[DDIntel] The Fall of Banking

May 21, 2023

The future of 722 US banks hangs in the balance as they face the risk of bankruptcy, with unrealized losses exceeding 50% of their capital, according to a recent briefing from the US Federal Reserve (FED). The closures of several banks have sparked speculation about a controlled demolition of the financial system.

The losses suffered by these banks can be attributed to the decline in the value of Treasury securities and bonds purchased when interest rates were low. The same financial authorities overseeing these banks, who also determine interest rate policies, are seemingly aware of the impending collapse. This raises questions about their involvement in a potential controlled demolition.

Systemically Important Banks (SIBs), including JP Morgan Chase and Bank of America, stand to benefit from this consolidation, as depositors tend to transfer funds to these larger institutions during times of uncertainty. The reduction in the number of banks aligns with the ease of implementing Central Bank Digital Currencies (CBDCs), which offer increased control and monitoring capabilities but come at the expense of individual financial autonomy and privacy.

China's implementation of its CBDC, the e-CNY, serves as an example of the potential dangers associated with such a system. While CBDCs offer advantages like transparency and efficiency, the erosion of individual financial autonomy raises concerns. It is crucial for society to engage in open dialogue and careful consideration before embracing a fully digital currency system. Understanding the motives and implications of these changes will empower individuals to navigate the evolving financial landscape effectively.

722 US banks may go bankrupt

The risk of bankruptcy for 722 US banks is closely linked to the urgent debt crisis the US is confronting, as the federal debt approaches the approved limit of $31.4 trillion. Extraordinary measures taken by the Treasury, such as reducing investments in retirement plans, provide temporary relief, but a long-term solution is required. Democrats and Republicans are at odds over raising the debt limit, with the House of Representatives passing a Republican-backed bill that includes spending cuts, while Democrats advocate for a clean increase with no conditions.

Treasury Secretary Janet Yellen has expressed concerns about the impasse and emphasized the urgency of raising or suspending the debt limit to meet obligations. The legislative process required for a bill to become law adds to the urgency, as it involves scrutiny, debate, and voting in the Senate, reconciliation with the House, and the President's approval or veto. Political division on the issue jeopardizes America's financial stability, raising concerns about a potential default and its ramifications for the US financial system.

Assessing debt manageability requires examining the debt-to-GDP ratio, which has surged from around 35% in 1980 to the current level of 124%. High levels of leverage strain the economy due to interest costs, and elevated debt-to-GDP ratios can lead to increased borrowing costs if a country's credit rating declines. Interest costs on governmental debt have risen, with America's annual interest bill reaching $604.40bn in 2022, representing a 50% increase in just nine years.

Although the United States defaulting on its debt is rare, it nearly happened before. To minimize the risk of default and its devastating effects, it is critical to promptly increase or suspend the debt ceiling. Additionally, long-term fiscal plans, such as spending cuts, revenue growth, and addressing structural economic problems, should be explored to ensure financial sustainability, and that America doesn’t run out of juice.

America is out of Cash

The financial landscape is extremely uncertain, following the Federal Reserve's decision to raise interest rates, coupled with a surprising surge of 253,000 jobs in April. While the positive job data offered a momentary respite, cautionary signs from leading indicators continue to emerge, suggesting an economic downturn may be on the horizon.

Despite a week of declines, the S&P 500 made a remarkable recovery, bouncing back by 1.85% in a single session. This resurgence leaves many questioning the long-anticipated recession. However, it is essential to recognize that leading indicators persistently point to the likelihood of an economic downturn. While they do not guarantee a recession, historical patterns strongly indicate its probability when negative signals emerge. On average, it takes around eight months for the US economy to slide into a recession after leading indicators turn negative, although this timeframe can vary significantly.

As the situation unfolds, the labor market, particularly in inflationary cycles, tends to deteriorate during a recession. Although employment in the residential construction sector, a crucial economic cycle indicator, shows signs of cooling off, a full contraction, a typical precursor to a recessionary period, is yet to occur.

Further analysis of broader employment data reveals a distinct slowdown in job creation, with the three-month average hitting its lowest point in the current expansionary cycle. This provides additional evidence of a cooling-off period, suggesting a high probability of an approaching recession in the months ahead.

Is Recession Looming?

While the fall of many banks and the Recession may spell doom for many Banks and other institutions, there are some who have proven to survive in the past.

In the midst of a banking crisis that rocked the United States, J.P. Morgan emerged as a pivotal player in stabilizing the industry. While other banks faltered, it was J.P. Morgan Chase that prevented the crisis from spreading further.

To understand J.P. Morgan's significance, we must delve into the history of its founder, John Pierpont Morgan. Born into privilege and driven by ambition, Morgan became a towering figure in finance. From starting as an unpaid clerk to establishing his own company, Morgan reshaped the banking industry through strategic investments and industry consolidation.

One defining moment was the Corsair Pact, where Morgan brokered a mutual agreement between rival railroads. This showcased his ability to stabilize industries and solidified his reputation. His most significant display of power came during the Panic of 1907 when he orchestrated a rescue plan to prevent a nationwide depression.

Despite the scrutiny, Morgan's legacy endured. Institutions like J.P. Morgan Chase and Morgan Stanley carry forward his philosophies of prudence and stability. They serve diverse clients and embody his enduring influence in the financial world.

The recent banking crisis reaffirms J.P. Morgan's critical role. As others faltered, the institution stepped in to prevent further contagion. This resilience positions J.P. Morgan to emerge stronger, cementing its status as a global financial leader.

Reflecting on John Pierpont Morgan's life and legacy, we recognize his enduring influence on modern banking. His unwavering belief in character and integrity, his ability to stabilize industries, and his establishment of thriving institutions all contribute to his status as a financial icon. While the economic building may fall, there will be some pillars that will not.