I am joined by John Maxfield, banking expert and author at the Maxfield on banks substack. John, welcome to Forward Guidance. How are you doing? I'm doing great, Jack. Appreciate it. Glad to hear it.
我和银行专家、Maxfield on banks substack的作者John Maxfield在一起。约翰,欢迎来到Forward Guidance。你怎么样?我过得很好,杰克。谢谢。很高兴听到这个消息。
John, we're recording the afternoon of April 3rd. So it's been a few weeks since the fall of Silicon Valley bank. So we can sort of get out of the sort of, you know, fog of war, everything is happening at once and maybe have some longer term reflections. I first want to start out, I want to get you what, what do you think is going to happen next? But how would you, how have you made sense over the past month? You know, I know you focused a lot on history. Would you say this is more like 2008, more like 1990s or something that's more vanilla and not that big deal?
It's a big deal, right? But like for the people who were involved, right? Anybody impacted it would be obviously a really big deal. But like stepping up, you know, a million miles from the perspective of like the banking industry and what this all means. And all of that, I would say that, you know, we've had nine major banking panics in the history of the United States.
So 1819, 37, 57 civil wars, a big panic, 73, 90, 18, 93, the Great Depression, the 80s, and then the financial crisis. Okay, so those are those are the big ones. And so what happens there is those are followed by long periods of time where the economy is depressed. There have been probably 20 smaller panics since the beginning of the country. And the ones that are best known are the panic of 1907 when JP Morgan locked a whole bunch of people in his library until like all these bankers decided to help the other banks in town. And then that took care of that. So like there's there's there's fewer issues for a few days than that dissipated the issues. And then there's a one in 1884.
And that one was predicated by the failure of a company called Grant and Ward. Grant Ward was like a brokerage company like a Wall Street kind of like investment bank brokerage company, but it was named after President Grant. Like he was literally a partner in this in this in this in this in this firm. So, but again, then the government came in with a whole bunch of stimulus took care of it. And then that kind of like dissipated the panic. And so, you know, if you where this will fall in the history of kind of panics and stuff like that is on that side like the 1884 one or the 1907 one. It's like, you know, they are the government was able to come in and take care of it before cause seems to be the case at least before causing significant economic damage.
那个事件是由一家名叫Grant and Ward的公司失败所引起的。Grant Ward是一家经纪公司,类似于华尔街的投资银行经纪公司,但它以格兰特总统的名字命名。事实上,他在这家公司中的确是一名合伙人。不过,后来政府介入并提供了大量刺激措施,解决了问题。这缓解了人们的恐慌情绪。所以,就像1884年或1907年那些历史上的恐慌事件一样,政府能够在经济遭受重大损失之前介入并解决问题。
So what's your outlook going forward? I mean, do you think that more banks will fail the they won't fail? I mean, you've got a great chart from Maxfield on banks showing just how the number of failure failed banks and how it really peaked into 1800s and even in 2008 to his 9th and 10. And we didn't get to you know, where we were into the 19th century, even one or two more failed banks would still be a huge deal. So what's just what I look going forward and why.
The thing to know about banking is that failure is the rule not the exception. So, you know, I've kind of collected as much data as on this as I can I've kind of built out a data set going on the back the beginning of the country and what you what I found is that there's roughly like 18,000 banks that have failed. And that's super conservative because there's like voids in the data like in between the revolution in the Civil War, like there's certain states that didn't collect very good data all that kind of stuff. So this really conservative let's just call it 18,000 and then let's maybe I don't know another faith 7000 because there's 22,000 mergers. Let's call it say 7,000 of those are potentially mergers in lieu of failure.
So it's called 25,000 failures in the past, right. There's about there's less than 5,000 banks today. So that means that a bank is five times more likely to fail than it is to succeed. So that that's an important thing to keep in mind. So yes, you should always anticipate that there will be more bank failures. And the question is why, why are there bank failures, why are banks of prone to failure. I guess I was just laying this out like they are more prone to failure. They're about I think it's like 30 to 40% more prone to failure than your typical business. If you take an average through a full cycle.
And the reason they are well, there's two kind of broad reasons one is that they are very, very vulnerable to errors that they commit to unforced errors really, really vulnerable and they're vulnerable because one they use a lot of leverage. So 10X leverage. Like Washington Mutual failed only 3.4% of its or I think a 3.4, 3.6% of its loans were on non performing. So it's got like a 96 and something on its test and it's still failed, right.
So that means that you're borrowing deposits, right. Your deposits, you're borrowing those, but those can be taken at any point in time. Right. And so if you, you're like, you never have all the cash on hand that you need to satisfy all your depositors. So if there's a run, I mean, there's a liquidity crisis. It just happens really quickly. So that's the second reason.
Third reason is that when a bank, so when you look at a bank balance sheet, like, you know, whatever 60, 70% of it is made up of loans, right. Well, a loan is you mean to make the loan this period at this time and then it goes, goes, goes, goes, goes, goes. And then there's a hopefully payoff. Well, during this whole period of time, you have very little sense. I mean, you can, you have sense, but like, you don't know if the loan is good until it's paid off. And so you have this opacity in your cost of goods sold. And so you can like make a whole bunch of loans and you see this all the time, make a whole bunch of loans. They're all going just fine. And people like, oh, our loans are great. But then they're not. And so it's like a red herring almost it causes that. So there you have that vulnerability to the mistakes, do the consequences of mistakes.
And then the other major point part of this is that you're also very prone to make the mistakes in the first place. And that's because you can grow a bank as fast as you want, because there is literally an infinite demand for credit. And if there's something that we know about humans is that they want, you know, the rewards in the short term, not the long term. Right. Your point about credit bank loans right now on a credit basis look quite good because it's always backward looking. So even though we've had these outflows, it's the loans themselves, people are people are still paying them down. But as you mentioned, that can always change.
And how would you characterize the fall of Silicon Valley bank signature bank. You mentioned three, four reasons why banks can fail. What reason was where those. I think it's easy to look at Silicon Valley bank and be like, that isn't an anomaly. Right. Cause like, like, off top of your head, Jack, do you know of any other banks that are failed like that? No, I mean signature bank. It's kind of kind of kind of signature bank. Yeah, I mean, right. The bank of the United States in the 1930s.
So now you see now that's the New York in you see that's good. So that the best for every no.
现在你看到了,这就是纽约,你看到了,这很好。因此,这是每个人的最佳选择。
So the bank United States, it's failure is the thing that caused the great depression. That transfer transform a large recession into the great depression, because that's the thing that triggered all the bank or a lot of the bank, the major, major, major bank runs when it failed in December of 1930. And it was not a central bank, not the first bank or the second bank in the United States. It was, that was just a misnomer. Because maybe it says give people confidence that it was safe, because it's the bank of the US.
But, but okay, John, let's go back to 2023. I have to remember the year there. Yeah. Yeah. You were, you were saying Jack had you know of any other banks that failed like that. And it was tough for me to come up. Yeah.
And so, okay, keep this in mind. Remember, there's 18,000 failures that we know of, confirmed failures on the record. And there's like a dozen reasons the banks fail. So what does that mean? It means that like for every bank that fails today, there's probably hundreds. Maybe thousands of banks that are failed for the same damn reason in the past. Okay. And so, so you think about the buckets. You put probably all these different buckets and like the biggest bucket that causes bank there is commercial real estate.
Commercial real estate. I'm just like it gets, I mean, I don't know if it's 70% or 75% but we're talking like a healthy majority of bank voters that caused by commercial real estate. In fact, the first failures in the country because in the 18 or 90 or cause by commercial real estate. That's not what this was, right?
What this was was you had a company that goes out and gets a ton of money. Okay. It's a ton of money that's floods in. And they say, what are we going to do with this money? Right. What are we going to do this money? Because they have to do presumably they have to do something with it because they are 60 billion and ask and deposits going into the going into 2020. Then they got they grew 130 billion just inflow of deposits. So they tripled in size as a result of that.
So if you just leave that money and do nothing with it, you leave it in cash. Well, you still have to service that money. You still have to service those customers. So you're still absorbing the cost of servicing them, but you're for going the revenue. Right. So what does that do? That causes your return on assets to drop precipitously. Right. And like, look, if you're a bank and you're a private bank and I say it's the John and Jack bank, we own 100% of the bank that doesn't matter. Like we can like, we'll just let it drop. It doesn't, you know, we'll still make money. We just not as much and like, we just got to get through this.
But if you're publicly traded bank and you're you do not own a controlling interest in that bank, you're kind of at the whims of like other people telling you what they think you should or shouldn't do. You know what I mean. And so, you know, that that's kind of an element of play.
So what did it do? It went out and it bought. So in deposits. A lot of people think that like deposits are an example of borrowing short and lending long. They're borrowing short because it, you know, you have you, but the deposit can go get that money whenever they want it. They have the option to get it every time. But in many cases, they don't. In many cases, they keep that there for 10 years or 50 years. That's right.
And so a deposit is like a non-interesting deposit is actually one of the longest term, longest duration liabilities on the bank balance sheet. In fact, I made the longest duration liability on the bank balance sheet.
And so what do banks do? They match the duration of their liabilities with the duration of their assets. And so in Silicon Valley is sitting there thinking like, well, what are we going to do? Let's match the duration. So they go and they buy long term a whole bunch of less $70 billion or something like that long term mortgage back securities. Okay. And so what and then it got caught because the interest rates go up and the value of those things go down and then you have people valuing those and saying that bank is insolvent. And so let's run on it. Let's go get our money for everybody else does.
So what you have there, you have a mismatched type of like a failure as a result of duration, right? Because there are way too long interest rates go up. So you look in history and long hold.
There's a bunch of banks that have failed for this very same reason. The 23rd largest bank in the country in 1980 was the biggest bank in Philadelphia was called first Pennsylvania bank. And it did the same thing in the late 70s is run by this guy named John Bunting. He was a real character.
Like their interest rates are going up because we're in their indigestrian crisis. So John Bunting is like let's see they can't go much further like let's buy a bunch of long bonds. And bet that they're going to go down. So he loaded up their balance sheet with these long bonds. They didn't go down because then Paul Volcker came in and jack him up up to nearly 20% that thing that thing that's it first Pennsylvania.
And then the arms of the FDIC and then again early early in the 70s. Same exact thing with the bank right outside of Detroit that did the same thing but with mean with municipal bonds. So again, you see these things over and over and over again in time. And first Republic owns some municipal bonds. So a lot of bank run is present at many instances of a bank failure.
That's on the liability side when you said the 12 13 reasons that banks fails. And then you talk about commercial real estate versus the securities. That's on the asset side important to draw a distinction there.
And yeah, as you say Silicon Valley bank had a huge influx of deposits in 2020 2021, 2022 as the IPO initial public offering machine was getting worrying and a lot of tech companies who received that money they bank their venture capital money was flooding in. And these companies are unprofitable and this is sort of my theory and they you know they're going to be constantly withdrawing money unless new funding is coming in from venture capital and initial public offers that wasn't a problem in 2021 but it was in 2022.
Okay, so this argument that this observation that rising interest rates, especially when they're very quick can hurt banks and cause bank failures. I decided several examples from the 70s and 80s and Silicon Valley bank that in some way contradicts or challenges the notion John that you know I've heard I've said I've heard on many TVs that rising rates are good for banks.
Are they well depends on your asset sensitive reliability sensitive if your asset sensitive that is great if your liability sensitive is horrible. And what I mean by that is that if it's assets sensitive the yield on your assets is going to outpace and rising rate environment yielding assets is going to outpace the yield on your liabilities. It's the opposite of your liability sensitive and so that's a bank can be a bank can be positioned however I want a bank wants to be positioned.
There's there's there's derivative instruments or I mean all is he whatever you want you can do the smart thing is to be neutral the smart thing is to be neutral because there's one thing we know it's that nobody can predict this stuff and see just you just stay neutral you earn a healthy return on equity and just move on down the road.
What is going on what is the what's the root cause of all of this what is the root cause of all this well how would you say the root cause is of all this rising rates large influx of liquidity in 2020 quantitative easing that caused banks. To then you increase deposit because they bought back the securities at the fed bought so m2 went up you know that's the chart that everyone's talking about and now I'm to use negative.
And the volatility you know this happened over 60 years maybe would be okay but over two years it's quite extreme am I am I close. The liquidity you're right on with the liquidity so if you go back to like 2001 2002 after September 11th what the Federal Reserve do drop the drop the the interest rate weight really low right and I'm really low compared back then I mean the high compared to what we were experiencing the last few years but like.
And so then you see this OCC start issuing these bulletin and they're like it's basically telling the banks like we know we dropped it that they're interested to really low and where you started to notice a bunch of you guys doing silly stuff with your securities portfolios reaching for yield like don't do that you go back it's it you see this over and over and over and over again through history but the best story of this is that in 1836 when Andrew Jackson.
Got rid of the second bank of the United States okay so it's like they basically central bank kind of like it was different but it's basically simple bank he is on a 20 year charter. The congress affirmed or voted in favor of its recharging with an Andrew Jackson vetoed that vote and got rid of that bank so what they did is they took on money in that bank and they distributed it to what they called pet banks.
And in New York City, the pet banks for mechanics bank bank of America, although a different bank of America than what we think of Bank of America today, and I can't remember the third bank was, but then you know what happened all two out of those three banks all done came with damn dear within failure and there's this great quote in this newspaper article about this from back in 18 1837 and it was that in it is oftentimes harder to bear prosperity than it is to bear adversity.
And like that if there's one kind of contextual way to think about all of this stuff that's the way to think about it is that when there is a when there is the presence of abundance the presence of extreme or promise of extreme prosperity that is when the stupid stuff happens. And so the issue was not that liquidity was pulled rapidly that may have been the proximate issue, but the prime cause was the huge influx of liquidity there so liquidity itself is a problem too much liquidity.
Yeah, I think what just Charlie Munger says like a little bit of liquidity is good but too much is bad for humanity or something that is detrimental to humanity. I mean yeah because you have all I mean you think about every system is a system that goes in and out of equilibrium in a sense right and so you think about society and then cash like we're it's always were kind of like moving towards equilibrium so you have you dump a whole bunch of stuff on top like you go out of equilibrium.
And so then you have to find your way back into equilibrium, and so when you think about like what just happened with Silicon Valley bank and signature and and and and silver gate like yeah that was a little thing but that was a little thing at the beginning of a much much bigger thing that that liquidity search that we had during the coronavirus pandemic that is going to be the thing that defines the next 50 years in in finance maybe longer 30 years 40 years 50 years 60 years 70 years.
You don't know, but these cycles can last the cycle before this lasted from seven 1973 until let's call it 2013 so that one lasted you know whatever that was that was 40 years the cycle before that lasted for 100 years. And so like we're at the very beginning of this new cycle and and and that's how significant that amount of liquidity was liquidity can be many different things but in this case it's just a huge rise in deposits for a variety of reasons and if you look at JP Morgan's.
All bank America all banks deposits pretty much every bank exploded higher in in 2020 and 2021 for a variety of reasons you can get into, but why is it itself that a problem when I have you know everyone's giving me money at 0% and so I have everyone's deposits and I can let it out at 2% 3% 4% 6% I can reach when you said reach for yield I can reach up for yield by taking credit risk or I can reach out for yield by taking duration risk.
It is the latter that Silicon Valley bank did and that was a very bad risk to take given that the Federal Reserve Jack interest rates up by 400 75 basis points in about a year which leads us to say very few people were expecting.
That's right I mean so let me make a point about liquidity so it's not just so there's two as I have come to think about it there's two tight in this context there's the need to think about liquidity into two context okay to kind of two buckets okay there's liquidity that's already within the system that's like already within the US economy right it's already here it just sloshes around from you know from one place to another place to another place right that's fine I mean like that that is all that that's the aggregate amount is in the moving towards equilibrium.
Where you come into a situation like this where it like will define a new era is when you haven't the introduction of novel liquidity flows right so novel new so in in from another system so let's say Europe to the United States that's what has happened back in 1870s and that's what caused that that huge 100 year cycle or you can move out of the system and into another system that what happened in the 70s when the oil crisis caused the same.
Indeed 90s when the oil crisis caught like totally switched around kind of the trade patterns in the in the global trade patterns and money sort of flowing out of the United States as opposed to in to the United States so that's what caused that second that that when from 73 to base was called 13 and so another type of novel liquidity.
And that's the type I like to think about is it comes up through the ground like a geyser. And that's what like the Federal Reserve just creates out of thin air, like there's a monetary policy or deficit spending by the government, then that money is then immediately inserted into the economy. So like that is another type of powerful liquidity, a novel liquidity.
And so that's what we have. And so that's the type that you need to think about when you're thinking about like what defines, you know kind of like, and that has a big impact on the economy.
所以这就是我们所拥有的。所以这就是你在考虑如何定义时需要考虑的类型,这对经济产生了很大的影响。
And now I've like gone off on my monologue and I've forgotten your question. My question is why is it a problem when there's a huge influx of liquidity?
现在我自言自语地说话,忘记了你的问题。我的问题是为什么流动性大量涌入会成为一个问题呢?
Oh, my the bank of John and Jack swelled by $100 billion, that sounds like a great problem to have. Why is that a problem?
哦,约翰和杰克的银行增加了1000亿美元,听起来像是一个很棒的问题。为什么会是个问题呢?
It's a problem because that money's got to go somewhere. The money has got to go somewhere, right? And so if your system is within equilibrium or close to equilibrium, then where's the money gonna go?
All that new money gonna go. You're gonna have to go out on the risk spectrum, right? And so you think about like, okay, the financial crisis, like so the financial crisis was the last hurrah of that liquidity research started in the early 70s, okay?
What brought it about? Well, it was about what subprime mortgages, right? Subprime mortgages, why were subprime mortgages such a big deal? Well, some people had figured out how to secure type subprime mortgages. And so they thought they got rid of the risk because you get spread across the country.
And you have no concentration, all that kind of stuff. So you have the securitization. Well, why did the people making those securities, make those securities? They made those securities because they were so damn much money and it needed to go somewhere.
And it was all this money that was in like the conference of Saudi Arabia and as well, all these oil producing countries that made all of that money when oil prices jacked up in the 70s and stayed there ever since, they needed that to go somewhere. And the US has the deepest and largest capital markets in the world. So that's where it came. So they needed to make securities to find that home.
So what it does is it just pushes you way out on the risk spectrum. Yes. But now the securities that were bought that were causing a lot of problem that are sitting on some bank balance sheets, they are not subprime mortgaged back securities, you're tied together into CDOs, not credit risk.
They are given to you by Jenny May, Fannie May, all of these government agencies. So the credit risk is not really a problem, really at all. It is interest rate risk. Is that significant?
And you also tied it back to the 70s and 80s. Like what happened in the Volker era? I mean, first Pennsylvania failed. Yeah. Like duration risk or interest rate risk, like it can be as deadly as credit risk. You know what I mean? It can be as we saw. You know, it can be just as deadly.
And so like, if anything, it'd be more so because on credit risk, you don't know how much money you lost, but actually people can't really, you know, it could be worse, but people don't know it. But in interest rate risk, it's like, you bought paper that yields 3%, and now interest rates are at 7%. Finance 101, I put it in my calculator, I know exactly how much money you lost.
Oh, the money that you lost is more than the book value or equity of your entire company, your insolvent bank run and so's.
哦,你损失的钱比你整个公司的账面价值或股权还要多,你的银行已经无法偿付了。
Well, and here's another kind of anecdotic kind of like to throw into the mix. So there was a bank that failed in January 16th, 2009, okay? Is the first failure of that year. And that year was the, that's when failure, the failures really jacked up.
I think they're 145 or something failures that year, and then the next year they're 1502 or something like that. Okay, so that's a heart of the failures of financial crisis, okay? And this was a really peculiar one because what it had done is in 2003, four, six and seven, it had said, you know what, interest rates are really low.
Like I was saying, those bulletins at the OCC was releasing, like saying, like don't do stupid stuff with your portfolio. So one of the things that regulators like, well, why don't you just go buy preferred shares of Fannie Mae and Freddie Mac? I mean, there's an implicit government guarantee.
I mean, like, what is it? John, I read that on Maxila Banks today in preparation for this interview. I didn't realize that the regulators encouraged them to buy that. The regulators encouraged them.
Yeah. And so whenever there's a failure, and remember the bank failure that will cost either the greater up, $25 million, or 2% of the banks, the failed banks assets, there needs to be what's called a material loss review.
And the material loss review isn't done by the FDIC, but it's instead done by the Office of the Inspector General of the Treasury Department. And so they go through and they look at why did this thing fail? And then they say, well, what did the regulators do and did the regulators act appropriately?
So the idea is that you have this kind of neutral party in there kind of assessing everything that went on. And I've read, I don't know how many dozens or hundreds of material loss reviews, but it is the only one that's sympathetic to the individuals, because everybody was like, these things are safe. They're safe, they're safe, they're safe, they're safe.
So these guys are like, the interest rates have been dropped because green sand drop in September 11th, so they're looking for yield. That's the highest yield that they can get on what seemed to be super duper safe securities. So they get them, and here's what this, and then Fannie Mae, Freddie Mac are then, I'm gonna get promoted by the government on September 7th, I think, in 2008. And then when that happens, Hank Paulson has a joint press release with a guy named, I think, is a lock art, I think is this is the last name, Josh Lockhart or something like that. He's the head of this new thing that's gonna oversee Fannie Mae and Freddie Mac.
And they come out and they say, look, basically, they don't say we're wiping out the equity, but they say, look, common comes last, preferred comes right before that. So we're just putting that out there, basically saying, they're saying, but not saying that we're wiping out the equity. And the next two sentences they say, we know a lot of community banks hold this stock.
And there's only a couple of them that hold them in significant amount, but we're aware of that. And so I just think about, these guys who ran this bank, many women who ran this bank, we're probably watching that press release. And when they said that sentence, they must have been like, we're screwed, because they had, it was like 277% of their tangible common equity, that's the size of their position in Fannie and Freddie stock. I mean, it just obliterated that thing overnight. It's just like up and up and smoke.
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There are some pretty alarming charts out there if you put the data together as people have about the unrealized losses on banks balance sheet. It's not just Silicon Valley bank and as a percentage of book value equity, tangible book value, whatever you wanna say.
And in some cases, it's true. Correct me if I'm wrong, and I'm not just talking about Silicon Valley bank that the unrealized losses exceed the book value, meaning that Mark to market if the bank had to be liquidated tomorrow, it would be your Mark to market insolvent. Is this true? How worried should we be about it? Are there a plethora of examples throughout history of, oh yeah, that bank was Mark to market insolvent, but it still is with us today.
How big of a problem is this? So first of all, I'm not somebody who thinks that I wouldn't recommend anybody be worried. I just not gonna do anybody any good. So let's start with that. But yes, there are some banks that when you mark there, so important to know, and I know you know this distinction, but there's two, you can hold, you can designate securities in one of two ways.
One is available for sale, and if you designate them available for sale, you're just constantly marking them to market, right? As you're coming out with your balance sheet. Or which means, oh, you know, interest rates went from zero to three percent, we're marking it down from a hundred cents in the dollar to 87 cents in the dollar. And that's reflected in, is that reflected in that income or in book value or both?
It need the one of them is good. Yes. But in the other bucket, it's called whole to maturity. And those securities are, you do not mark, you do not change the value of those securities on your balance sheet, because the idea is that look, if these are riskless securities, IE like government, US government bonds, right? And you're gonna hold them until they mature, when you're gonna get the value of the bond when it matures. So you don't need to adjust it, you know?
And so, and that's where like, you know, your banks with big bond portfolios, that's where they'll put their bonds a lot of times, right? For that very reasons, because you don't want that volatility. And so this is what I would say about, should you be worried and all this kind of stuff? We don't want our banks, market their bond portfolios to market. We don't want our banks, market their loan books to market, because you go through these cyclical patterns. That's just part of humanity. You go through these cyclical patterns, and if you're market and market everything, they all fail every time. Every time, every time, every time.
You want your banks to fail, all the banks to fail every time. You know, you want the banks to fail every time. Like this is kind of an accounting fiction that they've created to like make it possible to run these highly leveraged institutions through kind of the vicious cycle that the United States financial system is. Right. So it needs to happen if hold a maturity, it wasn't happen, you know, very few banks would exist to you.
1929, 1933 would be every single day. Sure, but you said it's a fiction. It is a fiction. I mean, it kind of, right? It kind of is, right? I mean, like, yeah. Yeah, I mean, because it gives, it's like if you sold it, you're marking it at $100. If you sold it now, you'd get $0.80 on the dollar.
And I'll note in non-financial corporations, including financial corporations, such as Berkshire Hathaway, if they hold equities, they have to mark those to market. You know, if there's a SPAC that has a warrant liability, they can mark those up and down every single quarter. So banks are giving, being given a special exemption, but you're an insurance company too, probably. You're saying that they need the exemption?
I'm saying we need it. Yeah, okay. I'm saying the US economy needs it, okay? Because this is a country that like, these are not banking issues, okay? These are fundamental economic issues. These are what we think is important for the US, for the, for our country. And so one thing that we think is important is being safe, having a strong military, right? Like, that's really important. You have China coming up, like, you don't know, we don't know what they're right, what their plans are. You know, I mean, like, we want to be protected. Well, military's are not cheap, right?
You got to have a strong economy is the key to a strong military, okay? So now what makes a strong economy, okay? Well, you just break down economic growth, right? Is it labor, capital, and productivity coefficient, okay? Like, we can only do so much with labor. You know, that's just like, we let so many in a year, and like we have birth rate and death rate, oh, that kind of stuff, right? Like, that's your labor. It's the capital where you can really juice your growth, right? And who is the primary provider of capital? It's banks. And why are banks the primary providers of capital? Because they use 10X leverage.
And so like that, if as a country, we say, you know what, economic growth is not that important. A big powerful military is not that important. We'll take our chances. Yeah, I mean, like, let's not ignore these fictions. And let's like, let's punish all the banks like for like having so much leverage. But if I would suspect most people prefer this be safe, that I mean, I see your point, John, but just for the sake of argument, you could say if you we have these held to maturity conventions, banks can feel safe by parking the, you know, securities that would trade at $0.85 or $0.78 on the dollar at $100, banks feel safe.
And so they buy a lot of bonds. And so there's a moral hazard. I'm not the biggest fan of most moral hazard arguments, but I actually do see that could be a case, right? Oh, what's the problem? I'll just put it up market at $100. Yeah, but I mean, so would you say that should banks mark to market their loan books? If bank A has a tons of agency mortgage-backed securities that their value get 100 and then interest rates go from zero to 4.75, so interest rates go. So yeah, the calculation is, it's not easy, but it's to be done, but a mortgage book is so complicated because it's, you know, individual mortgage, individual mortgage, individual mortgage, but there are an interest rate component there, right?
所以,他们购买了大量的债券。因此存在道德风险。虽然我不是最大的道德风险支持者,但我确实认为这可能是个问题,是吗?哦,有什么问题吗?我只需要把它在市场上标价 $100 就好了。是的,但我的意思是,你认为银行们应该将其贷款账簿按市场价值核算吗?如果 A 银行拥有大量机构抵押债券,它们的价值为100,然后利率从零上升到4.75,这样利率上升了。所以,是的,计算并不容易,但必须要做,但是抵押贷款账簿非常复杂,因为它们是个人的抵押贷款,每个都不一样,但是其中有一个利率组成部分,对吧?
I mean, mortgage-backed securities built up at the same thing as mortgages, so maybe it makes sense. I don't know. I mean, I don't know, huh? A bond and a loan are the same thing. They're the same exact thing. It's the same thing, you know what I mean?
So here's the alternatives. Like, if you think about, they say, okay, well, let's say we go down the market market road on everything or even just on all the securities, right? What would that mean? Well, banks would have to sit with a lot more capital. They'd have to sit with a lot more capital. And so what is that going to do? That's going to reduce your return on that capital. And you're also, there's going to be a transitionary period where it's kind of your level setting to having a much more capitalized banks and that is going to have an appreciable difference on your growth rate. And so everything, like anything can be done. This is a democracy, I mean, although like our politicians are kind of clownish, but like, you know, we, these are choices that we get to make.
So we say, are we willing to trade off these cyclical patterns in order to get accelerated growth in order to have all these other things? Or do we not have that mix right? And I think, I mean, it's like a more of a societal question. Right. Okay.
Setting aside the issue of, should it be the case that banks are allowed to do that? That's a wormhole in itself. And you make a lot of good arguments. Earlier I asked, should people be worried about the fact that there are other banks who have unrealized losses on their securities? And in some cases that exceed tangible book value, I wasn't saying, you know, I agree that people, it's a good if people are not worried because crisis can feed on it as self as we saw with sort of the rumor-mongering and which is trying not to be correct, with Silicon Valley. And it could be a self-fulfilling prophecy.
But so setting aside, should people be worried? What is your view on while other banks feel, the, you know, meet the same fate as Silicon Valley bank, if they also have the unrealized losses, Twitter uses it, it's depend on the deposit outflows. And, you know, there are banks now where their common stocks have collapsed maybe 80, 90% in value for exactly this reason. And of course, the rumor-monger continues where if the stock goes down, people will draw more money. And then there's been liquidity injection from, you know, the big banks and then there's the bank, the bank term funding program. So a lot, a lot we haven't talked about, but yeah, you know, John, sticking to right now, I mean, what is your base case, except sort of how this thing evolves?
I mean, is the banking panic over? Is it just getting started or is it about to end? I mean, and obviously, no one has a crystal ball, but I just wanna hear your sort of high level thoughts. Okay, in my opinion, in my opinion, that's what I'm saying. Yeah, that's caveat. I think it's over. Okay, I think it's over. That doesn't mean everything is over, but we have been through the cute period. Like, I don't think we're gonna see another, one of those here bit. I mean, if here for a while. I think that the response, the government's response was powerful enough that it took care of that.
Now, that doesn't mean that there aren't gonna be other failures, but when you think back of those days, like when that was going on, it's so convoy, I mean, there was like, people were panic. I mean, I have friends who like the NBC world and like, they were trying to get their money out running, and then I knew people who were getting their money out of the British public. I think those days are over. Now, let's game out like what it could look like going forward. What if you look, and you to look forward, you have to look back.
If you look at all these different crises, like you see that picture back there, the yellow and the blue, it's that's the panic of 18, that's the panic of 1837 or 1857. And what you see over and over again through history and all those major panics is these two spikes. The first spike is the market spike. So that's bank failures as percentage of all banks. You have an initial spike that's caused by the market response to like an over extension of credit.
But then the follow up spike is caused by the regulatory response and readjustment because the regulatory response in a highly competitive industry, where you're dealing with 100% bunch of product. It can change the equilibrium. Totally jacks the equilibrium off. So you got to get back into equilibrium. And so then that's that second spike. The question is, is like, well, what's the regulatory response going to be? And is that going to cause issues? I don't think that it will. But you don't know for sure.
So let's say like, I mean, you could say, you could see a situation where they say, okay, you're going to mark the market all your bond portfolios, right? And so that's going to make it harder to return a decent return on equity. And so what you have, there will be banks that in that scenario will go out and do stupid stuff with their loan books because they're trying to maintain, earn their cost capital. They're trying to maintain their positions the most profitable bank in the United States. Or that kind of stuff, you know what I mean? Like that's where the carry on effects that I think that you'd want to be looking out for. That makes sense.
How do you think bank profitability will be affected by this? People are saying, oh, you know, banks used to be able to pay, you know, nothing on deposits and earn a spread on loans above the interest on reserve. And if they wanted to even park it at the Fed, they could get the 4.6% or 4.7% there. That was a great, juicy arbitrage. And that spread will narrow now because people are pulling money out of the banks. Oh, and this is what I want to ask you about. You know, people are pulling my hand out of banks deploying them into money market funds, buying treasuries. How does that affect bank profitability and bank liquidity?
The banks will always make money. And there will be years here and there and there, I don't think as much. But the banks will always make money. I mean, they are a central component of the ecosystem, central component of that equilibrium, right? So like, the equilibrium has got a part of that where it will settles is the banks. Like, they have their fingers on that scale. I don't mean that in some sort of like conspiracy oriented way. But in terms like, they've got to earn a cost of capital or like, capital won't be attracted to that place. And so like, things will just set. Like, they'll just set. Like, they're, you have these intervening time periods where like interest rates shot up real quickly. And so like, you know, it's now out of equilibrium. So, but it'll move back into equilibrium. You'll have banks that will be able to earn 12% on their equity, 14% on their equity, assuming they don't like jack up the capital rules, you know, really high. They'll just go back to how it was, you know, and you know, just that's the one thing. If you, the longer you can look out over time in your head, like the, if you, it just, everything goes back to normal. Everything goes back to normal always. And always has, and I think we should expect it to always do that in the future.
In the long term, definitely. But if so, if the cost of deposits is going to continue to rise and will even accelerate, how will banks make as much money? Will they be making more loans? Will the spread on those loans go up? Yeah, what you do is it's the spread. They make money from this, it doesn't matter where the interest rates are, as long as you can make a spread. And so that's, I mean, that's what they'll have to do. The lending rate, you know, what it will cost to borrow money will just go up. Or they'll like try to find some like, I mean, not interest income source, but like, they're just, he just can't, he's not like standing on the street corner of every street. So it's like, yeah, you just have to, you just have to raise the cost of borrow.
What about, and I know this is an issue much more in residential, it's very cute and residential mortgages than may perhaps other sectors. But when interest rates are zero, everyone wants a mortgage. And when interest rates are at 7%, it's a lot harder. So when the bank wants to make a mortgage, there are fewer people who want a mortgage. And when the bank is like, you know, interest rates are at zero, I'm making a mortgage at 2.9%. I don't, I'm not really making much money. And I'm vulnerable to interest rate hikes as we've seen in the past year. That's when everyone wants a mortgage. So to what degree is that, is that a problem in other parts of lending, commercial real estate, you know, consumer banking, stuff like that?
Well, if you hold all else equal, higher rates will reduce demand for whatever that is, right? But this is not a world that you do hold all of us equal, right? When do you have high rates? You have high rates when the economy's going really well. Do you know what I mean? It's a counterbalance. When you have low rates, you have low rates when the economy's doing really horrible. So actually, if you actually think about it, it's actually reversed. The demand, there's an absence of demand when the rates are low. And there's too much demand when rates are high. It's like this counterintuitive reality about the demand of things that are balls credit. Right. But for residential mortgages over the past three or four years, I mean, demand really has fallen off cliff. Now that interests are higher than the shorter, but yeah. But in every aspect, I'm sure you're right, Jeff, generally.
Yeah, I mean, like there are periods of transition. There was like six months or eight months or like, there are these periods of transition where we're fighting our way back into equilibrium. Whereas everything is just like kind of wacky and like, and we're in that right now, we're in that right now. But we'll get back into equilibrium. Like we like we'll more closely approximate this idea of equilibrium. Right. And and that'll be like, like I said, I mean, just think about how many times this happened. It happened after the financial crisis, right. It happened after all that stuff in the 80s. I mean, there were like four crises at the same time in the 1980s. There was a great depression. I mean, it's just like, it's that historical context is like, it helps you be like, oh, just none of these things. And not always none of these things. It's a little one of these things. It's not a big one. Mm hmm.
To what degree do you think this will impact bank lending? And maybe take us back to, you know, how much are we going back in further? After the great financial crisis, we had all this quantitative easing assumption was, oh, banks are going to lend this money out. Of course, you don't really lend a specific part of money. It's like social security. But, you know, and the banks didn't, you know, lending was actually quite low. However, I didn't believe we had a sort of a lending boom in 2021 and even as 2022. Do you think this panic might make banks a little more cautious? What do you think? What do you say?
I mean, these things always increase or reduce risk appetite. The banks, the one point banks want to lend money. They want to lend money. If every good loan that walks in that door is going to go, and they're going to, they're going to make that loan. But if you don't have good loans walking in the door, you don't want us. We don't want our banks making those loans. It's just, that's just as simple as it is. Isn't it true that default rates, the link with C's net charge of credit reserve bills, however you want to put it in terms of people not paying banks back when they make loans. Has been extraordinarily low in 2020, 2021 and 2022. And even now, you know, default rates on auto loans, let's say are. Pretty much where they were in 2019 more, I mean mortgage link with C's are pretty close to the record level, lowest ever according to Federal Reserve. So if you have so few defaults, what's the, what's the problem? Why don't make them some loans?
And hey, if your net interest margins just got shook by, oh, we bought all these, you know, made loans at 2% and bought mortgages at more risk. I squeeze at 2%. What better way to increase the net interest margin by lending even more? You know, it's in that, and there will be banks that do that. Yeah. And you will pay for it doing that. But to, to, to, again, we, you don't know whether a loan, a loan isn't good until it's paid back. It's just, it's not good until it's paid back until then it's like, TBD, that's what it is. You know, I mean, it's like, you know, I just don't, you just don't know it. And so, so you, you, you, you, you got to keep that in mind.
And so what the really good bankers, they're constantly worried about their loan books. It's the, it's the bankers and like, let's be clear. Like banking is like any, it's like, good, policeman is like garbage men. It's like, you know, the lunch ladies is like, whatever, right? There's, there is a spectrum of quality. And it's like the 10, 10, 80 rule, you know, like there's 10, really good 10% of the good. There's 2% that really bad. And evil. And then there's the ones in the middle that can kind of go either way, depending on the influence of the environment. Like the really good bankers that your, your, your Renee Jones is the Goggins, Aaron Graff down at Triumph, uh, Brent Beardall at, um, Washington federal, like, they are patient. They're patient. So you have like, let me give you an example. So Patrick Goggin at Hangem Institution for saving.
所以真正优秀的银行家,他们不断担心自己的贷款项目。银行家们都应该明确地说,银行业与任何行业一样,有优秀人员和普通人。这就好比警察和垃圾工人。午餐主管也是一样,有不同的质量。大众常说的“10-10-80法则”,10%是真正的好银行家,2%是定性对差的银行家,剩下的中间人物则取决于环境影响。比如像Renee Jones、Patrick Goggin、Aaron Graff和Brent Beardall这些优秀的银行家都很有耐心,比如Patrick Goggin所在的Hangem Institution for saving。
So this is a phenomenal, phenomenal bank. Okay. But one of the things that they do to, they have like their efficiency ratios, like 20 some percent. It's like, it's incredible. Um, I don't have unchecked it last couple of quarters. Explain for me.
And the odds, what, what again, it's a efficiency ratio. So the efficiency ratio is the, the percentage of your revenue, that you're spending on expenses. So let's say you bring, you bring in $100 of revenue, and you have $60 of expenses, your efficiency ratio would be 60%. Right. So the bigger, the lower the efficiency ratio, the better, right? Because that means more money is being kept and just drop straight to the bottom line.
Okay. And so what the way it has a, one of the reasons it has such a low efficiency ratio, in addition to just their discipline around costs, is that they bought, they borrowed a lot of money from the federal home loan board. And then that kind of stuff. So you don't have to have as big of a branch network and branch networks are expensive.
Well, when you're using that kind of financing structure, that your liability sensitive in situations like this. And so your, the cost your liability outpaces the cost of your assets. And so like their name gets, their name gets crushed. And so you say, okay, like you talked, you talked to me, say, well, what are you guys going to do? And this is basically what they say. So like, look, like, things are going to go back. Like the biggest mistake we can make right now is to go out and change everything. Just because of the short term things that are happening right now, because we know things will go back. And so you just got to stick to our guns, just ride this out. And everything will be just fine.
What do you mean by go back? I mean, go, interest rates will go back to zero. No, no, but no, but it'll interest rates are always coming. Right. The story of interest rates is that they're always moving. You know what I mean? Will they go up to 20% like they did in the eight probably not, right? But they're always moving. And so what I mean is that we'll get back into a place for that spread for the banks is more of a kind of a normal spread. Right now, it's not because we had, because you're in such a dynamic environment where the rate shot up so fast, that it kind of like broke all of that.
Like the banks will get it back where there's a, there's a healthy spread. And we want that as society. Like we want our banks to earn money. Not too much money. But we want them to earn a respectable amount. Right.
So if it's your base case that loan spread over cost of deposits have to return to something that is good for banks. And if cost of positive is going up, that means the loan yields will go up. There are two ways that could happen. I imagine one is a huge, you know, the demand for credit continues to be high. Or the supply of credit from banks goes down. If the, if supply of credit goes from banks goes down, that probably not very good for the economy. Whereas if people demand a lot of credit, that actually, you know, could be quite good. Do you have a view on which it is?
Well, and to your point, yeah, because I mean, that's that there's an over supply of credit right now. Why is there over it? Because all that liquidity. Got all that liquidity, right? It's like. The time that it's still in the system. It is still there. A little bit went out to tiny bit went out from this, from this, that panic we had, right? Tiny bit, but it is still there. It's still there. And that's why like, there's all these people out there like, oh commercial real estate, that commercial real estate, this.
You know, I mean, like, that's going to be the next big thing. Like, M and T bank, like, they have masterfully masterfully managed the liquidity situation. I mean, just like, what Ray Jones has done there over the past. I mean, just like, it's mind boggling how well they did that. Tell me, I know they have a really good reputation about it. I don't know the details.
I'm telling you about how you manage a liquidity situation. And maybe we can also talk about hedging interest rate risk later. So, you know, the biggest thing is that so you're going to these conferences, right? René doesn't own a majority of that stock. Anyone's a very, very small, it's a huge bank. René knows very, very, very, very small percentage of it. So that means that he's got a, he's kind of at the whims to certain extent of the market, right?
And so they go to these events, they get on these conference calls when they're in, and all the analysts are all the time. Are you going to protect your net interest margin? Are you going to protect your net interest income? Like, how are you going to do that? How are you going to do that? How are you going to do that?
What the analysts are saying is go by long bonds. That's basically what they're saying, okay? Because they're interested in this short term, okay? René is basically like, no, not going to do that. Like, we know that we're not, when you're, you do not buy bonds on the interest rate of 0%.
He's, that's just like a fundamental, you just don't do that. It's just like, it's ludicrous. Like, he's like, we're just going to wait this out. We're going to, what we'll do in response is we will portfolio some of our mortgages as opposed to secure ties them. Okay? So you're retaining more of that yield and you are in control of that credit risk, right? So if you're comfortable with the loans that you're making, like, bring on your balance sheet, take the yield from that, then just sit out and hold it, hold it out until interest rates go up and just wait and cash. Cash, cash, cash, cash, cash. Interest rates go up.
And so that's what they did. So they're, they're, they're bond portfolios are just naturally going through attrition and going to really, really low because these interest rates situation. And then the Fed jacked up interest rates to 5% in 2022. That's when they made their move and bought a whole bunch of mortgages or not more mortgages, but that's when they bought a whole bunch of bonds. So it's just like waiting it out.
And so the heart of part is when everybody is telling you to do this one thing and you know what's wrong. The hardest part is like just sticking to your guns and doing the right thing.
Hey there, sorry to interrupt. A lot of forward guidance listeners are not into crypto. If that's you, please skip ahead, get back to the interview.
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How many sort of M and T banks are there out there and how many Silicon Valley banks are out there and just because it's Silicon Valley bank doesn't mean it's going to fail out by Silicon Valley bank. I mean, didn't manage their interest rate risk appropriately. And maybe if you disagree with that, we can get into that we can get it to hedging and the duration of deposit, which is a very fascinating topic that I'm a little, little about. But the question is how many banks are there that manage their interest rate risk, frequently and how many did not. Not very many managed it well.
But like that is not to be that's I'm not saying I would have done it any better. You know, I mean, like I probably went out. I would probably done it just the same. In fact, I think you can even take it a step further.
Think about if you were the CFO of Silicon Valley bank. And you're sitting there and a hundred billion dollars in cash is dump on your head. What are you going to do? And so remember, and this is where everyone's talking lower for longer, lower for longer, lower for longer. That's what everyone's saying back then. We're not even thinking about thinking about raising rates. Not even thinking about thinking about raising rates exactly.
And then, well, oh, then we saw what happens then. And then, you see inflation go boot shoot up in 2021, right? It's like in I think it's April, it's like kind of close to the middle of 2021 inflation shoots up. So you think like, OK. They they still had a lot of cash. So they were there like, oh, well, now inflation is going up. So what does that mean?
Remember what the argument was then? Transitoring inflation is transitory. Transitoring. Transitoring. Transitoring. Right. Everybody thought inflation was transitory.
So if you think it's transitory, you don't need to continue on lower for longer. Right. Transitoring means it's going to go back to what it was before it was before it was before it's lower for longer. So you can see how that was made.
And then the other mistake really that if there was one quote unquote mistake that they made that like maybe, maybe would have been caught. By others, it was that not all deposits should be treated equally in terms of duration.
And so you have like you have somebody who goes somebody who grew up with no money and they win the lottery. And they put $10 million in the in the bank should the bank assume that that $10 million is going to stay in there for like 30 years, probably 90.
Like it may last for two years and then you'd spent down to zero. So that you have a surge deposit scenario. And in those scenarios, what you do is you adjust the duration on those. And so if there's you use a coefficient to adjust the duration. So you know, if there's if there is an error of the errors that were committed, that was probably the principal one.
And so they didn't adjust it for the search and it doesn't seem like they did. So deposits can be called overnight can demand deposits. But that doesn't mean they have a duration of one day because many instances they stay there for lifetime. It's about the optionality.
So you said this Silicon Valley was assigning a duration of about seven years to its deposits. And I assume that's based on historical patterns based on oh, from 2013 to 2023, the average withdrawal rate was X. So the maturity was Y. The duration is Z.
And I'm, you know, probably accurate. But is the mistake to assume that historical patterns would continue. And is that mistake, you know, something that's might be, you know, my words not yours, egregious given that the money came in last year. I mean, you can't say the money came in the money that came in last year is going to have a duration. It's it's been there for one year, you know.
I mean, I wouldn't say any mistake that was made here was egregious. I would say all the mistakes you can, if you if you're willing to like give, if you're willing to be honest with yourself. I think all of us would say I could see myself making the same damn mistake. I mean, but the if you were the CEO of a bank that had their deposits go up by, you know, 180% yes.
Yeah, and because the other thing is that like, you know, Renee and M. T. like they manage a mass fleet, but they had, it was nothing like the surge the Silicon Valley had. I mean, Silicon Valley was like, it was so far out on the spectrum in terms of like, I mean, it was like eight standard deviations. I mean, like, so much liquidity came into that.
Like none of these other banks that have been criticizing it, none of them, none of them dealt with with that quantity. None of them tripled in size with cash dump on their head. None of them came close to that. So like Silicon Valley, it is, it is peculiar in the quantity that came in and again, banking fundamentally is about managing abundance. And the hardest and the hardest time to run a bank is in times of prosperity. And that's what liquidity. That's what that's what liquidity brings about.
Is it true that banks really should manage their interest rate risk in that in other words, so that the risk is zero and the duration of your liabilities is the same as duration of assets. This is the whole thing about banking borrowing law, borrowing short and lending long and, oh, okay, we want to hedge our rate.
So we're going to do a swap or we're going to issue some long term bonds, you know, maybe buy some like mortgage servicing rates or something like that. But isn't, isn't making lending a borrowing short and willing to go.
Okay, so this is the, yeah yeah, so like this is a nuance, but it's important nuance that there's a difference between taking a directional bet on interest rates. And earning a spread on your, on the money, on the difference between your, but you borrowing and what you're, what you're, what you're selling that money at. That's a fundamental spread or difference and like it doesn't see, it seems like a nuance, it doesn't matter, but like when you think about how that impacts the decision making, which each incremental decision, it's really significant.
Right. And so it's all this, it's a series of incremental decisions that lead to everything, you know what I mean. And so like that in an environment where there's basically no margin for error, the quality of those decisions matter. And they've got to be made for the right reasons. So if you're making them for the wrong reason, because you want to do directional bets on interest rates or anything, like you're, you know, you can't see the future. So we know that's a crap shoot.
Maybe that work, but maybe they don't, you know what I mean. And so like that, that's, that's, that's the difference. Is the treating of deposits, assigning a duration to them that is, you know, longer than just very short term duration, is that something that's widespread without the industry not just Silicon Valley bank, because I and I presume you many people watching this who say they think of demand is borrowing short, you know, you can get it anytime.
So the, it's called asset liability management is like what that whole like kind of the thing is that it's about matching the duration. And so that came that came about really in the 80s when you had that first search is basically similar to today, but it happened, you know, 40 some years ago. And so that's when people are like, whoa, we need to like match because that was with that caused the savings and loan crisis.
The savings and loan crisis that get all these thrifts, the savings and loan organs and associations that were all they could do all they could hold on their balance sheet was 30 year basically 30 year fixed rate mortgages and they are averaging like 8%. Okay.
The short term interest rate went up to like 18 19%. So they're paying they get I don't know how far they've got up, but like 14 15 16% to borrow money that then they're lending out at 8% doesn't work. So that's when everyone's like, okay, we need to like put some discipline around this this this duration risk, you know what I mean.
And so that's when asset liability management came out. And so they answered your questions. Yeah, every bank does every single bank does it. Now the question is how formalized is the process your smaller banks can be less formalized right. The bank the bigger banks like JV Morgan is going to be really, really, really sophisticated.
But yeah, I mean, you want your banks doing that. It's a they need to do it or else they'll have what happened to sell a valid bank will happen to them. Right.
Do you think that the expected duration of deposits a year ago from banks not just looking at a bank. So does that compare to the sort of realized duration that we've seen right now and I guess duration interest rate sensitive, but also just how many people withdrawing their money because I think I was on Friday that I can pull this to six up.
I mean, people are withdrawing their money from banks. And so does that rate of withdrawal match or exceed the rate of withdrawal that was anticipated by banks. Maybe let's say a year ago, given the sort of asset liability management that you just talked about.
The ninth straight period of declines. That's just the data points are. Okay, so my guess I don't know the I don't know for sure what the answer is, but my guess is that what happened to not match up with the models.
Because then you wouldn't that wouldn't have happened because the models would have associated it. I take care of it. So my guess is that the duration on the first republic. I'm sure they were like, maybe this is not as long as duration as we thought they were. Obviously. So, but like, you know, you still need to.
Like modeling is like, it's kind of like a monkey game. Yeah. And that's just the honest like modeling anything is kind of monkeyish because it's like nobody knows what's going to happen in the future. But at the same time, if you run an institution with like 40,000 employees or 200,000 employees, like, you can't just like wake up in the morning, be like, what are you going to do today? You know, you can't even have a plan.
And so like models kind of that's the where they that's kind of the role that they play.
所以,就像模特一样,这就是他们扮演的角色。
And like I'm just picking JP Morgan as example of the long term bank that. That's why I think that was a lot of what happened. I'm not going to be thinking about this.
But by my examination and other people have corrupted this. Man, I'm sure interest rate quite well in terms of their size. They didn't take much duration risk had like shorter term duration, and they did a lot of hedging.
If in an opposite world, interest rates were still at 0. J Powell sort of kept to his word of not even thinking about thinking.
如果在一个完全相反的世界中,利率仍然为0。J Powell会按照他的承诺,不去考虑思考这个问题。
I'm not saying he's broke his word. He did he did give sort of ample evidence to people paying attention.
我不是说他违背了自己的承诺。但他确实向那些关注的人提供了相当充足的证据。
Oh my God, Jamie Diamond, he put on all these rate hedges. Jamie, why not take a little extension risk? I mean, you got Silicon Valley bank, they're buying all these 20 year mortgages. And you're buying this four year piece of garbage? What's going on? Jamie, I thought you were a good banker.
That's right. That's a, it's a Warren Buffett in his 1990 shareholder letter. And he's talking about, he's explaining why he bought 10% a Wells Fargo, okay?
没错,就是沃伦·巴菲特在他1990年的股东信中所说的话。他在解释为什么他买了10%的富国银行股份。
And it's like, I don't know how many words that section of the letter is, but it's, it's I couldn't be, it can't be more than 800 words. But it's like, it's like, I mean, like, it's the fun of, it's like, it is the, there's, there's the mother root of sophisticated modern banking philosophy, what, how he articulates it there.
And it's all based on this idea that like, look, you know, banks with all this leverage, you know, so they're vulnerable to mistakes. Mistakes are the rule, not the exception. I mean, the reason mistakes of the rule, not are not the exception is because this concept of institutional imperative. And that is that basically the way Keynes defines institutional imperative is that it's better to, it's better to, to, to die a conventional death than it is to live an unconventional life. You know, and I mean, if there's one thing about banks, it's there's a herd mentality, herd mentality. And that there's a lot of reasons for that. They're understandable. But yeah.
John, before I asked my final few questions, tell us a little bit about, your sub stack, why did you want to start it and how did sort of your prior work lead you to creating the sub stack? So I, I'm a study banking. I just try to figure out ways to get paid study banking. And I love it. I'm like, I'm fascinated by it. It's like a subject matter that like, I've really, I've been working to crack the nut and to reduce it to its essence, distill it, and distill it all the way down due to essence. And I've been working on that for a dozen years and like that.
And so at 12 years in, I couldn't, I wasn't able to distill it down to that thing. I'm like, what is going on? So like getting last year, I was like, I'm just going to give everything I got to this. And I spent the entire year, I'm like 18 hour days, every single day, Monday through Sunday, how holidays, everything, every single thing. Only thing I did is I gave myself an hour a day where I played past my boys. I've two, two and a 10 year old sons. I guess they're 11 now, but they just turned 11. So when I started in the 1790, I just read contemporary materials all the way through to today. And it was, I was making my way through that and I realized the mistake that had made, that made it, that had interfered with my ability to distill it all the way down. And it had to do with this constipated periodization where you break an industry down into, a history of an industry down into eras, which seems academic, but it's actually incredibly important because there's too much stuff there that's unorganized.
You have to have a way to organize it to understand how it works. So I saw where it was flawed and I went back to the beginning, started all over again, then figured out how to fix it. And then once I figured out how to fix it, then it put me in a position where like I done enormous amount of research and very little writing, very little sharing. And there was, I mean, I read from 1790 to 2020, contemporary materials all the way through in the course like three months and then I did it twice back to back.
And so you're sitting on all of this knowledge and you feel a duty to like to share it and it is valuable, valuable knowledge. I mean, these are insights that like our people, other people just don't have because they don't, they have jobs, they have responsibilities like I just kind of a clown who had all this time, you know? And so I'm going to use it and you'll see, I mean, you've started reading some of the Jack, like the quality of the content is very high and like it's original stuff. This is not stuff that you will read anywhere else about banking. And so it's the vehicle that I'm going to use to share all of that, all that stuff. And just max build on banks at sub deck. Yeah, it's original content.
I've really enjoyed reading the work filled with banking history. One of my questions for you, John is take us to the savings and loans crisis. Volker, Jack, that interest rates way more than Powell has and probably, probably. Like that was very bad for banks, but how bad was it for the economy? I think there was a con you have recession in 1980 and then one in 81, but I don't think of the sort of cascade of failures of banks as to what the later 80s and even the 90s. And how is it possible that banks were failing in the 90s because of interest rate hikes that happened in 1981?
So there's a series of events. So it starts with the interest rates. So the interest rates jack up, you have a mismatch crisis. So where the thrift is primarily thrift, so we're getting hit right there because thrift can't have variable rate mortgages or very, very variable rate loans commercial banks could. And so like the thrift's got hit, right? So then what happens then there's deregulation. And so they deregulate the liability side of the balance sheet. So what they tell us that regulation queue. Yeah, they got rid of regulation queue because regulation queue said you can only charge this much for your positive or you can only pay this much for deposits. They lifted that ceiling. So then the thrifts were pay, then they had to pay huge amounts to borrow money to service their portfolios.
Our earning half as much. So then what do they do? Then the policymakers are like, oh, we need to deregulate the asset side of the balance sheet too and let them go out and basically buy whatever they want on the asset side so they can earn higher yields to so they can pay for that money that they're borrowing, right? So they deregulate that. So what do they do? They go into commercial real estate. Okay. So they're going to surge of money into commercial real estate.
You also had a tax law change early in that decade where it promoted more money coming into real estate and you also have the energy crisis, right? So then you start taking these banks, these banks start taking and companies start taking losses on energy so they need to make those up. So then that money goes into commercial real estate. So you have all this money is flooded into commercial real estate and the second half of that decade is a commercial real estate crisis and into 91 and 92. That is a huge commercial real estate crisis.
Like you go down to Dallas, I don't know if you've been to Dallas, but like you look at the skyline, all those buildings were built in the 80s. It's like they all were and like you see that Oklahoma city and like over and over and over again and so like that you had two, you had these fallen crisis and then in the middle of this crisis, in the middle of those two, you had the LDC crisis, the less developed loan crisis. Emerging markets. Emerging markets. Mexico, Brazil, Argentina and what you have there was these.
So you had all that money, right? That was sitting in the coffers, Saudi Arabia and stuff like that, needed to go somewhere. So some of it went to mortgage back securities, right, for the subprime. With some of it went to like, it was then brought and made into government loans, right? And so then you have, but then you have the interest rates go up on those government loans. And what happens then, the government started faulting. So Mexico was the first to go and it defaulted. I think it was August 82 and they basically came up and said, we're not going to pay. We're not going to bear that. And so those loans had gone through American banks. And so all of those loans had to be basically in your head just written down to zero.
So there was a for years in the 1980s, every single one of the biggest banks in this country were underwater. They were all insolvent for all intents and purposes. And so that brings up actually an even bigger point is that like, if there's something to be pissed about in banking, okay? If you want to be pissed about banks, something in banking, what you should be pissed about is the fact that we let these little banks fail all the time.
And yet we let these big banks get away with this stuff, stupid stuff, harmful stuff to the economy. And when they get in trouble, we bail them out. And like, we should bail them out, okay? But then we need to do something on the little banks I too. Like, they can't get that disparate treatment.
And I think it all reduces to compensation. I think it, I think it all, if you go through the full analysis of banking, like what makes an exceptional bank, what leads to stupid access is that the bad banks, I think you can draw it all down to compensation. Jamie Diamond is pretty highly paid. Banks very well run. That's, so that's maybe an exception. Yeah, I mean, Jamie Diamond is a savant. Brian Moynihan, he deserves to be highly paid, okay? I don't know if you guys do exceptional, but the problem is that you go throughout these regional banks of the country.
And so keep in mind a couple things. So the general rule is failure, not success. Number one, number two, even the banks that don't fail, it's a minority of them that earn their cost of capital. What do you mean by that? And also how do you square that with your prior comment that banks, it's always going to go back to normal, but banks, nims will be restored. How can both of those things be true?
So the cost of capital is, okay, so. Nims is not interested in, sorry, go ahead. Right, so you're a capital provider. You have $100 million that you have to allocate, right? Where are you going to allocate it? You're going to allocate it on a risk of just a basis to the place that gives you a decent respect for return, right? That's basically your cost of capital, like then a amount that allows you to be competitive with, to track capital, right, as a bank, right? So you got to earn, you know, whatever it is. I think the general rule is a bank needs to earn around 12% to earn as cost of capital. That's general rule, although like each and each bank is slightly unique, but that's the general rule. 12% on its assets or 12% on its equity or return equity. So that would be 1.2% on assets, assuming that typical bank is leveraged by 10.
So that's what your cost capital is. And John, it sounds like a really bad fact that you just said that so many banks, you said all the banks were marked, marked, and solvent, but that actually can perhaps elase some fears right now that just because on some bank balance sheets and perhaps a lot of bank balance sheets, the unrealized also securities, market to market, insolvent, that doesn't mean that people are going to pull their money. And that doesn't mean that they should. And if they're, if they're insured, they definitely should not pull their money.
Oh, you talked about the community banks and I was going to ask you about, it wasn't Secretary Yellen before Congress asked by some senator from the middle of the country who said, my community banks are struggling. Are you going to bail out them? And she basically said no, but then she hinted, maybe it's yes, maybe it's no. And so this is the question of will the help extended by the FGIC and the Treasury to Silicon Valley bank depositors, uninsured depositors over a quarter of a million dollars and signature bank? Will that be extended to other banks if they fail?
Your point about the 80s and all those banks being insolvent, sitting insolvent, like, I never connected that in my head, Jack. And like, when you're saying that, I'm like, oh my god, it's like, that's such a good point. But the forbearance was the way to deal with that. There's appropriate way to deal with that. Otherwise, you go into like the dark ages.
What is forbearance? Yeah. Forbearance is when a bank or so let's say you are delinquent on your loan as opposed to the banks coming in and just for closing on you, they'll give you some time, try to work it out with you, you know, like make it possible, like maybe you want to have to for close, you know what I mean? Oh, that's what forbearance is. But on securities where there's no credit risk and it's all an interest rate risk for bearance would now. Well, it would be forbearance on the part of the society forbearance on the part of regulators.
Because that's in the 80s, those forbearance on the part of regulators, they're like, well, I mean, theoretically, y'all are, you know, insolvent, but like, we're not going to, we're not going to come into seize all of you, you know what I mean? So it's kind of forbearance in the broadest possible sense. But the other point about the, let me, so remember the 80s were a total shit show, okay, for in banking, all right? And the big ones in particular, they were all insolvent or like all the ones in Texas failed, all the big ones in or, or emerged in lieu of failure, okay?
You go back and you look in the 1980s, you look at the highest, and I'm an Uber capitalist. Let me be very clear about this. I'm not against people getting rich, but you got to get rich the right way. That's the thing. You go back to the 80s and you look at, you get the list of the highest paid bankers every year. And I swear to God, every single one of their banks either failed or was insolvent for a significant period in that decade, and you say like, what are we compensating here? What are we compensating? Like, what is this all about?
So then let's take it up to more modern times. You look at that you take every single public to trade a bank in America, okay? And you rank it by all time total shareholder return. The amount of value this thing has created since it went public. You just put on a chart and there you will see is that there are two that are way out, way above all the rest. There's like two that go up here and all the other even that the second or the third, fourth, fifth, they're down here, okay?
What are those two? Glacier bank or open calisthenum antenna and imit bank up in Buffalo, New York. And then you say, well, God, those guys must have made a ton of money. You know what I mean? The CEOs. The CEOs must have made a ton of money. And they did. They did. But you look on a year to year basis, Mick Blanick, the guy who is responsible for that performance at Glacier. He earned that you take, you look at his peer group, he was the lowest paid in his peer group, not just the lowest paid, all right? He earned a third of as much as the second lowest paid, a third. This guy was making like $260,000 a year. There were other clowns in his peer group that were making like $4 million. And Mick blew them away. I mean, I mean, these guys weren't even in the same universe as Mick in terms of the performance and how rich his shareholders got. And it was the same thing with Bob Wilmer.
So you look at his lowest paid in his peer group. And you think like, is there something to this? Is there something to this? And I think there is. And this is what it is.
Banking is not rocket science. Okay. It is not complicated. It's not. You know, you don't have to be a genius to do it. But you cannot be too ambitious. You cannot be too ambitious. You cannot be going after all the money you can make as quickly as you can make it.
And so what does that translate into corporate speak? It translates into corporate speak through the fiduciary duty against self-dealing. Now that requires you to do is you have to put yourself in the shoes of the principal. You're the agent and like in the shoes of your employer, not in your own shoes. They go before you do. They are more important than you are. They get the priority, right?
And that's what all these CEOs want their people to do. But yet they won't do it themselves where it matters the most. And it's in conversation.
所有这些CEO都希望他们的员工这样做。但是最关键的时候,他们自己却不会做到。这就是在对话中。
And so the best way to cap like this whole thing is that you think about it like this. In 1949, a guy by name of APG Neenie died. He was the guy who in 1904 founded a bank called Bank of Italy that eventually became Bank of America. That by 1949 was the biggest bank, I'm not an America, it was the biggest bank in the world. Okay. And so in the end of the year, he was the biggest bank in the world.
And so he died. His estate was worth $550,000. Okay. Just that for inflation, that's about $6.5 million today or something like that. That's a lot of money, but a fraction of what the big bank CEOs make in a year right now. He could have had Vanderbilt wealth. He could have had Rockefeller wealth. And he started a separate company that was also a huge today is still Trans-America. You think that was really.
Another separate company that he started laughing off. I mean, like, the guy was amazing.
他另外开的一家公司,他自己都笑话了。我的意思是,那个人太厉害了。
And then you go to 1998 and a guy by name of Dave Kulter becomes a CEO of Bank of America. This is what I was still in California. And he was CEO for two years. Okay. Two years. That's it. He sells that bank to Humacall, Nations Bank out in Charlotte. So Kulter sells that bank to Humacall. Kulter takes a $100 million Golden Parachute. $100 million Golden Parachute. And then he just almost like- They took the name so it's now called Bank of America now. Yeah. So it gets a better name, right? The nation's back. So it's like, yeah. But the bank from America, we think of things that's not Bank of America. That's a nation's bank. Yeah. You know what I mean? Like that's what that is. But it's like, so Dave Kulter, he monetized APG needs life work. And APG needing wanted to do the right thing and not monetize it.
And so you think like two things. Like first, like that's just wrong. You know what I mean? That's just wrong. It's just, it's unethical in my opinion. But the second is that like you've all these people who think like who look back on history and they like degrade history and like all these people are back in the day where all just like bad money grubbers and stuff like that.
Like that's not true. Like to a certain extent that's commitment to fiduciary duty in the banking industry. At least, and I think it's this case throughout corporate America has eroded. It's eroded and there was a time when the our executives took a much more seriously. Yes. I think that's particularly vivid in 2008 when you had people being, you know, having bonus package after a very, very bad risk management.
John, I got two more final questions, which is, do you think there is a learning for banks from this panic? Is it don't take too much interest rates, don't assume that certain deposits have a liabilities? Excuse me, I have a duration that's longer than they are. Is that a learning?
And by learning, I don't just mean, oh, in retrospect, it's true, but it's going forward, we should keep this in our minds when we do risk management. Or is there is there no learning because banks fail all the time and this is just part of nature?
Always a learning. There's always a learning, right? And I would be more general about the learning in this case.
总是在学习中。总是在学习中,对吧?在这种情况下,我会更加一般地考虑学习。
And I would say that if you fail, you could, like, it may not be fair that you fail, right? Like there could be rumors, gossips, there's a study done of all these banks that failed in the 20s. And they just looked at why they failed and like 50% of them failed because of just like idol gossip, rumors, okay? Like you can fail for unfair reasons. But if you fail, it's on you.
It's on you. Like you are a highly leveraged institution. You use fraction of reserve banking, like you have got to be prepared for everything. It is your duty to protect that money. And so like all of these things you got to be prepared for, you know what I mean?
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And what does that mean? The biggest risk is the risk you don't know, right? So that's some of the possibility. But like the biggest thing is that like you got to go out on the stream of the spectrum and say what is the least fair way we can fail? Like they start all these horrible things and none of them are true and like people believe it. How do we survive that? And so that's what I would think, you know, if I was running a bank, like that's where my head would be.
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I think like we need to make sure that doesn't happen to us. Right. And it's kind of funny, ironic, sad that the one sector of the S&P 500, everyone gets hurts by raising rates, costs of capital, blah, blah, blah. But the one sector that benefits is banks. And then you have some things.
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So it's three final question for you, John, is a lot of people out there are quite pessimistic they say this bank crisis is not over, you know, Domino one was to look at the big Domino two was signature bank. What's next? Who knows? You are sounds like much more optimistic. You said the banking crisis probably already over.
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There could be failures, but there's one piece of systemic. You give us many reasons to have this in every but just to summarize, this is the final question I promise. Summarize what is sort of the main reason if you had to pick one about why you think you know, everything's going to be all right.
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I mean, it's because when you study this stuff, you see it over and over and over and over and over and over. It's like baking a pie. Like my mom can look at that. She like the pie is done or the pie is not done. I'll look at them and be like, I don't know idea of that pie is done. I just the up and on. And you know what I mean? Like, like the pie is done is in my opinion. It could be wrong, but the pie seems to be done.
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I mean, in March, so in April 2009, not April 2023, what would you have said? Like, is the pie done? Like, why would you say the pie would not have been done then? Because the pie was not done. Yeah, the pie was not done. What was the risk that led to the pie not being done in terms of it failing that you don't see now? Because there are things, oh, unrealized losses, commercial real estate, which you know, some of which is speculation. Whereas in 2009 with the benefit of high state, we know that there were lots of issues that led to the problems continuing.
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Here's why there's just too much money out there. Still. So 2009 was the end of that liquidity cycle. It was like the final, then you had the European debt crisis. That was the final hurrah, right? That was the final hurrah. We were like 2009, we were there. We were there. Like, there wasn't that much liquidity. So like things, but we are sitting under this giant mountain of money still. And like, it's looking for places to go, you know?
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So like, I think that I think that that doesn't mean nobody fails. Doesn't mean there will be a recession. That's normal stuff. That's normal stuff. Yeah. But I would be shocked. And somebody like I studied the stuff right more than even in this country, like I would be shocked. And maybe that's famous last words. Also, yeah, and this was the other thing you learn. You know what I mean?
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I would be shocked if if if this wasn't good. If we weren't through the queue, the queue, the queue. You'd be shocked if another big one, let's say top 10 bank fails. You would be shocked. Oh, I would if you had top 10 bank. Yeah. Oh, I mean, I would that I think number 16, number 18 biggest bank. Yeah. That would be shocking. If if top 10 bank, yeah, that would be like my brain didn't even go there. I mean, like although city group, I mean, I feel like it's always on the like version of your.
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Well, John, it's been a pleasure getting to hear your insights, which are vast. You can check out your work on Twitter at max field on banks and your your sub stack is max field at banks. Thank you so much. Thanks for being generous with your time and thank you everyone for watching.
嗯,John,很高兴听到你广博的见解,真是一种愉悦。你可以在Twitter上查看你的工作,账户名是max field on banks,而你的SubStack账户是max field at banks。非常感谢你慷慨地分享你的时间,也感谢大家的收看。
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I just want to say Jack real quick for you turn off. You do an excellent job. You do appreciate that. Appreciate what you do very much. Well, you do an excellent job.
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Hey, John, final question. How many of those books in the room behind you that we can see are about finance and banking specifically?
嘿,约翰,最后一个问题。我们能看到你身后房间里有多少本关于财务和银行业务的书籍?
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No, those are all that's my finance and banking library. So 100% all right. Thank you.
不,那些都是我的金融和银行图书馆。所以完全没问题。谢谢。如果需要的话,可以重新表述第13段。
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Forward guidance, the program you just enjoyed, hopefully can be viewed on YouTube at Blockworks macro or hurt as a podcast on Apple podcast and Spotify episodes are typically released on Apple and Spotify a few hours before they air on YouTube. Please leave a review on Apple podcast if you feel so inclined.
希望你刚才收听的 Forward guidance 节目能够在 Blockworks macro 的 YouTube 频道上观看,或者在 Apple Podcast 和 Spotify 上作为播客形式收听。一般来说,节目会在 YouTube 上播出之前几个小时在 Apple 和 Spotify 上发布。如果你愿意的话,请在 Apple Podcast 上留下评论。
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Also you can get 10% off to permissionless 2023 and blockworks research using code guidance 10. Again, and be well.