Is the banking crisis over? Depends what you mean by over

Bloomberg News

At 3 a.m. Monday morning, the other shoe that the banking industry has been anxiously waiting to drop dropped: First Republic, the next-most-wobbly bank after Silicon Valley Bank and Signature Bank failed in March, went into receivership and was sold to JPMorgan Chase.

If you count Silvergate Bank's voluntary self-liquidation in March — not a failure, to be clear — we've now had four banks not succeed in three different ways over the course of about six weeks. All of them had an over-reliance on uninsured deposits in common, all of them sought liquidity from the Federal Home Loan Banks and all of them ended up underwater on long-dated securities.

So the logical question to ask is: Is it over now? 

Some CEOs of the largest banks certainly think so. Jane Fraser, CEO of Citigroup, said at a conference Monday that "it's good to have really the last remaining source of uncertainty resolved," referring to First Republic's sale to JPMorgan Chase. JPMorgan CEO Jamie Dimon echoed that sentiment, saying Monday in a call with investors that, while "no crystal ball is perfect … the banking system is very stable."

In one sense they are correct. Any banks that didn't get the memo about unhedged interest rate risk and uninsured deposits a month ago certainly have received it by now. Earnings calls from midsize regionals last month seemed to paint the picture that deposit levels have stabilized and customers are no longer running for the exits.

But just as I write this, two more western regional banks — PacWest and Western Alliance — had trading on their shares halted because of precipitous drops in their values, probably because of investment downgrades related to broader concerns about net interest margin and increasing costs of funds. Ironically, a plummeting share price makes the cost of funds that much higher, but I digress.

The fundamental business environment for banks is challenging right now because the Federal Reserve did what it doesn't typically want to do: raise interest rates a lot, and quickly. The quantitative easing era loaded up the banking system with an ocean of low-interest loans — loans that are no longer competitive in the current interest rate environment. People have also gotten used to money being cheap, so it's more difficult to get borrowers to take out mortgages at 6.5% interest when their friends and neighbors got 2.5% mortgages two years ago. So replacing those old loans with new, profitable loans is going to be tough. 

But that's interest rate risk, and those risks can be hedged or mitigated. All other things being equal, that makes this moment a tenuous but tolerable time to be a bank. What we don't know is what is lurking around the corner, because as Dimon pointed out earlier, no crystal ball is perfect.

There are a couple of notable hidden risks out there bumping in the night. One is the possibility of credit losses. As has been noted in these pages for quite some time, commercial real estate exposures may be the new kiss of death in three months, playing the role for investors that uninsured deposits have played over the last six weeks.

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There is also the increasingly urgent problem of the debt ceiling, which, if not raised, could lead the United States to default as early as June 1. As I've said before, there are real reasons to be concerned that this particular encounter between Charlie Brown and the football won't end in laughs.

With all of that being said, it is not inevitable that regional midsize banks have to be an endangered species. Stock values are indicative of market confidence, but not necessarily a perfect indicator of solvency. If those banks whose stocks are tanking today are fundamentally sound, investors will figure that out and buy the dip. I also tend to think that there are more uses for empty office space than are widely appreciated, meaning that defaults may or may not amount to a widespread rash of bank failures. And, at least for now, the United States has never defaulted on its debt. 

To paraphrase Winston Churchill — or possibly Arcade Fire — it's never over. There is no perfect future where there are no unanticipated and unhedged risks, no regulatory or supervisory structure that catches 100% of management errors or malfeasance. But maybe a better question is: Are things getting better or worse for the banking industry? 

That depends on a lot of things, not least the way banks manage their risks going forward. After all, no crystal ball is perfect.