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    Banking Crash Highlights Fragility of the Entire System

    Well, here we are! Much sooner than I thought, I must admit. I figured we would have maybe another six months to a year before the real chaos started, but I was wrong. It looks like the cracks in the US banking system are showing, and the whole world is watching intently to see what happens next.

    It all started with Silicon Valley Bank (SVB), a bank that lends to technology and biotechnology companies. I have been reporting in the Weekly Market Wrapup series on JM Bullion’s YouTube channel about layoffs in the first quarter being concentrated in the tech sector. It is no surprise, therefore, to see the first bank down was one backstopping much of that sector’s companies.

    What Started it All?

    The major issue precipitating the crash was the inability of SVB to raise funds to pay off customer withdrawals. Venture capitalists (VCs) who had cash on deposit, along with other wealthy customers, had begun to withdraw funds from the bank in a rush. The bank had assets on the books, but due to the rising interest rates in the economy, had been devalued. Remember that bond face value falls when interest rates rise, making them less valuable in the open market when it is time to sell.

    Customers last Thursday yanked $42 billion in deposits, leaving the bank in a negative cash position. As word of this came out in public, the run on regional banks started in the form of the collapse of another bank. Not to be outdone, word came out shortly after that that Signature Bank, which had made its reputation servicing the crypto industry, was seized by regulators after customers withdrew more than $10 billion in deposits because of the SVB failure.

    What had started at one bank, affected by last year’s downturn in the economy, had already begun to spread to others that previously were not in the same trouble. What we had brewing was nothing other than an old-fashioned bank run.

    Government’s Initial Reaction to Stop the Cascade

    In order to stop the dominoes from falling across the banking system, the Treasury and Fed came together and guaranteed the deposits of both SVB and Signature’s depositors. The scheme will be paid for by some existing insurance funds held in place by the FDIC. Eventually, the costs will be passed to the other banks in the system which undoubtedly will be passed along to consumers in the form of higher costs.

    In addition to the above steps, the government is also providing short-term loans to the market in exchange for high-quality short-term debt. CNN reports that “to prevent a repeat at another bank, the Fed said it will offer banks loans for up to a year in exchange for US Treasury bonds and mortgage-backed securities that have tumbled in value. The Fed will honor the debt’s original value for the banks that take the loans.”

    This will work well for bigger banks that have treasury bonds and mortgaged-backed securities on their balance sheets. Banks that do not may not have access to those funds, which may include smaller regional banks. But at least it is an emergency credit line should the banks with those assets need them.

    While the current shock looks like it can be handled by such a scheme, the American public is not going to want to bail out more banks if it happens again. And what in our deteriorating economic outlook give us reason to hope this is an isolated incident? The reality is that the FDIC right now is capitalized with 1.26% of deposits held in the banking system. And major shock which requires a large-scale bailout is going to bankrupt the system. And when that happens, the bail-ins will start. We will get to that in a moment.

    It is hard for me to criticize the government’s response in this case. After all, they really have very little they can do in the long run. The FDIC insurance scheme is not meant for large-scale bank panics. If the system needs serious liquidity, then it is up to the Fed to accommodate. Given that they had been tightening the lending environment by raising interest rates and selling some of their debt, the system had less liquidity sloshing around than it otherwise might have. Will the Fed reverse course and start quantitative easing again? Time will tell, but it certainly must be an option on the table at this point.

    What Comes Next

    Not all of those invested in SVB and Signature will be made whole. 85% of SVB’s depositors are uninsured, and it is unclear what will happen to them. Amidst the flood of news flow, this weekend were indications that customers with over $250k in deposits would be issued share certificates and possibly have their funds paid out as dividends over time. That assumes officials can keep the bank running and generating revenues, perhaps finding a takeover candidate in the meantime.

    Secondly, existing shares and bondholders are going to be wiped out. The government is clearly protecting deposits here, in a bid to stop depositors from getting spooked and withdrawing money all over the banking system. They will deal with investors later, apparently. The final fallout is unknown now, but the crashes will have lasting effects on the economy as well as the perception of how healthy America’s financial system really is.

    The markets were not happy to receive the news, and are expecting the Fed to accommodate by easing again. US Treasury rates fell on the news Monday, perhaps in anticipation of the Fed announcing a reversal of the recent tightening policy. I doubt seriously the Fed pivots unless we see another bank crash, indicating the government’s assurances are not going to be enough to stop it from happening again.

    On Tuesday, rates across the US Treasuries were rising again as the market absorbs what it just saw. What we have now is the formal acknowledgment of system risk that all market participants are now digesting. Those that were bullish on the economy have had cold water thrown at them. Every fund and risk manager in America is furiously busy this week trying to gauge the long-term risk to their companies.

    From this point forward, everything changes. All of us must be on our guard for the next domino to fall. The economy is lurching towards a recession which we have not even had the formal announcement of yet, though production numbers aren’t looking particularly rosy now. And we have already had our second and third largest bank failures in US history happening in a single week.

    What happens when we formally reach a recession, expected by many major analysts to happen this year? Well, given the early signs of how fragile the entire financial system is, I think we can begin to imagine the potential scope of a system meltdown. It may entail widespread bank failures, lack of access to cash, lack of movement of capital across the system, and likely long lines at the bank. What will ensue is a liquidity crunch that tightens the screws on an already slowing economy.

    I am not mincing words here. If the system does collapse due to a banking crisis, we are in different territory than these generations of citizens have ever experienced. We may have to step back to the 1930s to understand the potential impact of a bank collapse on our economy. Let us hope and pray we do not arrive there. But that option has to be on the table for you to consider in managing your financial risks going forward. There is no other way around it.

    Final Thoughts

    I had been writing about the debt and its risks to the system lately here on JM Bullion, almost as if on cue. I did not expect the eventual crash to get started with a liquidity run on the banks, but it does make sense if this really is the big one. After all, the dollar system is built upon confidence in debt. When confidence in debt fails, the bills come due and we deal with the consequences.

    What is even more important for you to consider is how you would handle such a high-risk event. Do you have enough personal liquidity in the form of cash? Do you have a stable bank that you believe in? Do you have backup plans in the case of a run on the banks? These should all be vital questions in the minds of Americans today.

    Perhaps it is also time to realize the value of precious metals in our plans. Because when the banking system crashes and dollars are short, it is likely people turn to other tried and true forms of money. The kind that holds their value over time. Those would be the precious metals.

    Disclaimer: All Market Updates are provided as a third party analysis and do not necessarily reflect the explicit views of JM Bullion Inc. and should not be construed as financial advice.

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