InvestMacro

By Dan Steinbock

In view of the Fed, American banking crisis is over. Yet, US and European banks face the most acute stress since 2008 and 2011, respectively. Global economy is exposed to new headwinds.

Last week, as the Federal Reserve pushed ahead with its 10^th rate hike since last March, its chairman Jerome Powell declared that the period of U.S. bank failures had come to an end. That’s why Powell assured Americans, “There were three large banks, really from the very beginning, that were at the heart of the stress that we saw in early March — the severe period of stress. Those have now all been resolved, and all the depositors have been protected.”

In other words, the failures of Silicon Valley Bank, Signature Bank and First Republic Bank mark the end, not the spread of the banking crisis. As Powell added, the most recent failure of First Republic, and its subsequent sale to JPMorgan Chase, “kind of draws a line under that period.”

Obviously, such ideas are plain silly. U.S. banking crisis is not over; it has entered a new stage. And it continues to spread.

As dominoes fall

Nearly half (48%) of Americans are concerned about the safety of their bank deposits, according to a Gallup poll last week. Distressingly, the survey results resemble the aftermath of the Lehman Brothers’ collapse.

Recently, Lawrence McDonald, former vice-president at Lehman Brothers, projected that the banking crisis could derail another 50 regional lenders in America if the US fiscal and monetary authorities fail to take steps to resolve structural challenges.

In the U.S. and European banking sector, the rollercoaster ride began in early March, with three weeks of substantial volatility. First, two major US regional banks (Silicon Valley Bank [SVB] and Signature Bank) failed. Then, one of the 30 global systemically important banks, the Switzerland-based Credit Suisse, lost its autonomy after a government-facilitated takeover by UBS.

In the process, market and depositor confidence dissipated in key parts of the sector, with adverse repercussions in investor and consumer confidence.

To prevent the situation from affecting more banks, global industry regulators – including the Federal Reserve, the Bank of Canada, Bank of England, Bank of Japan, European Central Bank, and Swiss National Bank – were compelled to intervene and provide extraordinary liquidity.

How could it all happen – again?

Bank analysts would say that the lead-up period saw many banks invest their reserves in US Treasury securities. So, when the Fed sharply tightened financial conditions last year to rein in surging inflation, companies found it challenging to raise cash, which triggered deposit outflows.

To meet those outflows, SVB sold its long-term Treasuries at great loss. As a capital raise to cover the losses fell apart, a huge run on deposits ensued leading to the largest bank failure since the 2008 financial crisis. What compounded challenges was several banks’ exposure to the bursting cryptocurrency bubble. These events sparked a broad migration of deposits from the banking sector to money market funds while migrating to global systemically important banks, thus forcing some banks to source liquidity from the Fed – the mistakes of which had compounded the challenges in the first place.

After mid-year 2021, when inflation started to climb rapidly, the Fed shunned a timely response. Instead, its chairman downplayed the threat of soaring prices calling them “transitionary.” The stunning complacency proved costly. By mid-2022, US inflation peaked at 9.1%; a four-decade high. And it remains around 5%, more than twice the 2% target. That’s too why the Fed raised the fed funds rate by 25bps to a range of 5%-5.25% in its May meeting.

If the Fed’s monetary pain wasn’t enough, the White House’s foreign policy has contributed to runaway inflation and elevated uncertainty. After years of trade protectionism, the global pandemic and depression, the net effect of the high-cost US/NATO-led proxy war against Russia in Ukraine has been a lethal mix of a global energy crisis and the meltdown of the global food system.

The spread effects

The elusive calm until the demise of First Republic Bank did not reflect the end of the crisis, but its steady progress. As Mohamed El-Erian, chief economic advisor at Allianz, put it last week. “Now we have stage two, where banks that are not particularly badly managed they have issues but they’re not particularly badly managed – are suddenly vulnerable.” In other words, “the cancer within [these banks] is starting to spread.”

As credit conditions are tightening, the risks of further contraction rise with banking contagion. Structural vulnerabilities remain huge. In parallel with the demise of SVB in March, one consequential study indicated that almost 200 more banks may be vulnerable to the type of risk that caused the collapse of SVB. These banks across the US could fail if half of their depositors quickly withdraw their funds. Even insured depositors — those with $250,000 or less in the bank — could have problems getting their cash if these institutions face the kind of run that SVB experienced.

According to the co-author of the study, a banking expert at Stanford University, half of US lenders are underwater: “Let’s not pretend that this is just about Silicon Valley Bank and First Republic,” he said recently. “A lot of the US banking system is potentially insolvent.” Presumably, some 2,315 banks across the US are currently sitting on assets worth less than their liabilities.

Still worse, the lingering banking crisis occurs at a time, when the White House is engaged in the largest war funding in decades and the Congress has wasted half a year failing to agree on a debt limit.

U.S. default risk as an “economic and financial catastrophe”

A week ago, US Treasury Secretary Janet Yellen warned that the US will run out of cash by June 1 if Congress fails to raise or suspend the debt ceiling. She urged Congress to act “as soon as possible” to address the $31.4 trillion limit. President Biden has called a meeting of congressional leaders on the matter on May 9.

The US hit the statutory limit already last December. Since then, Yellen has repeatedly warned that “failure to raise U.S. debt ceiling would lead to “economic and financial catastrophe.” Unsurprisingly, the Biden administration is under mounting pressure to reconcile the conflicting demands.

Historically, the debt ceiling has been raised, extended or revised 78 times since 1960. If this time is different, it will have significant and adverse global repercussions. If, however, a new debt limit arrangement will be achieved, it can only happen by taking more debt. In this case, Washington will delay its default by buying time, which will make the eventual US debt crisis worse.

The economic fundamentals and safety nets that prevailed in 2008 have been largely exhausted. The West is navigating in perilous waters with leaking lifeboats.

About the Author:

Dr. Dan Steinbock is an internationally recognized strategist of the multipolar world and the founder of Difference Group. He has served at the India, China and America Institute (USA), Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see https://www.differencegroup.net 

By Alexander Kurov, West Virginia University and Marketa Wolfe, Skidmore College 

Insider trading is the term used to describe the illegal act in which someone relies on market-moving, nonpublic information to decide whether to buy or sell a financial asset.

For example, say you work as an executive at a company that plans to make an acquisition. If it’s not public, that would count as inside information. It becomes a crime if you either tell a friend about it – and that person then buys or sells a financial asset using that information – or if you make a trade yourself.

Punishment, if you’re convicted for insider trading, can range from a few months to over a decade behind bars.

Insider trading became illegal in the U.S. in 1934 after Congress passed the Securities Exchange Act in the wake of the worst sustained decline in stocks in history.

From Black Monday 1929 through the summer of 1932, the stock market lost 89% of its value. The act was meant to prevent a whole litany of abuses from recurring, including insider trading.

While insider trading typically involves trading stocks of individual companies based on information about them, it can involve any kind of information about the economy, a commodity or anything else that moves markets.

Why insider trading matters

Insider trading is not a victimless crime. People trading on inside information benefit at the expense of others.

A key characteristic of well-functioning financial markets is high liquidity, which means it is easy to make large trades at low transaction costs. But when traders fear losing money to counterparts with inside information, they charge higher transaction costs, which leads to less liquidity and lower investor returns. And since a lot of people have a stake in financial markets – about half of U.S. families own stocks either directly or indirectly – this behavior hurts most Americans.

Insider trading also makes it more expensive for companies to issue stocks and bonds. If investors think that insiders might be trading bonds of a company, they will demand a higher return on the bonds to compensate for their disadvantage – increasing the cost to the company. As a result, the company has less money to hire more workers or invest in a new factory.

There are also broader impacts of insider trading. It undermines public confidence in financial markets and feeds the common view that the odds are stacked in favor of the elite and against everyone else.

Furthermore, since inside traders profit from privileged access to information rather than work, this makes people believe that the system is rigged.

Hard to prove

Research shows that insider trading is common and profitable yet notoriously hard to prove and prevent.

A recent study estimated that overall only about 15% of insider trading in the U.S. is detected and prosecuted but suggested more of it is coming to light in recent years because of increased enforcement.

One of the more famous – and few – examples of insider trading being prosecuted was the 2004 conviction of businesswoman and media personality Martha Stewart for selling shares based on an illegal tip from a broker.

The sudden collapse of several banks in 2023 has also caught the attention of authorities. The Securities and Exchange Commission is reportedly investigating executives at both Silicon Valley Bank and First Republic Bank, which was seized and sold on May 1, for potential insider trading.

And, so, the cat-and-mouse game between regulators and those who want to game the system continues.

This is an updated and shortened version of an article that was originally published on Feb. 18, 2022.

About the Author:

Alexander Kurov, Professor of Finance and Fred T. Tattersall Research Chair in Finance, West Virginia University and Marketa Wolfe, Associate Professor of Economics, Skidmore College

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By George Prior 

Artificial Intelligence (AI) stocks should now be part of most investors’ portfolios as Big Tech prepare for an AI boom, suggests the CEO and founder of one of the world’s largest independent financial advisory, asset management and fintech organizations.

The comments from deVere Group’s Nigel Green follow last week’s earnings reports from tech titans including Microsoft, Alphabet (parent company of Google) Meta (parent company of Facebook, Instagram and Whatsapp) and Amazon.

It also comes after legendary investors Warren Buffett and Charlie Munger, the Chairman and CEO and Vice chairman respectively of Berkshire Hathaway, spent hours this weekend at a shareholders’ meeting in which they expressed skepticism about AI.

“I am personally skeptical of some of the hype that is going into artificial intelligence. I think old-fashioned intelligence works pretty well,” Munger noted.

However, Nigel Green says: “Despite Buffett and Munger’s scepticism, Big Tech last week posted robust financial performance reports for first-quarter earnings. The pace of growth has picked up noticeably.

“But the real story was the tech giants’ seemingly relentless mania for AI. Most of corporate America clearly think that this is the future.

“The importance of this cannot be overstated considering that just five tech companies have made up two-thirds of the S&P 500’s gains so far this year.

“Besides guidance, which suggests how companies are positioned to manage an economic downturn, and data on how effective cost-cutting measures have been, the Big Tech earnings season was dominated by AI detail.

“The tech titans are fully aware of the enormous returns that could be secured when AI starts to radically change the way businesses work and consumers live their lives.

“We fully expect that the volume of chat around AI will ramp up in future earnings seasons.”

His belief is backed up by recent events. The AI chatbot ChatGPT became wildly popular in just a matter of weeks – and took off faster than social media platforms like TikTok or Instagram. Only two months after its launch in late November, it had 100 million monthly active users in January, according to reports.

It is because of the potential way that AI is expected to impact society and global business that Nigel Green now says that “AI stocks should have a place in most investors’ portfolios.”

Including AI exposure into an investment portfolio offers several possible benefits for investors, such as “potential strong returns, risk management, diversification possibilities, and future-proofing advantages because as the use of AI continues to grow and become more pervasive, those companies that fail to adopt this tech may be at a competitive disadvantage.”

The deVere CEO concludes: “We expect that companies that have substantial AI interests are likely to benefit from the growth of the industry and this could have potentially significant rewards for early investors.

“But, of course, like any investment strategy, including AI in a portfolio carries risks and requires careful consideration. Investors should seek professional advice before making any investment decisions.

“We believe that AI is the future, and we know from the past that early investors in innovative technologies often reap enormous rewards.”

About:

deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients.  It has a network of more than 70 offices across the world, over 80,000 clients and $12bn under advisement.

By Tony Cookson, University of Colorado Boulder and Christoph Schiller, Arizona State University 

The Research Brief is a short take about interesting academic work.

The big idea

Prior to Silicon Valley Bank’s March 10, 2023, collapse, conversations on Twitter among investors about the bank spiked – helping fuel the SVB bank run. As we explain in our new working paper, “Social media as a bank run catalyst,” those tweets also destabilized other financial institutions with weak balance sheets.

The number of tweets mentioning “SIVB,” the bank’s stock ticker, increased sharply on March 9 around 9 a.m EST. That was roughly two and a half hours before tweets mentioning “SVB” or “Silicon Valley Bank,” which were part of a more general-interest discussion, began.

That spike in investor tweets coincided with the rapid drop in the bank’s stock price on March 9, which continued in after-hours trading and before the market opened the next morning. Trades in SVB’s stock were halted on March 10, the day the bank collapsed.

Together with several other colleagues, we grouped U.S. banks by the number of tweets posted about them and by their vulnerability to a potential bank run. To measure vulnerability, we multiplied losses the banks incurred due to the string of interest rate increases that began in March 2022 by the proportion of their deposits that were below the Federal Deposit Insurance Corp.‘s insurance limit of $250,000 per account.

We found that shares of banks with a lot of Twitter activity in January and February incurred much larger declines in March. This effect was stronger for the group of banks with the most vulnerability. One of them was First Republic Bank, which subsequently failed on May 1.

When we looked at what happened to the stocks of all the banks with vulnerable balance sheets from March 6 to March 13, the one-third of banks with the most tweets experienced declines in their share prices on average about twice as large as the others.

Why it matters

U.S. policymakers have acknowledged that social media may have played a role in Silicon Valley Bank’s demise.

Existing knowledge about bank runs comes mainly from banking distress during the Great Depression. Back then, word of mouth, media coverage and public signals, such as long lines outside of banks, spread panic among bank customers.

The breadth of the audience and the quick spread of ideas make social media distinct from newspapers and broadcast news since traditional media outlets mostly rely on one-way communication from official sources to the general public.

This will surely remain an important issue for banks, especially as other financial institutions face issues similar to those that felled SVB.

What other research is being done

A report on SVB’s failure that the Federal Reserve released on April 28 underscored many of the points we made in our paper. It highlights poor risk management by SVB in combination with a large fraction of depositors concentrated in the Silicon Valley startup community, who are often very active and highly connected on social media.

Another team of scholars, led by University of Pennsylvania finance professor Itamar Drechsler, determined that the recent growth of uninsured deposit accounts can destabilize banks.

As ongoing research by a team of researchers at Columbia University and the University of Chicago suggests, this risk may further be amplified by the rise of fully digital banks and mobile banking apps.

What is not known

Depositors who rapidy withdrew money from SVB also reportedly relied on private communication channels, such as group text messages, Slack and WhatsApp, as well as phone calls, to share their fears and concerns. But since there is no publicly available data, it is hard to find out what role those other less formal conversations played in precipitating the SVB bank run.

About the Authors:

Tony Cookson, Associate Professor of Finance, University of Colorado Boulder and Christoph Schiller, Assistant Professor of Finance, Arizona State University

This article is republished from The Conversation under a Creative Commons license. Read the original article.