March 14, 2023
At Husker Harvest Days in 2021, I had a grower ask me if the U.S. would ever switch its currency to crypto amid the rapid rise in Bitcoin, Dogecoin, NFTs, and others. I sort of dodged the question at the time because crypto was so hot and so new. And I didn’t want to invite the wrath of the crypto bros into my sphere – for obvious reasons.
But in truth, I was mystified that anyone would think that tying something as critical to the world economy such as food exports to a relatively new, unstable, and unproven asset that IS NOT, in fact, a currency was a viable economic idea. My suspicions proved correct with the recent bank failures at Signature Bank and Silicon Valley Bank.
I was comforted yesterday when the U.S. Treasury Department assured the markets that federal tax dollars would not be used to bail out depositors at Signature Bank and Silicon Valley Bank. But having worked in the trenches as an ag lender in a past life and hailing from a family of bankers, I think we all need a refresher on how we got to this point in the banking industry and why it is significant for all consumers – and farmers – going forward.
A brief history of banking
The Glass-Steagall Act of 1933 separated commercial banking (i.e. your operating line of credit and real estate notes) from investment banking (i.e. raise money for companies, governments, and miscellaneous organizations using large, complex financial transactions). Glass-Steagall also created the Federal Deposit Insurance Corporation (FDIC) after the devastating stock market crash in the late 1920s that ushered in the Great Depression due to rampant securities speculation.
What is the difference between the two? Capital reserves for commercial banks are required to utilize more stable securities like bonds that are less likely to see a risk in sudden price changes to preserve depositors’ balances.
The price tag of the Great Depression? GDP fell by nearly half between 1929 and 1933, from $104.6 billion to $57.2 billion (not inflation-adjusted). It was catastrophic and is increasingly disappearing from current memory as that generation passes on.
The Gramm-Leach-Bliley Act (aka Financial Modernization Act of ’99) repealed the Glass-Steagall Act provisions that separated commercial and investment banking. The reduced regulatory environment allowed for commercial and investment banks to take greater risks with depositor dollars, which fueled the Great Recession and financial crisis of 2008. It also improved bank communication with customers regarding information-sharing practices (silver lining!).
The 2008 financial and housing crisis was a direct result of banking executives taking advantage of the Gramm-Leach-Bliley Act. Essentially, investment bankers incentivized commercial banks to prey upon low-income families and individuals, selling them subprime mortgages at adjustable rates. The investment bankers then bought those subprime mortgages from commercial banks, combined them into larger securities and traded them.
But when interest rates rose for the homeowners, the payments became unaffordable, and it caused the whole housing market and financial system to collapse. As a result, over $2 trillion (not adjusted for inflation) in value disappeared from the global economy, shrinking global GDP by 4%.
The Dodd-Frank Act passed in 2010 following the ’08 crisis to curb the risky lending practices that led to the financial meltdown. It also sought to strengthen capital reserve requirements for banks that eventually played a role in last week’s meltdown.
Ever since the Economic Growth, Regulatory Relief and Consumer Protection Act in 2018, legislators have been paring back those lending and capital reserve requirements for regional banks (of similar size to Signature and SVB) and attempting to weaken regulations that ensure middle class consumers are protected from risky Wall Street behaviors.
How regulatory failures triggered the current crisis
Both Signature (5%) and SVB (7%) had below-industry average levels of cash (13%), which limited their liquidity. SVB also had a high ratio of fixed-income securities (55%) compared to the industry average (24%), which further increased its risk as these securities are derived from debt products that are more susceptible to value shifts amid rising interest rates. Plus, a staggering 88% of deposits at SVB were not covered under FDIC’s insurance umbrella of $250,000 which is TERRIBLE wealth management customer service for any bank.
Translation: Signature and SVB made big bets on tech start-ups and cryptocurrencies that have eroded in value as consumer spending is drying up. They also relied heavily on debt-derived securities that have lost value as the Federal Reserve inevitably raised interest rates to cool inflation.
With the 2018 repeal of some of the Dodd-Frank capital reserve requirements for banks, SVB and Signature were able to get away with such concerning capital reserve practices that clearly deviate so far from the industry norm. These failures over the past several days suggest that the Dodd-Frank regulations need to be revisited and strengthened if stability in the banking industry is to be ensured for depositors.
Around $100 million disappeared from the stock markets last week. SVB sold off its $21 billion portfolio of securities (stocks, bonds, T-notes, crypto, etc.) at a $1.8 billion loss. The shady capital reserve structure for both banks and investment of capital reserves into questionable assets (CRYPTO and other misc. startups) is not likely to spill over into further bank failures – these were just two banks that didn’t manage current market conditions competently.
And friends – I have a low threshold for incompetence.
At the core of this issue is this: Main Street banks continue to suffer from Wall Street’s mistakes, even 15 years later. The i-banks were bailed out in ’08 but millions of middle-class Americans struggled to find jobs, pay rent, and build sustainable wealth. I had many college classmates struggle to find employment during that time, so I have personally seen how Wall Street’s missteps can limit an entire generation’s financial future if not managed effectively.
I come from a family of bankers and have a banking background – I’m not naïve to the plight of banking regulations. Commercial banks are held to a more rigorous level of oversight than their investment bank counterparts. But ensuring the financial viability of the middle class is a more sustainable economic option than allowing investment banks to make risky bets at the expense of the taxpayer.
What does this mean for farmers?
The banking system is safe, and this event should not be cause for any panic in Farm Country. But it serves as an opportunity to improve your financial acumen and take a closer look at the financial institutions on which we rely to sustain the businesses that support our families.
First and foremost, this raises into question the certainty with which the Federal Reserve will continue to raise interest rates. “There is a saying that the Federal Reserve raises interest rates until something breaks,” Nick Timiraos wrote for the Wall Street Journal yesterday. “A big surprise over the past year had been that nothing broke.”
The Fed is balancing its fight against inflation with financial stability. It remains unclear how the SVB and Signature Bank failures will impact Fed rate hikes, so all eyes will be on any comments made following the next Federal Open Market Committee meeting next Tuesday and Wednesday.
For those of you who work with investors to lease land and/or capitalize on future ownership opportunities, ask to see their balance sheets. Grill them on their organization’s capital reserve requirements and structure. Request to see their investor prospectus to see what they have been investing in lately and determine if they are in a sustainable position to weather upcoming financial market volatility.
You don’t want to be left without access to a crop planted this spring if they are receiving their funding from questionable debt products, cryptocurrency (“It’s something that affects the world and shouldn’t because it’s imaginary.” – my husband’s insightful analysis of crypto) and NFT products or struggling technology companies and suddenly bleed dry as interest rates continue to rise this year.
In the meantime, there is easier action to be taken. As more growers seek to utilize working capital in favor of high-interest rate operating and intermediate-term loans, it may be prudent to work with your banker to make sure your deposit accounts are structured in a way that provides maximum protection under the FDIC’s $250K deposit limits if you are nervous about the banking system (but again, you shouldn’t be worried).
If you feel so moved, you can call your legislators and remind them of the importance of banking regulations that protect Wall Street from ruining Main Street (again). If you’d prefer a more inquisitive talking point instead, you can ask them how much big banks contributed to their latest election campaigns.
Our January 2023 Farm Futures survey found that farmers had slowed grain sales late in 2022 even as commodity prices soared. But if the economy is suddenly facing murky waters, commodity prices will likely soon face headwinds. Futures prices, though declining as of late, remain profitable – if you book sales now. An uncertain time may be fast approaching and as ever, a bird in hand is worth two in the bush.
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