Banks are in trouble. Is consolidation the answer?

Treasury Secretary Janet Yellen was meeting with a group of some of the nation’s leading bankers and told them that it’s likely that America is going to have more bank consolidation, by which she means mergers and takeovers such as what we saw, for example, for First Republic Bank recently. Well, she’s got a lot of data supporting her. Just the week before, the Federal Reserve released a study that showed that there were 722 banks that had unrealized losses of more than 50% of their capital. 

Now, you might remember that that was how Silicon Valley Bank got into trouble. It had losses on its long-term Treasury portfolio that was destroying its capital; the depositors found out and they began to run. So having more than half of your capital eaten up by prospective losses is a big number. Worse, 31 banks had net losses sitting on their balance sheet of more than all of their capital. In other words, if you counted those losses, they would be underwater. Thirty-one banks. But it gets worse. If you look at the industry as a whole, those losses, those unrealized losses, account for 30% of total bank capital in the country. 

Wow, that kind of sounds like if you’re gonna have consolidation, it’s a lot like rearranging the deck chairs on the Titanic, don’t you think? I mean, there just isn’t enough capital to go around  at some point, if we recognize those losses. Well, what’s going on? The banks know they’re in trouble. They’re trying to clean up their balance sheets by selling the securities, i.e. the long-term government bonds, that are sitting there on their portfolios. They can’t afford to have more losses; they’re selling. The Federal Reserve is also selling through its quantitative tightening program, which gets rid of $95 billion a month of their $9 trillion amount of holdings. 

That’s a lot of selling. Who’s going to do the buying? Well, it turns out, it’s largely agencies, institutions, that are non-banks. A lot of them are so called “real money buyers,” such as pension funds, annuities, insurance companies. Their purpose is not so much to worry about the current loss, because ultimately, that bond is going to be paid back in full. Their challenge is to have, when the money comes in when the asset matures, be at the same time as when the money has to go out to either pay off an insured, an insured individual, or to meet pension obligations or what have you. It’s called “duration match.” That is their purpose. It’s a huge advantage they have over banks, because they can take a long-term view, whereas banks can’t because depositors and banks can take out their money at any time. 

Well, thank goodness, they’re there. But we now have a bunch of Senators demanding more regulation of these non-banking institutions. Hey folks, if you’re barely making it, and something is not broken, don’t try and fix it. It’s only going to make matters worse. We need those institutions, the insurance companies, the pension funds, and the various private equity suppliers of capital that they deal with, to have free rein, to be able to absorb all these bonds that are coming off. 

Now is not the time to change regulations. Now is not the time to raise capital requirements, because it’s going to make it harder to buy all those bonds. Remember, with the bank selling and the Fed selling, you gotta have somebody out there buying or the country’s in a lot of trouble. Regardless, even if we avoid the mistakes politicians want to make, we have higher interest rates in our future. That’s the inevitable result of needing more bank consolidation.