Rates, Populism, Banks Shift To Private Markets

Rates

The Fed raised rates by 0.25% yesterday, as originally anticipated two weeks ago. That was before Powell spooked markets with talk of higher rates for longer, and then regional banks fell apart due rate hike induced bond losses. Despite all of the noise, the predicted 0.25% hike occurred. The next hike is over a month away, with another CPI release due in April. Currently, rates are at 5%, while the last CPI reading was 6%. Powell, and everyone really, would like to see those numbers cross. This rate hike cycle is nearing its final chapter. Powell mentioned during the conference that FOMC members expect lower rates in 2024 and 2025.

Due to an emergency situation, FDIC uncapped their $250k deposit insurance and quickly bailed out all impacted customers. That support can be viewed as money printing or further quantitative easing, which is a reversal of the policy to tighten financial markets. Furthermore, bailouts like the SVB situation can be interpreted as fuel for populist narratives.

Populism In Markets

Meme stocks in 2021 and many parts of crypto are examples of populism expressing itself in financial markets. First Republic Bank and Silicon Valley Bank cater and market to elite clientele. The optics are not great when those institutions get bailouts for mismanaging their risk obligations. Simultaneously, Bitcoin has surged dramatically and Balaji Srinivasan, the former CTO at Coinbase and major crypto figurehead, started an energized marketing campaign claiming Bitcoin will go to $1m within 90 days. Balaji’s thesis centers around an imminent collapse of the financial system and hyperinflation. 

The original meme stock, Gamestop, also surged 40% after earnings this week. Populism thrives on emotion in a crisis and an us-vs-them anti-establishment narrative. These types of investments come with millions of followers, endless reels of content and outlandish predictions. It’s important to be aware of these ongoing political and market forces because they represent real dollars and are not really driven by any traditional financial models.

Shifting Banking Functions

There’s a worry out there that collapsing regional banks will dry up credit, which will add to the slowing of the economy. Small and medium sized banks are responsible for 38% of all oustanding loans. This seems like an inevitability as deposits flee small banks for the safety of large “too big to fail” institutions, but I’m not so sure that credit will dry up. It’s possible, or even likely, that small banks were 38% of the market specifically because of the local relationships they have with customers. The demand to borrow capital is still there and there is plenty of capital out there searching for yield. Private market lenders have been growing steadily since 2008 serving clients that “too big to fail” banks could no longer support due to regulation. The gap in credit demand can probably be filled by private credit funds seeking yield on invested capital. It’s not good news for small banks but it doesn’t have to be negative for the broader economy. 

For what it’s worth, it sounds like private credit funds may be a more structurally sound system for providing credit. Private credit managers have a fiduciary responsibility to protect investor capital while earning a return on their investment. Banking institutions have mixed responsibilities. Banks earn a spread on customer deposits by loaning that capital out and keeping the difference for themselves and their owners. Customers don’t want their checking accounts to have any risk whatsoever, yet their deposits are tied to opaque risks. Broadly speaking, I’m not sure we should be funding credit with government guarantees on checking deposits. There’s plenty of investment capital that can serve that purpose and earn a yield at the same time.

Most people use checking accounts because they want to be able to store and send money. To the average banking customer, a checking account is more of a technology service. Tangentially, the S&P financial services index is finally adding Visa and Mastercard to their index. Previously those companies were in the information technologies index. As a whole, the financial services sector lags in adopting new technology.

We mentioned last week that not many banks support crypto, but it turns out there is a small and growing list of crypto-friendly banks compiled and maintained by Wolf & Company.