and let us know if you think there are risks we should discuss. Our initial financial planning work provides a good baseline for financial decision making, but every day is “Day 1,” and we should revisit planning strategies if you think circumstances have materially changed.
b. Evaluate Bank Cash Holdings
Federal Deposit Insurance Corporation (“FDIC”) insures up to $250,000 of each bank customer’s deposits. Credit Unions have similar coverage from the National Credit Union Administration (“NCUA”). When working as a bank manager early in my career, FDIC limits were lower, and I had clients who had lived through The Great Depression. It was common to see those clients with funds spread across many banking institutions.
Today, one of the action items you can consider is to greatly extend your FDIC insurance coverage through account structuring. In this example from the FDIC, a couple has $3,500,000 of coverage through smart account structuring:
ACTION ITEM
Review deposit accounts and your FDIC/NCUA coverage and determine if steps should be taken to obtain additional account insurance coverage.
c. Consider Series I Savings Bonds
I have been advocating for “second tier” savings, money that can be set aside for at least the one-year minimum holding period, to be held in U.S. Treasury Series I Bonds. These bonds, which you must directly purchase from TreasuryDirect.Gov, provide downside protection, and their unique return structure provides a valuable inflation adjustment.
ACTION ITEM
Consider buying I Bonds with savings that can be locked up for more than one year.
d. Invest in Your Future
Does it make sense to keep excess money in the bank when it’s losing value due to inflation, and you’re paying taxes on the sub-inflationary rate of interest earned?
Cash is still king for its versatility, liquidity, universal acceptance, and as primary emergency funds. However, for the reasons I mention in my blog posts below, buying goods in advance and in larger quantities than normal could be a financial win—and provide tremendous comfort in times of physical or financial crisis.
Physical Goods as Emergency Savings
Money Matters Radio Interview: Planning for Emergencies
ACTION ITEM
Consider turning eroding, taxable dollars—particularly those exposed above FDIC limits—into the essentials of future daily living.
e. Buy Long-Term Assets
“Many an optimist has become rich simply by buying out a pessimist.”
~Laurence J. Peter, Maxims of Wall Street
We build wealth by buying a broad collection of quality assets over time. We protect wealth, in part, by planning to avoid selling depressed assets at the wrong time. Ideally, we buy cheaply at bargain prices, but the reality is that buying consistently and having time in the market is a more reliable path than trying to time the market.
History has shown that today’s market tops will look like bargain prices in the future and points of panic and turmoil have often provided great entry points.
ACTION ITEM
Continue to add funds to your portfolio that can be committed to long-term investing.
We are Here for You
As always, our team is here for you! If you’d like to review your financial plan and any of the action steps listed here, please let us know.