Monday, March 13, 2023

Messy Hair & Busted Banks

As is so often the case, I found myself in a political conversation.  This time with someone who was expressing her dislike for former British Prime Minster Boris Johnson. "Ugh," she grimaced, "I would never support him.  He's awful."

I found that intriguing. "And which of his policies, "I queried, " do you find so objectionable?" My question was followed by stunned silence. I waited.  And waited. After a minute or so, I couldn't resist:

"You have no idea of ANY of his policies, do you? You just don't like that he's fat and his hair is a mess."

Her sheepish grin indicated I was right on the money. She's an American. She doesn't follow British foreign or domestic affairs. But she does watch American mainstream news, which displays large, bright publicity photos which constantly confirm that Boris Johnson truly is one unpleasant-looking man. But no matter how disheveled he appears, can it be that people really form their opinions on such little, irrelevant information?

Sadly, the answer seems to be yes. Too many people don't take the time to understand what's happening or why it's happening. They simply eat what the mainstream news serves up -- which is often painfully misguided.  And nowhere is this more true than the latest (March, 2023) banking turmoil afflicting the United States (and echoing around the planet). 

Allow me to explain, because no doubt, you're going to find yourself in a similar situation, where you have to educate and explain about banks and their failures:

The first thing people need to know is how the American banking system works, which is unlike anything you and I practice as private citizens. American banks make profits by lending out money. They lend the money their customers (depositors) entrust with their savings. The banks pay the depositors, say 2% interest on those deposits and they charge 6% to borrowers for loans.  That's a 4% profit margin, right? 


As private citizens, you and I can't lend out more money than we have. But thanks to government reserve requirements, Federally chartered banks can lend out up to five times the amount of money they possess.  That's right, banks need only 20% of the money on hand to lend out five times that amount in loans.  Multiply the aforementioned 4% by five and now you can see why banking is such a great business. The reasons why this system is in place are as follows: 

First, the system relies on creditworthiness of borrowers to pay back loans, so nobody really is taking real cash out of any accounts.  They're making promises to pay the loans back and they usually do -- or suffer harsh consequences.  Second, as long as the creditworthiness holds out, lending five times as much money as you have accelerates economic growth:  more loans to more businesses means more people do more business -- generating more taxable revenue. Third, the Federal government tries to assuage depositors' fears by insuring each account's total deposits up to US$250,000.

As precarious as it may sound, most of that works just fine -- most of the time.  Every so often, however, bankers may be greedy or just plain stupid -- or both.  And that's when things go south very quickly.  This aptly describes the geniuses at Silicon Valley Bank (SVB), the piggy bank of some of the most reckless tech investors in the world.  Here's what happened:

If you didn't know, SVB is centered in the heart of the most woke, left-leaning, well-monied community in the country. These are people who, like my friend above, donate and support political candidates pretty much based on what little they know politically.  They're the same with their investments. And most of the time, it works for them.  

Remember that 20% reserve requirement? Well, like so many other bankers, the masterminds at SVB decided that simply holding that 20% in cash seemed awfully tempting.  After all, that 20% represented billions of dollars and it seemed a shame not to invest it.  So like other banks, when interest rates of Federal Treasury notes (bonds) started inching up from zero to 1.9%, SVB scooped up as many as they could find, telling depositors that these were safe, low-risk, government bonds.  To anyone not paying attention, that probably sounded like a smart move after so many years of interest rates being near zero.  

And that's where the problems started.  It sounded like a smart move. Because nobody knew enough to question it. The big secret about "safe" bonds is that nobody holds them to maturity. They buy bonds hoping future rates will go down, making their bonds more valuable to sell at a profit.

But this time, it didn't:  Because within a few months, all those bonds paying 1.9% were eclipsed by bonds paying well over 3%, which rendered those 1.9% jobs practically worthless.  SVB couldn't unload those bonds to anyone, because everyone was busy buying higher rate bonds.  Pretty soon, when SVB customers tried to withdraw cash from their accounts, there was no cash was available. Not for bills, payroll, or anything else.

Some people were told not to worry, because the Federal Deposit Insurance Corporation (FDIC) insured their accounts up to US$250,000.  That was all well and good until the bank revealed that only 2.5% of deposit accounts were valued at US$250,000 or less.  The rest of the depositors' accounts -- some 97.5% --  far exceeded that amount, ranging into the millions and even multi-millions.

Poof.  Gone. And that's when the state and the Feds closed down the bank.

At the time of this writing, nobody knows for sure how or when SVB will be bailed out. If recent history is any indication, ignorance, mediocrity and stupidity will create a program that will funnel your tax dollars into a program designed to save a severely corrupted system.  Nobody will be held accountable. And the people and politicians who knowingly allowed it to happen will likely suffer no consequences.

But at least now you know what happened and why.  Maybe that will teach people that when making really important decisions, there are many more important issues to consider than, say, messy hair.


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