Banks are adjusting to the new normal — if it can stick around

Bloomberg News

Baseball, for all its advanced sabermetrics and weird stats, is fundamentally a superstitious sport. Yes, there's the weirder ones like where players won't wash their uniforms if they're on a winning streak or not touching the foul line on their way on or off the field. But the best baseball superstitions are for the fans: Changing seats and turning your hat inside out if your team is down late in the game, or not talking about a no-hitter in progress (or preferably not talking at all) are important pieces of the experience, and a big part of what makes it fun.

One of my favorite superstitions in baseball — and the occasion I have long been waiting for to allow me to talk about baseball in a banking column — is the superstition that Philadelphia baseball teams have the power to tank the economy.  

The Philadelphia Athletics won the World Series in October 1929, just weeks before the stock market crash that ushered in the Great Depression. The Phillies won their first World Series in 1980, just a few months before the Federal Reserve raised the federal funds rate to its all-time high of 20% — and were still reigning champs when the economy went into recession in September 1981. And of course the Phillies last prevailed in 2008, just as the Great Recession was getting underway in earnest. 

It should be possible to have both a thriving economy and a World Series champion from Philadelphia — we have bad economies and bad Phillies teams at the same time, so there's no inherent reason why the reverse shouldn't be true. But as of yet, we've never seen it, so this is entirely in the realm of the theoretical. By the time I'm sitting down to write next week's column, we very well may know whether the Phillies are going back to their second World Series in a row, and we may have another chance to find out if the Phillies really are cursed or not.

At the considerable risk of sounding optimistic, I think this could represent the best chance we have yet had of Philadelphia going all the way and the economy not hitting the skids — even more so than when the Phillies went to the World Series last year. Part of that is because the Phillies have gotten hot at exactly the right time and have a stacked lineup that can put up big numbers against whoever is on the mound. Good pitching beats good hitting, but the Phillies have a way of finding the bad pitches and making you pay for them. 

But a bigger part of that is because banks have a tendency to be at or near the center of gigantic financial crises, and despite a very concerning rash of midsize bank failures earlier this year, the sector seems to have stabilized.

Deposits

Profits soar at JPMorgan, Wells Fargo as they defy deposit pressures

October 13, 2023 5:47 PM

Third-quarter earnings season is upon us, and so far many banks — particularly the largest banks — have been doing surprisingly well. The biggest risk to banks from this spring's unpleasantness was the risk that deposits would continue to flow out of banking and into higher-yield venues like money market funds. Something like $300 billion flowed out of the banking system in those early days, and that combined with falling share prices and underwater securities created the necessary conditions for banks to fail without having a chance to put their houses in order.

That risk seems to have abated, with JPMorgan and Wells Fargo reporting solid deposit stability and beating their earnings targets, and even Bank of America — which was more deeply mired in underwater securities than its megabank peers — beating its earnings target and reporting 200,000 new accounts last quarter. Even Charles Schwab, which was among the banks that concerned investors the most earlier this year, reported that deposit flight has stabilized and they can make up some lost ground with interest income tied to variable-rate products.

That's the good news. The bad news is that the squeeze on net interest income will continue — and perhaps get worse — as customers become more accustomed to getting decent returns on savings. The other bad news is that things are still tense in the midsize regional bank tier. PNC has announced layoffs as part of a general contraction in lending activity, KeyCorp has likewise refocused its efforts on bread-and-butter lending and Truist is actively looking for ways to cut $750 million in expenses. And the much-feared reckoning on commercial real estate lending — particularly for office space, but also retail — could be a serious drag on bank profits in the next 3-6 quarters. And, of course, there is the lingering specter of regulatory capital adjustments to add to the pile of things that go bump in the night.

But what is encouraging to me is that there seems to be among bankers an expectation that they can and will adjust to meet these new realities — particularly the higher-for-longer interest rate environment — rather than moping and looking for some kind of bailout. Certainly banks would like to see regulators not add insult to injury, but ultimately that will be for a court to decide. All other things being equal, banks would like interest rates to be lower — but for that to happen in the near-term, there would probably necessitate a broader deterioration in the economy, which cuts both ways. In the meantime, banks can hack it. 

Now, as always, the biggest risk to the economy is the thing that no one is thinking about — like a global pandemic — or the collapse of some pillar of strength, like stock valuations in 1929 or mortgage-backed securities in 2008. The slow grind of war in Ukraine and prospect of more of the same in the Middle East is concerning, but doesn't necessarily rise to that level — at least for now. Banks, in other words, have adjusted to the new normal — the concern is whether they will have to adjust to an even newer normal, and fast.

So is it safe to root for the Phillies in the World Series? I'd give it a tentative yes — just diversify your portfolio first.