The banking industry has moved from panic mode to a state of high alert with regional banks nervously waiting for more fallout from the ongoing liquidity crisis. Getting through the weekend without another bank failure was critical.
But Treasury Secretary Janet Yellen threw a monkey wrench into the Biden administration's response to the crisis last week by saying the government would only support uninsured deposits for banks that pose systemic risks to the financial system. Uninsured deposits would be covered in the event that a "failure to protect" them "would create systemic risk and significant economic and financial consequences," Yellen told the Senate Finance Committee on Thursday.
Yellen's remarks sparked fear and worry among uninsured depositors — particularly corporate clients and small businesses — over whether their bank qualifies as systemic. After the failures of Silicon Valley Bank in California and Signature Bank in New York, regulators protected all uninsured depositors at both banks and created a new lending facility large enough to cover all insured deposits in the banking system.
"Yellen's remarks were absolutely destabilizing, and what it did was it left the holders of uninsured deposits with dramatic uncertainty as to whether they should stay at their existing banks or move the funds to a too-big-to-fail bank," said Peter G. Weinstock, partner and co-practice group leader of the financial services group at Hunton Andrews Kurth.
Now some observers want the Fed and FDIC to guarantee all depositors to stave off further bank runs. Weinstock said the FDIC should immediately reinstitute the Temporary Liquidity Guarantee Program, which was adopted in 2008 during the subprime lending crisis to calm market fears and bring stability to the banking system.
One of the program's two components, the Transaction Account Guarantee Program, guaranteed all domestic noninterest-bearing transaction deposits in full. Currently the banking system has $10.5 trillion in uninsured deposits and $7.4 trillion in insured deposits, according to the FDIC.
Most retail deposits are fully insured and pay little interest. But some observers worry that unless the federal government takes more decisive action to protect depositors, small businesses and corporate clients with deposits at small community and regional banks will rush to the exits and try to move their deposits to the four largest retail banks.
"This needs to happen immediately because it's the only way to give small businesses and holders of uninsured deposits comfort that they can stay where they are," said Weinstock. "We need the deposits to stay where they are. Prudential regulators can say it's systemically important to do this, and they can do it. We have had experience with it, and it worked."
Though the authorization for the 2008 program has expired, regulators could invoke it again under the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, the $2.2 trillion economic stimulus bill passed in 2020, Weinstock said.
Rod Dubitsky, a former advisor at the asset management firm Pimco, agreed that bringing back the 2008 crisis-era program would calm markets.
"Reinstituting TLGP will definitely help and will be the howitzer needed to stop the liquidity issues," said Dubitsky, who managed some of the largest post-financial crisis issues. "But it is a radical step."
Bankers at smaller institutions are particularly concerned about being left out in the cold and of regulators picking winners and losers that could force more depositors to flee.
Some observers are faulting the Fed for keeping rates too low for too long, and for then raising rates too high too fast starting in March 2022. Federal Reserve Chairman Jerome Powell has raised rates by 4.5 percentage points in just nine months, an unprecedented increase that led, in part, to the current problem: underwater securities portfolios.
At the Federal Open Market Committee meeting on Wednesday, the Fed may again raise rates or hold steady. Before the two regional bank failures, the consensus was that the Fed would hike rates by either 25 or 50 basis points because of persistently high inflation and jobs numbers.
Many banks invested in low-yielding and long-term loans and bonds during the pandemic, when they were flush with deposits and rates were low. Now they are being squeezed by a higher cost of funds as well as deposit run-off, as depositors have fled to the safety of money market funds. Meanwhile, the market value of many securities that banks purchased when rates were low have dropped.
"Bank assets are hard to liquidate even in the best of times, and this is a liquidity crisis," said Scott Alvarez, a former general counsel at the Federal Reserve Board during the 2008 financial crisis.
Some banks have rushed to raise cash to cover rapid outflows of deposits. But doing so could mean selling securities at a loss and cause further panic,
Already a coalition of midsize banks is asking regulators to extend FDIC insurance to all deposits for the next two years. Doing so would "immediately halt the exodus of deposits from smaller banks, stabilize the banking sector and greatly reduce the chances of more bank failures," the Mid-Size Bank Coalition of America, a trade group of roughly 100 banks, wrote in a letter to regulators, according to
Early last week, demand for liquidity by regional banks
"We have passed through the hardest part of this crisis, since customers are not taking their funds out of most retail banks," Alvarez said. "The bigger problem is, what do we do next?"
Kevin Jacques, a former senior financial economist at the Treasury Department in the George W. Bush administration, said panicky investors could still spark contagion, but it likely won't be systemic.
"Will we see more bank failures? Yes, I believe we will," said Jacques, a finance professor at Baldwin Wallace University. "You can almost feel the market churning and asking, 'Who's next?' There are some banks out there that are going to have some problems."
The Fed's Bank Term Funding Program, which was announced on March 12, has started to serve as a supplement to the central bank's discount window, its standard last-resort lending facility. Under the new program, which is designed to help banks, credit unions and other eligible institutions shore up their liquidity, the Fed is making loans that are collateralized by U.S. Treasuries, agency debt and mortgage-backed securities. The Fed is valuing the collateral at par.
Last week, banks received $152 billion through the Fed's discount window and $11.9 billion from the Bank Term Funding Program, according to
Some experts, however, are critical of some of the Fed's programs.
"The Fed is taking enormous risks," by funding securities above market value via the new program, said Dubitsky, founder of the People's Economist, a fintech startup. "It's a really bad precedent."
While there may be no magic bullet, experts have identified several other ways the Fed, Treasury Department and the FDIC could restore confidence to further increase liquidity and stem deposit outflows.
"One thing that has to be considered is whether the Fed, Treasury and the FDIC come out with a broader statement of support for deposits for a stated period of time just to quell any concerns," said Stephen M. Cross, a financial industry advisor at Alvarez and Marsal and former deputy director at the Federal Housing Finance Agency and former bank regulator.
On Monday, California State Treasurer Fiona Ma called on President Biden to fully protect 100% of business and individual account deposits "until full confidence is restored in our banking system."
"Banks of all sizes — large, regional, and community — should be included," Ma wrote in a press release.
Some observers think deposit insurance should be raised above the current $250,000 threshold to something much higher, specifically for small businesses.
Sen. Elizabeth Warren, D-Mass., speaking Sunday on CBS's "Face the Nation," suggested that Congress should raise deposit insurance from the current $250,000 to between $2 million to $10 million. After the financial crisis in 2008, the FDIC raised its deposit insurance cap to $250,000 from $100,000, and the higher limit was made permanent in 2010 by the Dodd-Frank Act.
"Small businesses need to be able to count on getting their money to make payroll, to pay the utility bills," Warren said. "This is a question we have got to work through. Is it $2 million? Is it $5 million? Is it $10 million? It is one of the options that's got to be on the table right now."
Raising the deposit insurance limit would require approval by both the Democratic-led Senate and the Republican-controlled House.
"This may be the kind of issue that both sides could agree on because it doesn't involve taxpayer funding," said Alvarez.
Other potential solutions run the gamut from having the Fed buy and finance underwater securities and whole loans at par; issuing zero-interest rate convertible notes for troubled banks; and providing guaranteed asset protection that would shield a potential buyer from the risk of losses.
While some experts compared the current liquidity crisis to the savings and loan debacle of the 1980s, others suggested that banks are on the verge of a rerun of the 1907 bank panic that led to the creation of the Federal Reserve. The
But Jacques expressed hope that the fear of the last week and a half will subside, in light of the capital that banks have built up since the 2008 crisis.
"Capital is supposed to function as a cushion against unexpected loss — and it's doing exactly that," Jacques said.
Jordan Stutts contributed to this story.
