All eyes around the world are currently on the banking system and the shockwaves rippling through it?
How bad is the risk of further contagion?
What’s likely to happen next?
And how are bankers themselves looking at the situation? How worried are they?
To find out, we’re fortunate to talk with banking analyst John Maxfield today, he’s spent the past several decades covering the banking system and the players in it.
John Maxfield 0:00
If you go back in time, really to the beginning of the United States, we’ve had nine of these major panics. And there have been, I don’t know, like probably a dozen minor ones. So if really, they’re pretty common things, but when you’re in the midst of one, I think it’s easy to lose that context. Think like, Oh, my God, like the world is over, like banks are gonna go out of business. But really, it’s just, it’s a pretty regular thing in the financial system.
Adam Taggart 0:28
Welcome to Wealthion. I’m Wealthion founder Adam Taggart. All eyes around the world are currently on the banking system and the shockwaves rippling through it. How bad is the risk of further contagion? And what’s likely to happen next? And how are the bankers themselves? Looking at the situation? How worried are they? To find out we’re fortunate to talk with banking analyst John Maxfield. Today, he spent the past several decades covering the banking system and the players in it. John, thanks so much for joining us today.
John Maxfield 1:00
Pleasure to be here, Adam.
Adam Taggart 1:02
Well, John, I’m very excited for this discussion. This first time you and I are meeting face to face. You are referral from Edwin Dorsey from the bear cave, who gave a phenomenal interview on this channel, great young talent, really appreciate him connecting us in the connection could not be more timely with everything that’s going on in the world with the banking system. So lots of questions here for you. But But let me just start with a high level one. It’s kind of a variant of the one I like to ask everybody who comes on this channel. What’s your current assessment of the banking system?
John Maxfield 1:36
Well, you know that my current assessment is probably similar to everybody else’s, although maybe with a little bit more historical context. So we’re in we’re in the midst of maybe kind of the kind of moving towards the end of kind of a classic bank panic. And in a bank panic, what happens is, there’s concern that depositors will lose their money. And when that happens, there’s are there runs on the banks that they think that that’s going to happen at. So we saw that with Silicon Valley Bank, we saw with silvergate Wasn’t that it wasn’t a run, but there was kind of a similar situation where it voluntarily shut down. First Republic, we’ve seen it with them. So we’re seeing a lot of these banks losing a lot of deposits. And if you go back in time, can relate to the beginning of the United States, we’ve had nine of these major panics. And there have been, I don’t know, like probably a dozen minor ones. So it really, they’re pretty common things. But when you’re in the midst of one, I think it’s easy to lose that context. Think like, Oh, my God, like the world is over, like banks are gonna go out of business. But really, it’s just it’s a pretty regular thing in the financial system.
Adam Taggart 2:42
Okay, so regular thing in the financial system? Yes, banks go out of business all the time. And this was sort of one of the things that was being discussed two weekends ago. You know, I had, I had Joseph Wang here on the channel, he goes by Fed guy, he used to work as a Fed trader. So he really sort of understands how the the plumbing of the banking system works. And he was saying, Yeah, hey, look, you know, Silicon Valley Bank isn’t a systemically important bank, certainly not the way like a Lehman was. And we have a process for dealing with banks that get overextended and fail. And that’s what was happening the weekend, he and I were talking where the FDIC had come in on Friday, and was, you know, basically getting the bank ready to reopen the next week. So, you know, yes, we do have this process now. Silicon Valley Bank wasn’t, it was showing some some, it’s the right way to say it, maybe largest by the government, because they did have some fears. That yes, while it’s not a systemically important bank, there is enough fear going on right now that, you know, people may rush out to their other regional banks, and start withdrawing money and take what would otherwise be a well managed, well run bank, and put that in jeopardy, sort of an unnecessary bank run into that standpoint. So you know, we’re not just letting the system run, you know, itself autonomously. Here, there is some intervention that’s still going on here. And I want to, I want to go through, you know, sort of what the government has done to date and get your sense as to whether that was the right thing to do, whether there was maybe something else we could be doing. And obviously, this isn’t a US story at all, at this point in time. And headlines have been very focused on what’s been going on with Credit Suisse, which is a very systemically important bank. And I’m curious to see if you think that the the steps that have been taken there are right and sufficient or if you’re more concerned about contagion from that.
John Maxfield 4:45
Let me give you one other let me give you one other context that I think you’ll find interesting and kind of context for like thinking about this stuff. Sure. The thing about banking is that so in any other industry, what is the primary you face these these things? straits, right? And the primary constraint you face in virtually any other industry is scarcity. Scarcity of supply, scarcity of demand scarcity of real estate scarcity of employees, scarcity of everything, right? Banking, it’s the exact opposite. The primary constraint you face and banking is abundance, its abundance, managing when there’s too much of something. Okay? That’s, that’s why these liquidity surges, start these new cycles, okay. And so you think like, Okay, well, what does that mean? What does that like mean? Like in terms of like, running a business, and this is what it means, in if you’re running a regular business, your job is just like you’re on the planet Earth, and you’re facing gravity, you’re trying to jump up, and all the effort is trying to get off the ground, right? It’s all the effort, banking, it’s literally like you’re on the moon, all the effort is just to stay down on the ground, don’t grow too fast, don’t grow too fast. Everybody else is trying to grow. You’re trying not you’re trying to throttle your growth. So it’s like you they face the exact opposite constraints of a typical business and see, like, like, Why have 18,000 banks failed since the Civil War. This is why because humans are not designed to deal with abundance. And there just are not very many good bankers in this country. I mean, I could literally list out probably a dozen bankers that are any good in this country. And there’s 4700 banks. And I know a lot of them, you know what I mean? And that’s why, because we’re just not designed to do that. It takes like a warren buffett type mentality to be able to do that.
Adam Taggart 6:31
Yeah, that’s a great point. And of course, you know, you give somebody more money to a certain point, you get the problem of, I’ve run out of good opportunities for it, but I still have all the money and got to do something with it. Right? So that’s where it just makes the temptation from our investment. Much more, you know, that siren song much more compelling, right? Should I get all this money coming in? I can’t just sit it I gotta do something with it. And yeah, maybe that sounds like a good idea. Right? Okay. Sure. Right. And then you make the cardinal sin of banking, which is you make bad loans, right?
John Maxfield 7:05
Silicon Valley Bank. I mean, that guy just couldn’t Danmarks their CFO just couldn’t sit on 100 billion. And like, you think like, I look at that, I think like, because I my good friends run these all the hedge funds in the banking space, and they were talented. Like, Dan, your duration risk is to your two and you’re taking on too much duration risk. But Dan was saying like known n n n n n and now, our models say that these are non interest bearing deposits, and our models are telling us that non interest bearing deposits have seven year durations. You don’t need to because he acts like oh my god, I’m gonna make all this money and I’m gonna like make all this in my bonus in I mean, yeah, got it, you’d like it. This is just a huge fundament. It’s these are just huge behavioral flaws. That
Adam Taggart 7:48
is it true that they were flying without a chief risk officer for the last seven months or whatever?
John Maxfield 7:56
lose any one. You gotta you got, you got to wonder why the former chief risk officer left?
Adam Taggart 8:02
Right. All right. The timing on her part, though? Yeah. And I’m curious, do you think? Do you think that there will be you know, there’s the whole like a these, especially the top execs, you know, pay themselves big bonuses in the 12 months leading up? And if you think there will be clawbacks? Are there provisions for that in the banking industry?
John Maxfield 8:24
Okay, so like, now you’ve hit on like the thing, all right, this is the thing, and I am not anti rich. I’m not anti capitalist. I’m like an Uber capitalist, right. But if you’re an Uber capitalist, you’re not in favor of people stealing from capitalists. And you look at about the across the banking industry, right? And the attrition rate and banking is, I think there’s been 40,000 banks have either failed or merged, okay. And there’s call 5000. Today, just for math purposes. So eight times more have failed, emerged, okay, so your attrition rate is really high. Then you look at you take all the banks, United States, public and private. And this is what’s amazing about banking, you can get all the performance data of every institution, whether they’re private or public. And you take all of them, and you put them on a histogram. And what you’ll find is that the majority of banks do not earn their cost of capital. And then you look at like the inflation going on in pay for these folks, you think like, and they’re talking about pay for performance, and they’re bringing in these executive cops comp consultants who are like, oh, we need to pay these people more. Like it’s total bullshit. Okay. Let me just show you one more chart this this is like, this is like, kind of this gets to the crux of the fundamental issue. Where do I have that? See here. But let me show you this. Then you say, Well, what is the thing that allows somebody to deal in this context where you have to deal with abundance, not scarcity, what is that thing? And it is my and I feel pretty strongly about this. So here is if you take every single publicly traded bank in United States, you rank them by all time total shareholder return, so the total amount of value they’ve created since going public There’s two banks that are way out there on standard eat in terms like there’s three four standard deviations out. glacier up in Kalispell, Montana, of all places, and m&t bank up in Buffalo New York m&t Is the bank that I run the thing for that guy who who did this, okay? And good guy who runs glaciers very real good friend of mine, let’s see, say like, okay, like, they’re way out their way out there. And then you look at this, you say, Oh my God, those guys must be rich, they are rich. But how did they get rich? Here is how they were paid compared to their peers.
Adam Taggart 10:35
So yeah, they didn’t know that they were getting an overly generous, you know, equity package, they really had to demonstrate growth in their bank and their
John Maxfield 10:45
aides forced their boards to keep their pay low, the board’s like, we need to pay you more, we need to pay you more we need to pay rent, they said no. Like, no, that’s not what this is about, like this, that is not about taking every like nickel today, you know, at the expense of a dime tomorrow, these guys like, let’s just we’ll just like because it impacts the entire organization, you can hire better your people are happier, like, you can buy other banks easier because people trust you. It’s like, it changes the entire dynamic of the whole thing. And then that, then you have that, that that that that parabolic return curve that just goes straight up as a result of it. And so you look at this, and it’s like, I swear to God, you go through, you go through the 1980s. And you look at the top 10 Every highest paid every single year, you know what happened to their banks. Either they failed, or they would have failed, but for forbearance on behalf of the regulators because they were doing stupid stuff. Every single one. And so what you find is there’s this inverse relationship. We’re being told all this stuff. And this is not about getting rid not getting rich. It’s about getting rich on the right timeline on the back into the timeline, not on the front end. Because if you get rich on the front end time timeline, you’re doing stupid stuff with your loan book. You know what I mean? So it’s all mentality that like, you can really and so you go you look at who are the best anchors today. There’s a guy by name of Ross McKnight. Right, he runs his bank called interbank down in Texas, Oklahoma Panhandle. This guy’s a this guy’s awesome, awesome, awesome. How was the pay himself? $0. It’s like, it’s it’s amazing how clear the data is.
Adam Taggart 12:17
And so his incentive is whatever equity grant he was given. He’s just trying to grow the actual value of the bank, right? I mean, Ross owns
John Maxfield 12:25
100% of a $4 billion bank. Just real well, okay. And the same thing. So this is a bank this this, there’s a bank in Abilene that if you take every you look at every bank in the United States at their valuation, this bank trace, like three, four times book, your typical bank is on one and a half times book. It’s like nothing, okay? And it’s been trading like that for like 15 years. Like, why is because it’s just it’s consistent earnings, consistent, done, do stupid stuff in wild times, it doesn’t get punished and bad in the bad times. And when you look at how it CEOs paid, same damn thing. So it’s like, like, It’s uncanny. You know what I mean? How how simple this stuff is, but like this, this cottage industry of these executive executive comp consultants, like, they just have just come to come in and kind of take it over.
Adam Taggart 13:11
Well, and I’m sure the execs love that one to feed that consultant ecosystem, because it means bigger paychecks and grants for them.
John Maxfield 13:22
Yeah, when I started talking about this stuff to them, I mean, they want to like dig it. The tar the feathers?
Adam Taggart 13:25
Yeah, totally. Yeah. You’re, you’re the guy who’s basically yeah, ruining the party for them. So maybe if we can, let’s review the major developments real quick for folks. So first, everything was fine. You know, we were we heard for years, the banking system is strong, it’s much better capitalized than it was prior to the 2008 crisis. We shouldn’t worry about the banking system. Janet Yellen had famously said at one point, we’re never going to see another banking crisis. And not sure if it was our lifetime or her lifetime she was talking about. But basically trying to sell the story that look, no matter what happens, like the banking system is the most rock solid part of the story at this point in time, then all of a sudden, we have three bank failures kind of in a row, right? silvergate signature and Silicon Valley Bank, probably all for somewhat slightly different reasons, you know, silver gate was very exposed to what was happening in crypto, Silicon Valley Bank kind of had its own issues going on. But what what what created the opportunity for those banks to just all of a sudden keel over?
John Maxfield 14:31
Okay, so this is actually a really, really good question that kind of touches on how the system works as a system, the financial system works. So if you go back, you know, there’s cycles, right? Everybody knows that there’s these cycles that occur. And then there’s a whole bunch of cycles that occur all the time and any industries, there’s various cycles within industries. But if you just take the big cycles, there are these big cycles that the financial industry will go through, okay. And then there are these little cycles where if you think about if you think about the Big cycles, you have to go back to 1973 for the beginning of the last big cycle, okay, and I’ll talk about each one of these, but then you go back from 1973, you gotta go back to the 1870s. That’s the beginning of the big cycle before the one that begins in 1973. And then before that there’s a series of smaller cycles that happened kind of recurrently in the in that period between the revolution and in the Civil War, okay, but let’s take those off the table, because that’s kind of a different scenario, what was going on back then, if you look at the three cycles, and then just recently with the corona virus pandemic, that was the beginning of another cycle in the banking and finance industry, and I’ll explain why. If you go back to 1870s, okay. The what you saw back then was this is when the United States was emerging, kind of on the world scene, right? This is the American Industrial Revolution, right? Like the assembly line, all these things are coming, coming to fold, right. So we’re making tons of money, Europe is biting. We’re injecting all this produce into Europe. So we’re making a ton of money, a ton of money is flooding into the United States. What happens? It’s the birth of disposable income, the birth of disposable income happens in the United States. And so what happens is, all this money is floating flooding in and piling up, piling up, piling up. And what is the finance industry do it arbitrage is money. So it sees this huge pile of money. And it’s like, oh, God, let’s go arbitrage that thing. So everything since then that huge pile of money is built up is everything since it goes to in the 1920s, the craziness, the 1920s. There’s all these regulatory legal changes that happened in this period. And then the stock market flies up in the 1920s. And then it crashes in the Great Depression. And you have those regulatory changes that come you know, the FDIC and all these different things. And then that goes into what World War Two. So this goes all the way until 1973. Okay, this cycle right here from that big pile of money downhill until 1973. What happens in 1973 is a break in time, just like a cut. It’s like a fatter, you’re cutting the fabric of time starting all over again. What causes us to start all over again, the oil crisis in 1973. So yeah, the Yom Yom Kippur war, we support Israel, the Arab states retaliate against us by putting in an embargo on oil exports to the United States that causes oil prices to shoot up inflation to shoot up. Paul Volcker then comes in and causes interest rates to shoot up. There’s a mismatch crisis and all these things happen. And then that leads into the financial crisis of 2008. And Ben Bernanke, he wrote a big paper on this, and he calls it the global savings glut. So that’s the second big cycle of the modern era. The third one begins with the Coronavirus pandemic. And here’s why. So you think about that big pile of money with disposable income. That’s one huge pile of money. You think about the second big pile of money, which is this pile of money that is amassing in the coffers of these oil producing countries, their Euro dollars, because dollars, but they’re not repatriated in the United States, they’re just building up building up building up building a building up. So what are the banks want to do arbitrage that money? So they go and they arbitrage that money, right. So everything since then is been happening as a result of that. And then the Coronavirus strikes, and what happens a ton of money floods into the system a ton of money, right? You have the fiscal relief, you have the monetary relief, like look like what is like GDP in the second quarter of 2020 20. Like what it like on an annualized basis, it felt like 30%, right, which is huge is more than great depression. So the government comes in pours all this money into the system. And so now it’s starting to make its way out of the system. And the one thing that we know when liquidity makes its way out of the system, is that it never just quietly exit out the side door like banks, it’s way out the front. And so this was the first knock on the door that we’ll see. And this could be this will be this pile of money will probably define it could be 20 years, it could be 30 years, it could be 50 years, but that big pile of money will define the next few decades and banking. So this is the remember those two piles of money I was telling you about? Those. Here’s the two piles of money right here. So this is the one on your left. That’s your that’s your birth of disposable income. The one on your right and I swear just for aesthetic reasons I swapped I made it like look like that the one you write actually should be like going out the same way. You know what I mean? Yeah. See, the numbers are backwards. Yeah. So that’s, that’s Euro. That’s Euro dollars right there from that oil crisis. Now, here’s what’s that if you want to know like, what caused those two piles of money? Here’s it. Here’s here’s what it is. This is the entire history of the United States. Okay. This is the trade surplus versus the trade deficit. This is what it looks like, the first 96 years, every single year, but for four years was a trade deficit. It then switches every single year for 96 years, but for four years, I mean, it’s an uncanny is a trade surplus, then it switches back every single year since basically 1970 has been a trade deficit. Well, the key the key thing is here is that when you switch between when you have economy the size United States, it switches between a trade deficit into a trade surplus or trade surplus and trade deficit. Think about the torrent of money you’re dealing with. They’re huge amounts of money. So those are the things that begin the crisis that began those two eras, those two big piles of money, those switches right there between those two things. Wow.
Adam Taggart 20:15
Okay. So we’re obviously very early on in that story, if this was a multi decadal cycle, and it just started it with a pandemic, right. So we’re technically what, two years at most, into it here. And you’re sort of saying that it’s the receding of this money from the banking system that’s causing some of these, you know, weaker players to grow here. Alongside that, in the here, and now part of the cycle is that the Federal Reserve and other major central banks are tightening as well, which which cannot help the situation. And there is a big duration mismatch right now, and a lot of banks. And by that, I mean that banks make their money by borrowing short and lending long. They have these big bond books that have basically lost a lot of value as interest rates have risen so far, so quickly. And if you can blast until those assets mature, you’re fine. But if you get caught needing money in the interim, you have to sell those assets, those unrealized losses, now become realized losses, and then can very quickly get into trouble. And as the headlines have helped us understand that was really the big deal with with Silicon Valley Bank, because they, they had fewer larger depositors. You know, as those depositors left, they were having to scramble to try to, you know, basically get the cash to give the depositors and they were having to sell their book, and that’s what caused them to implode. But that’s not that. Well, it was extreme at Silicon Valley Bank. It’s not unique to Silicon Valley Bank at any point in time here. So where we are right now, today, you know, what do you expect? Do you expect that dynamic to continue? And if so, should we be expecting to see more bank struggle as a result?
John Maxfield 22:10
Okay, so what we’re seeing right now, and I’ll give just a little bit more context, and then I’ll get into, into right where we are today. Okay. So what happened in that? What caught what triggered the Great Depression, the stock market crash of 29, Federal Reserve policy trying to suck liquidity out of the system? What triggered the crisis in the early 80s? So yeah, the interest rates and when they shot up what was going on there, Volcker trying to suck liquidity out of the system, what is going on today, it’s the Federal Reserve’s trying to suck liquidity out of the system. So what happens is when you put it all in there, and these are sucking it all out, it gets uncomfortable. So that’s what’s going on right now. So these say, Okay, why is Silicon Valley Bank? Why is silvergate? Why is signature? Why are these banks at the forefront of this? Why are they kind of the canaries in the coal mine? Right? Well, there’s a couple of different reasons. So in the context of silvergate, right, like when you think of asset classes, and you think of the ones that are like the furthest out on the risk continuum, you’re talking about your cryptocurrency assets, right? Like, what do you nobody really even knows? I mean, it’s, we can even call them an asset. You don’t even know
Adam Taggart 23:16
you? Nobody knows what fair value is. Yeah. Nobody
John Maxfield 23:19
knows. These things are, you know, like, and so like, this is way out there. And what’s interesting in the silvergate, wasn’t even a bank, really, I mean, it was, but it wasn’t right. What silvergate Was, Is it was a trading platform that facilitated the real time, a 24 hour day, real time, frictionless transfer of cryptocurrencies between the people on his platform. So when those cryptocurrency prices crashed, and we just suck all that money out of silver gate, I mean, I think they lost something like 70% of their deposits over the course of like a week or two, and which is amazing that they even survived. So so that’s what was going on with them. So they made it, they made it to voluntary liquidation, which is like an incredible story in and of itself, that they weren’t actually shut down. Then you move over to a Silicon Valley Bank. Okay. Now, why is Silicon Valley Bank? Why is it the next one to go? Okay, well, we think back to where did all that liquidity go when it came into the system, think about what was happening at the time, really, like everybody freaked out, and then all sudden the IPO started surging, and everyone just wanted to go public, and those IPO prices were just going bonkers. Or tons of that money flooded into the IPO market found its way into Silicon Valley Bank, because that’s the people that the companies that this banks caters to, then what happens then that liquidity starts to dry up, those companies start to eat into their balances. So they silver so so Silicon Valley Bank has got to start satisfying those deposits. And so when they’re satisfied those deposits because they had $100 billion of deposits flooded and this is like a $60 billion bank, and then $100 billion flooded into that bank, and they take those and they buy bonds with these with all that because they’re treating these deposits as they would treat any other deposit. Right. They list all this money floods in They have to start selling their bond some of their bonds to take care of that. And then that triggers the panic of Silicon Valley Bank because they have to realize losses on their bond portfolio. So now we’re at the state where the question is, is, are people going to be concerned that other banks will have to realize losses on their bond portfolios, because there’s two types of bonds, right, there’s the held to maturity, and there’s available for sale, available for sale, you have to mark the market. So as interest rates go up, bond prices go down. The banks, if they’re in the held to maturity portfolio doesn’t really matter. They just hold them, they don’t have to adjust them for the value. But if they’re they’re in they’re available for sale, you do have to adjust them. So you got to mark them down, right? Well, that’s the concern that if all these banks have got the mark on their bond portfolios, I mean, I don’t know what the I don’t know what the stat is, but a good chunk of them would be actually probably insolvent. So the fears that you have used to solve these kinds of zombie banks that are insolvent, because of their marketing, they’re marking down their bonds, and then that is the thing that triggered those runs. And then to add insult to injury, in all of these cases, these banks had a very small portion of their deposits were actually insured by the FDIC. And so that it kind of added to that fear that people would lose their money,
Adam Taggart 26:16
right, they had a lot of what are called uninsured deposits. Particularly in the case of Silicon Valley Bank, you had these corporations that were the depositors. So when they tend to have a lot more money, and you know, they were putting it all into a single account at Silicon Valley Bank, which is really pretty bad treasury management on the behalf of a company, you shouldn’t put all your eggs in one basket like that. You combine that with Silicon Valley Banks, terrible risk management that it had, in addition to this duration risk we were talking about, it was just a recipe for disaster. And it was and the rest is history here. So what’s what’s interesting to me about this, and then I want to quickly get on to what the government did in the wake of these bank failures and get your opinion on whether it was the right thing to do or not. But what’s so interesting to me about this is there, there’s blame to be cast on on many sides here. But really, I placed the majority of it at the feet of the Fed, because the Fed kept interest rates, you know, pursued at zero interest rate policy and kept interest rates at really record lows for many, many years. And so the banks just reacted to the tune that the Fed was playing, right. And they got very used to a business model, that, you know, was basically predicated on rates continuing to stay low, not only did rates start to rise, but the Fed, you know, did a total 180 from being the guy who’s doing everything they can to suppress interest rates to all of a sudden raising them, the furthest in the shortest period of time that they ever have done in history. So I’ve been likening this in recent videos here to, you know, the Fed driving the car 200 miles down the highway, and then jamming on the brakes. Right, and then everybody on the banks or the bodies hitting the windshield, right at this point in time, right. So in many ways, what’s what’s, you know, with the banks are suffering from is just following the lead that the Fed had set for them, and now they’re getting, you know, a lot of damage as a result of it. I guess, first question is, is do you see that is what I stated? At least sort of statutorily true?
John Maxfield 28:32
Yeah, so yes, I kind of like your metaphors. I think it’s very accurate. But here’s the question, Adam. So like, I think it’s easy to Monday morning, Monday morning, quarterback, the Federal Reserve. Do you know what I mean? I think it’s the easiest step back and like, look, in hindsight and be like, you did it too fast. He kept rates low, too long. But then like, if you actually go through the exercise and say, like, okay, like, I’m going to put myself in their position. Like, it’s actually I think it’s much harder when you think about it. I think that same thing, my good buddy, Morgan Housel, who writes on the stuff, he talks about, like, you know, it’s easy for people to criticize and judge like these bankers, as these greedy, fat cut people doing this and doing that. He’s like, You don’t know how you would react if you’re in their situations facing their incentive structures and failing facing their constraints. And it’s the same thing with the Fed. So whether it’s a miss I don’t know if it’s a mistake, I guess, is what I’m saying. But certainly kind of the factual scenario lately you laid out is kind of how that did unfold. Certainly.
Adam Taggart 29:31
Yeah. Well, people respond to incentives and the banks have been responding to the incentives that the central banks had set for them until they changed the game right now look, a couple of things one, you know, I would never want Jerome Powell his job. I still can’t believe that he willingly signed up for a second term, knowing where this was all going. So I don’t want to pretend that I would necessarily do a better job in his shoes. That being said, when It won’t keep me from from doing some Monday morning quarterbacking. In obvious one there is I think the Fed should have been started hiking a lot sooner, right, or they should very least should have stopped all their, you know, asset purchases of treasuries and mortgage backed securities in 2021, as the inflation rates started rising, right. I mean, it was it was clear that they had a hand in making transitory last a lot longer than they thought it was initially going to work. But But that’s, that’s for the history books to decide. And there’s another issue going on here. With with banks, that compounds this, too, which is, and this is where I lay some blame at the feet of the banks is once the Fed started hiking the federal funds rate, the banks did not commence early, raise the interest rates that they were offering to depositors. So, you know, we’ve gotten to the point where we are now where banks are earning what four and three quarters or whatever, you know, on their interests on excess reserves for the Fed. And yet, they’re paying depositors still, on average across the country, something, you know, almost statistically indistinguishable from zero, right. And so what’s happening is money is beginning to flood to where it’s better traded, people are taking their money out, and they’re putting it in T bills that are yielding 4%. Plus, they’re putting it in money market funds at their brokerage. And I think a lot of these banks, you know, it’s too it may be too late for a lot of them to do this, because their capital impaired now and they just don’t have the money to be able to do this. But you kind of nodding as I’m saying this, but is that a factual? Or is is that? Is that a understandable outlook? Or do you look at it differently?
John Maxfield 31:41
Well, they’re, they’re, they’re important nuances. Okay, and so not, they’re not all the accounts where money is put on deposit, or equal in terms of interest rates, right, your transaction accounts, typically don’t pay any interest rates at a interest rate at all, you know, your checking accounts, those kind of accounts, right? You go over and your savings accounts that pay a little bit more your money market pay a little bit more than your CDs, if I can lock the money up for a while. They pay more so the banks have responded with their CD rates and in the money market accounts. And those things like those those have gone up.
Adam Taggart 32:16
Just just quite, I mean, am I correct? I mean, it’s only been quite recently they’ve done that. I mean, I remember last year, looking at the Delta and just saying, Come on banks, or you guys are just raking the money in on this on the arbitrage between what the Fed is paying you and what you’re paying us.
John Maxfield 32:30
That’s true. I mean, there is a lag between when the Fed drops the Fed funds rate and when and when the banks will drop their with their rates as well. There’s certainly a lag. I, you know, I don’t look at that as being like, egregious lag. Because there’s lags on the asset side of the balance sheet, too. I mean, these things all take time to adjust. And they’re balancing both sides of that balance sheet.
Adam Taggart 32:54
So maybe it’s not just nefarious as I thought it might be. But but it still is the dynamic that I outlined in play, which is that money is just choosing to go where it’s better treated here.
John Maxfield 33:05
Yeah, absolutely. That’s absolutely accurate. Yeah. And let me to point out to kind of build off your word nefarious. So one of the things that I have done is I’ve cultivated a network of really like the top bankers in the country. And like, I know these folks I know, personally, I know well, and like, it’s when you look on the outside, it’s easy to look at and be like, Oh, they’re like, like I said, like these greedy, fat cats are just like making money off of other people’s money. But like, at the end of the day, like these bankers are pretty exceptional people. Like, you go into small town, you go into like, city, like who’s sitting on the boards of like, the United Way, who’s doing the work with the Habitat for Humanity. There’s always always bankers there who’s raising the capital for the hospitals. I’m not a bank or banking apologist, but like I do, I’m around these people all the time. And I kind of see what they deal with and like
Adam Taggart 33:53
your folks, you’re saying, hey, look, they’re not moustache twirlers, you know, we’re right there. They’re, they’re doing their best, but maybe, you know, they’re, they’re, they’re doing their best to run an imperfect system.
John Maxfield 34:08
Yeah, I mean, what my grandfather used to say the what the last perfect man died 2000 years ago, you know, it’s like, we could all we could all cast aspersions on ourselves, I suppose.
Adam Taggart 34:17
Okay, so anyways, how big of an issue is the second one that I raised, which is the capital that’s leaving the banks, in addition to the duration Michmash we talked about earlier. Okay, so
John Maxfield 34:27
there’s so it’s not capital that’s leaving its liquidity is how you should think about it. And so there’s two different types of liquidity. There’s kind of the liquidity that sloshes around within a system. And then there’s liquidity that sloshes in and out of the system. So it’s that liquidity that sloshes in and out of a system that’s really problematic. That’s the type of thing that causes these beginnings and endings of these huge cycles. The liquidity that sloshes within a system isn’t as big of a concern on a macro economic level, but there can be banks that get like individual institutions that get caught All right. And so Silicon Valley Bank, it got caught in a liquidity situation. Right? Yeah. I mean, like, basically all the banks that are experiencing trouble right now are being caught in a liquidity situation. Right. But they’re not being caught because the interest rates in another place are higher, they’re being caught because people are worried that the money in those banks won’t be safe. So yes, I mean, you’re gonna see this money sloshing around. But the money always constantly, always sloshing around. I mean, that’s just kind of like, how it goes. But the one thing I would say about right now is that like, let’s, let’s take Silicon Valley Bank, okay? They go into this thing with $60 billion on their balance sheet. $100 billion plugs in their CFO is sitting there thinking like, what am I going to do with this? If I keep it in cash, which probably what he should have done, right? And then in hindsight, right, by keeping cash, what’s that going to do? That’s going to cause my return on assets to fall by two thirds to return on assets, which is the principal profitability metric that analysts track is going to fall to a third of what former sell. So then you have your investors and your analysts coming in on these banks and saying, like, what are you doing, you need to invest that money. So then he thinks he’s probably sitting there thinking like, Well, remember back at the time, we’re thinking lower for longer, remember that lower for longer, lower for longer? That’s what everyone was thinking back then lower for longer. So he’s thinking lower for longer? So I’m gonna go by now, should he have done this? No, I mean, hindsight is 2020. Right? He goes and buys $100 billion worth of mortgage backed securities, and treasuries that are that an average duration of seven or eight years, they’re way out there. Right. So that was the mistake. But if you put yourself back and you can see why that happened. It’s I think that that’s just important context.
Adam Taggart 36:39
Okay, it is true. And when you say that sort of 100 billion came in, and he’s making those allocation decisions, where are you thinking about those? Is that like, 2000, Atari 2020? Or, okay, so it was 2020 and 2021. Okay, so this was back stone, we had rock bottom interest rates, and it looked like we were just going to get more of the same because we were still in a pandemic, and everybody thought that the Fed was going to be, you know, largest for everybody forever. Okay, so. So, you know, the events being with had been these three banks died, the authority stepped in. Let’s talk about Silicon Valley Bank and signature, specifically for a second. So kind of in lockstep the fed the Treasury, the FDIC said, okay, you know, we’re gonna, we’re gonna protect 100% of the deposits in this bank. Right. And I think first and foremost, that probably was done to try to prevent the the first republics of the world. So first, Republicans, another Bay Area, regional bank, kind of fighting for its life right now. Some steps have been taken to prop it up, we’ll talk about in a minute, but you know, it’s the concerns around Silicon Valley Bank spilled over into first republic and are to a certain extent hitting other banks as well. And I believe the logic behind this, okay, we’re going to just cover 100% of deposits, was taken as an extreme step to just kind of quell fears, so that we wouldn’t have these other big bank rounds. You’re nodding as I’m saying this.
John Maxfield 38:13
Yeah, that’s exactly right. But if you remember, the first thing that they did was they actually didn’t say they’re going to protect 100%. In that first communication, after they seized Silicon Valley, they came out and said, We’re gonna give them these certificates that then once we kind of figure out the asset liability situation, then they can come in with those certificates and kind of turn those in. And then we’ll see how much they get is basically what they said in that first communication. And there’s that communication that triggered the contagion. At least that’s that’s what it looks like. Because then people were like, Oh, my God, like, they’re not going to cover all these deposits. So then they said, then people looked around, and there was a list going around. I don’t know if you got that list. There’s a list going around of banks that were ranked by percentage of deposits that were uninsured. Yeah, definitely. Yeah. So this thing goes around as those start the run start happening on all of those banks. So then the federal then the FDIC comes in and says, whoa, all right, you know, what? Does it change your plans? Well, we’ll, we’ll protect those deposits, we’ll make sure you guys get all of those. And so that’s what they that was the first kind of step that they took to kind of like back up kind of that mud that initial if you want to call it a mistake by saying they weren’t going to cover them all.
Adam Taggart 39:21
Okay, so let me ask you a question. That is still not clear to me. That so after this announcement, the world sort of interpreted this as Oh, well, the Fed just announced it’s going to backstop 100% of all deposits in the US retail banking system. And I don’t think that’s what they said, although I understand people intuiting that from the action. There have been some attempts to get clarity. Janet Yellen was getting grilled on this a few days ago. I what I took from from her answers, and right now we’re in the blackout period for the Federal Reserve, which will end tomorrow. So we’ll we’ll actually be able to have journalists ask questions of the Fed, and hopefully get some much needed clarity here. But as best we understand it right now, and this might be still news by the time this video airs because of the Feds conference. But it sounded like what Janet Yellen said was, No, we are only going to do this selectively, when there’s a supermajority of consensus that we should do it both at the Treasury and the Fed. And then I, Janet Yellen, the Treasury Secretary meet with the President and we agree it should be done. We’re basically going to decide when and if we need to do this on a bank by bank basis going forward? Is that your understanding?
John Maxfield 40:50
Yeah, that’s my understanding. That’s kind of how they do it. Because think about it like this, Adam, like to remember if you go back to the Oh, a crisis. And that’s the situation Ireland found itself in when it had to take over its banks and basically bankrupted the entire government. Like, it’s really, really, even a government as big as the United States can easily be totally bankrupted by bank. And that’s because banks can just grow. And literally, there’s infinite demand for credit. I mean, you can just grow up and you could grow back from like, I mean, if you really wanted to, okay, and you have the capital to do it, you could literally grow a bank from like, zero to a trillion dollars over the course of like, three years. I mean, it’s, it’s crazy what you can do, because there’s such a demand for credit. And so you just you want to be selective and careful about exposing your government’s balance sheet, to that kind of like that old situation, because because it can get pretty messy as Ireland found out.
Adam Taggart 41:41
Okay, so So the people who are interpreting right now that the Fed just basically took a massive step forward towards socializing the banking system. Sounds like that may be a extreme and maybe somewhat erroneous conclusion. I’m not trying to say it’s not erroneous at all, in the sense that, to a certain extent, the Fed and the Treasury are now going to pick winners and losers. Oh, we’re going to backstop that bank at 100%. But that one, we’re just going to liquidate. And depositors are going to get what they get, you know her from 80 cents on the dollar. So again, you’re you’re nodding as I’m saying this, but it sounds like barring a clarification from Jerome Powell. Soon, that’s sort of where we are in the story.
John Maxfield 42:24
Yeah, yes. So this is just how it always goes, right? Remember, oh, eight, we backs up city, we backs up Bank of America, we backs up all these banks, right? But then they even injected capital. Remember all that TARP money, they inject capital into banks. So it’s like, but then we didn’t turn into a socialist society, you go back, every single crisis is the same thing. The government steps in to Soto doesn’t get as bad as it could get doesn’t turn into Great Depression. You know, they do these things that like maybe at the time are unsavory, but then everything typically goes back to normal. And that’s, that’s, that’s what will happen here, too.
Adam Taggart 42:58
Okay. So in addition to saying, Hey, we’re gonna backstop these two banks at 100%, they also announced the bank term funding program, which was $25 billion. That, you know, basically is there to, to be tapped by banks, if they want to, as I understand it, if they’ve got kind of money, good. investments like treasury bonds, they can sell them at par, which the federal then hold, and, you know, eventually you hold long enough to get the maturity. But in the interim, the bank is using that to remain liquid, if it’s in trouble. I want your nodding as I’m saying this, I will say when I heard 25 billion, my initial reaction was, that sounds really small, right? If we’re having liquidity issues in the banking system, you know, you know, JP Morgan and a bunch of 10, other banks just put 30 billion in first republic, just to keep that thing going a little while longer. Like, I feel like that could be drained by just one bank in trouble. So I guess my question is, is, what do you think of that step of the bank term? funding program? Was it the right move? Was it a good move? Is it gonna need to be added to it my concerns about its size valid,
John Maxfield 44:21
so that the term lending facility is an important one, you pointed out, one of the most important part of it was that so they’re not You’re not selling your bonds, what you’re doing is you’re giving them to the Fed as collateral for loans. But when you give those those bonds to the Fed as collateral they give you, they give you the price of at par. So you get all your there’s not a discount as a result of the decline in value that comes with that came about as a result of the rise in interest rates. So that’s, that’s a key. That’s a key thing. Now the size look, who knows? That’s what I would say we don’t we don’t know if it’s gonna be big enough or not big enough. But what we do know is that Typically, when you make a facility like this available, it’s more its availability than its size or any sort of specifics that helps to stem kind of the tide of the crisis. Right?
Adam Taggart 45:12
You’re saying it’s kind of like an optics type of thing here?
John Maxfield 45:15
That’s exactly right. The people know, like, Okay, if a bank really needs it, it can go and get it, you know what I mean? So that can kind of stop and can slow the panic, which, which I think I think that, you know, it’s hard to say, you know, what, exactly what thing exactly slowed it or how much it slowed it? But that’s certainly kind of played into kind of the the response.
Adam Taggart 45:34
Okay. So maybe, maybe going back to my thoughts about it seem really small. You know, maybe what you’re saying is, hey, it was a good move, because you didn’t have to put that much money in play, to kind of make people feel a lot less worried that the banking system was going to be taken care of.
John Maxfield 45:51
Yeah, it’s the same thing with tarp. Although I’m TARP was obviously a lot bigger, I think it ended up being 800 billion or something like that. But it’s just the availability of these, like, it’s a pressure release valve, that if a bank needs it, it can go in and get it. And 25 billion is, you know, you cite it first republic, right, you have the big banks come in and put 30 billion in there, is that going to be enough? And nobody knows. But what we do know is that it lost something like $70 billion in deposits in a single day. So like, hard to say if that’s going to be enough or not, but just the fact for most banks, $25 billion is going to get you a long way.
Adam Taggart 46:24
Okay, so we also have banks that are going and using what’s called the discount window. And actually, the usage of the discount window has exploded in the past couple of weeks. So can you just really briefly talk about the discount window, how it differs from the bank term funding program? And also in your answer, if you can, you know, presumably, banks really don’t want to have to borrow from the discount window thing if they can help it because it does get reported. And it’s, I’ve heard it’s sort of akin to, like, you know, covering yourself in blood before you jump in shark infested waters, right, it just sort of lets the world know that you’re weak, and therefore, you know, bad things happen when the world knows that.
John Maxfield 47:09
Okay, so what is a central bank? A central or what is this Federal Reserve? The Federal Reserve is the central bank, what is the central bank? A central bank is a lender of last resort. Okay, so what does that mean? banks typically don’t I mean, they’re they, you know, you they make bad loans, and everyone does that a little bit here and there. But the typical issue in a crisis is not a capital issue, its liquidity issue. And that is, and you can read back all the crises in the past, what happens is, there’ll be people coming in to get their money. And it’s not that the bank doesn’t have the money. But it’s it doesn’t have the money in like, money form. It’s in bond form, or it’s in loan form or another type of asset form.
Adam Taggart 47:48
This is the Jimmy Stewart speech from It’s A Wonderful Life.
John Maxfield 47:52
Exactly. So they got to transfer that stuff over into cash, right? Well, when you get into and one of the middle in the middle one of these things your market sees up, or they demand huge discounts on any assets that are sold, particularly by financial institutions. So that puts these financial institutions into a real tight spot, right? Because if they sell those at discounted prices, then you can’t have a capital issue, right? And the capitalist, you can make insolvent and the FDIC comes in on Friday and gets rid of you, right? So what what you have is you have the Federal Reserve will step back and say, Okay, we’re going to open this window, the discount window, we will take certain types of assets that are risk free, and we will give a we will discount those will lend on those. So we’ll give you the cash for those. So then you just kind of you pointed out the fact that like there is this general, kind of a negative impression of banks that go to the discount window. And that is true. It’s unfortunate, but it’s true. And that’s because if that is the case, the presumption is that like, there is a higher demand for cash coming out of that bank, maybe because of a run or withdrawals, then they’re able to satisfy on their own or in private markets. So it’s just, it could lead one to believe that there is an issue. But really what you want in a situation like this is you’ll have the bigger safer banks come in and use the discount window as well. That’s basically providing cover for the banks that really need to use us. The big banks are just saying, hey, look, everybody’s using this thing. Don’t worry about it. So that’s why you’ll have the pickup in a discount with the window, use it. It’s not just because more banks need it. It’s because the response from banks also say, let’s go on to the discount window as well to provide cover for the ones that do need it.
Adam Taggart 49:32
Okay, and I’m doing this from memory. So this might be wrong. But I think the last chart I saw a couple of days ago on the usage of the discount window and the week after Silicon Valley Bank went down with something like I know I got in around 150 billion, so there’s somewhere in that general range. If that’s wrong, please correct me but but is it a concern that we’re seeing such a dramatic surge so quickly? So in usage of the discount window right now, like Does that say something about the banking system? Or should we feel relieved that, you know, these people have a backstop that they’re now using?
John Maxfield 50:11
Well, the discount window is one of those things where it’s not like it, like just gradually goes up. It just can’t when it’s one of the things that just goes up. When you need it, you just just goes up, right? Because panic strike like that, right? Panic strike unexpectedly and quickly, like Silicon Valley. I mean, that basically went down in a day, this is a $200 billion bank and went down in a day, you know what I mean, the Federal Reserve, the FDIC didn’t even have they couldn’t even take all a Friday to seize it. They had to go on Friday morning. And so like, the it’s those moments, right, when that’s happening, where the discount window demand surges, right, then, and so if the discount window is working, that’s what you’re going to see. So that’s a good sign, not a bad sign. I would say that this is just signs of that the system is working is how I interpret that.
Adam Taggart 50:57
Okay. All right. So the question that I’m working my way up to here through all this is kind of How worried should people be and and then also sort of a follow on, what do you think is going to come next, right? Is it going to be scarier stuff, or things are going to start? You know, looking better? Right? Before I get to those two questions, though, there are a few others that I want to ask here around current risks to the banking system. So we talked about duration risk, we talked about money deposits, leaving banks to go where it’s better treated, potentially, outside of the banking system, you know, treasury bills, Treasury direct as an example. There’s the general fear of just, you know, people get spooked. Right, and hopefully, that’s quieting down a little bit here. But one of the things that that’s doing is that is taking money from the smaller banks, and really, by smaller banks, I mean, like, almost like every bank, but the top six, because we have such a concentrated banking system, and that capital is going into those bigger banks, right? You know, if you’ve got your money in a in a regional credit union, and you’re worried because especially if you’re out in the bay area, where Silicon Valley Bank just blew up overnight, and everybody thought that was the white shoe bank out here, you’re probably thinking, look, my money’s probably safer in one of these really big mega banks, like JP Morgan, or Bank of America or whatever, right. So we’re seeing that money leave the smaller banks. Now. And here’s where I’m getting to, there are for these smaller banks again, so most types of loans, more of those loans are held by the bigger banks and the smaller banks collectively. That’s not the case with commercial real estate. The smaller banks own a much larger share of commercial real estate loans than the big banks do. And the commercial real estate industry is looking quite vulnerable. It has been because of the pandemic. And you know, all the companies vacating their office leases. But now with rates having moved up as high as they have, you know, you’ve got mortgages are much more expensive to maintain for anybody who had a variable mortgage or whatnot. So that seems to be a big shoe that’s about to drop on the banking system that’s going to hurt these smaller banks more. Similarly, the auto loan market really seems to be in the process of I don’t know if imploding is too strong of a word, but default rates there are really beginning to ramp up quickly. And it’s largely due to again, you know, dynamics that were created during the pandemic, that are almost making the auto loan market, I think, kind of like what the subprime housing loan market was back in 2008, where there were just a bunch of bad loans being made willy nilly to kind of anybody who could fog a mirror, during the, you know, the craziness, the pandemic, where, you know, people had hot money to spend and, you know, dealers were happy to get the loans. So how big of a concern are those two issues in terms of the health of the banking system going forward?
John Maxfield 54:09
So, well, let me let me address I’ll address that in a second. So there’s this idea of small banks and large big banks and where the where the money is flowing right now. And so to your point, there’s an argument that the money is flowing from the small banks to the big banks, because there’s an implicit guarantee of your JPMorgan Chase is your city’s your Bank of America is your Wells Fargo’s because like, the government ain’t gonna let one of those things go down or it’s gonna be a frickin disaster.
Adam Taggart 54:34
Sorry, but just to tie this back earlier in the conversation, when when Janet Yellen said, at our discretion, we’re gonna determine if we need to step in probability is all infinitely higher, they’re gonna step in and protect JP Morgan than random little, you know, regional bank of Poughkeepsie.
John Maxfield 54:50
Yeah, they will not step in for regional bank of Poughkeepsie, and they will step in. That’s exactly right. Get guaranteed on both sides of that, I think. Yeah, and So, but here’s the thing, and I’ve been talking to a lot of folks that are involved in these conversations right now. And, and I, you hear different? I mean, I talked to like dozens of bankers, I talked to people who talked to dozens of bankers, it’s like, there’s probably a few 100 banks in the immediate orbit. And like, it’s not, it’s not clear that the money is flowing out of the big small banks right now. It’s just, it’s just not clear. Maybe the data will eventually show that when the next call reports come out. But that’s not what I’m hearing. And maybe I’m not listening to the right banks. But I’m not hearing that from the bankers. I am hearing that from people who are making the argument. So whatever that
Adam Taggart 55:43
means, I think some of these companies like JP Morgan and Schwab and others are saying, Hey, we’re seeing inflows of of x, so that when he’s coming from somewhere, maybe not from the regional banks, but it’s coming from somewhere, it seems,
John Maxfield 55:55
we think about like, first republic, that was a big bank, 70 billion left in a day, 40 billion left in the day from Silicon Valley. So you’re already up to 110 billion from just those two. And then you got your Western Civ. If you take out if you just look at the baby quarantine the banks that are the targets of the runs right now. I mean, you could be talking, there’d be a half a trillion dollars in deposit outflows just from those right.
Adam Taggart 56:18
That might explain what there’s the vast majority of what they’re saying is what you’re saying. Got it?
John Maxfield 56:23
That would be my guess, but I’m not sure all I know is that we’re not from what I can tell we’re not seeing it from the little banks kind of scattered throughout the country. Okay. So so yeah, yeah, that element. Now, it’s the question is, so you’re talking of the two types of loans credit, those care, right, and the and the auto loans, and whether that’s going to cause a bigger credit issue? Well, let me let me add two more categories of loans to that two buckets, okay. Because this is where the small banks really, really are important. And that is ag loans, small banks make 80% of the Ag loans in the United States. Okay. And so you think like, why are there so many banks, United States, there’s, what 4700 commercial banks United States, I mean, the next largest country has like, like, 400, or something like that. And we look way, way smaller. Well, the reason is, like where we sit on the globe, like you look at the United States of America, I mean, this is like really good land. I mean, it’s like, you drive through like, like Iowa, you drive through Illinois, you drive through Ohio, you’re like, that’s a really, really good land, you know, I mean, like, really good farmland really good country, for a foreigner to grow corn to have like livestock. All of those loans are really bespoke loans. You gotta go. And you got to know like the farmer, you got to know, how does he treat his equipment? Like does? What does? How does it where does the water sit on his property? So those are all handled by people on the ground have these small banks. Okay. So that’s why we have so many banks. And that’s why those banks make all those loans. CRA is another one, again, series bespoke stuff, you’ve got to know the dirt, right, that you’re glinting on, and you got to like, how did that dirt perform in the last crisis, all these different things
Adam Taggart 58:00
in Sorry, just so folks can follow you, when you say CRA, you’re talking about commercial real estate, that’s the acronym for it?
John Maxfield 58:06
Exactly. Commercial Real Estate like, and you’ll notice, like when you study these things, like a certain piece of property will perform better or worse in certain cycles. And like, you want lenders who know how that piece of property is going to perform through cycles, that’s really just bespoke knowledge. Right? And so that’s why the small banks handle all those. So the concern? So the question is, is, given that small banks handle all of these things, is it a concern that small banks do not have an implicit government guarantee of all their deposits, basically, like the big banks? I, I don’t know the answer to that. Because you either say look like, we’re either going to insure all deposits or not, you know what I mean? Like, that’s a societal question. It’s not a banking question. That’s a societal question, because that’s part of the safety net, right? Like, we just have to that has to be a policy decision that has to be made, or you leave it up to the, you know, the regulators in the crises to make specific exceptions to it, and basically, let the little bank suffer at the expense of the big banks. But again, I’m not seeing the concern about the little banks right now. So it’s not as big of a concern to me that these loan categories are going to be impacted. Just because, like, I’m not seeing that impact that that people are kind of talking about in a theoretical sense.
Adam Taggart 59:23
Okay. It’s really interesting, and it’s useful intelligence to have so it sounds like in your, your conversation with these regional bankers, they’re at least not saying, Oh, my God, all my deposits are walking out the door. Right. So that’s good to hear. Right? And look, you know, one of the reasons why I’m really digging into this is we want to have a resilient, healthy banking system with a lot of competition in it. We don’t want to have all these small banks die off and just have the too big to fail banks get even to bigger to failure, right. So it’s good to hear I I, you know, I don’t know if we’ve necessarily seen the worst yet of what’s going to happen with commercial real estate loans and with auto loans. And obviously, the the higher for longer policy that’s going on right now is just going to hasten whatever implosion may happen in those markets. So I guess maybe it’s just a big TBD. But those do seem to be two areas where the regional banks are a lot more exposed. I know less about the ag world, I’m gonna guess it’s maybe not as vulnerable as fake commercial real estate is right now. But I could be wrong. Who knows?
John Maxfield 1:00:35
And that is the thing to keep in mind, Adam, is that there’s always cycles, you know, I mean, they’re like, they’re, there’s like, always cycles. So it’s like, yeah, they’re, they’ll credit losses go up, and credit losses go down. And so it’s like, it’s not, it’s not a scary thing, or like, unless I’m going to grow unless they go up to like, Great Depression type of levels, then that that could be a little scary, but like, it’s just an anticipate it should be anticipated. And so when you think about it from like, a person, you say, okay, like, why do I care? Why does it matter? What should I do about it, you know, what I mean? Like, basically, what it means is like, you just you got to build in some resiliency into like, your balance sheet. You know, I mean, like, if you really want to think about it on an individual basis, because like, these things happen, cycles happen, like, people lose their jobs when cycles when cycles occur. So it’s like, you can think of talking about any theoretical context. But like, on an individual level, it really is about like, being able to make it through those things.
Adam Taggart 1:01:28
So let’s get to that in just one second, because I think you’re making two really important points, there’s that one, but then there’s also look like, the natural progression of an economy is the boom bust cycle, right. And I’m one of those guys who will get on a soapbox and say that the the Fed and rest of government complicit has really tried to break those cycles, right? They’ve tried to have it always be eternal summer, right? And the more that you, you distort the system, inevitably you get the bust, but the bus is a lot worse than it otherwise would have been. Right? So you want these sort of healthy, shallower, boom, bust, you know, repeating cycles, and during a bust, you’re gonna lose banks. Right? That’s, that’s what happens, right? You know, my concern is more of a generic, you know, garden variety bust of the smaller banks, and more of like a conflagration that just ends up, like I said earlier, with a lot fewer smaller banks, and much bigger, too big to fail banks. And there is a chart, which I’ll find it I’ll put back up here, which shows the number of FDIC backed banks since the turn of the century, and they’ve been in decline. I mean, they’ve almost like cut in half. Right. So we are, to some, it’s a concerning trend, right? And from what I’m hearing you say is like, Hey, you’re you’re not at a DEF CON level one, you no worry about that, at least not yet from from the folks you’re talking to, which is good. So feel free to opine on that and any way you like, but to your second point. So, you know, there are bank failures, you know, good years and bad. You could say, Hey, as long as you got under 250,000, you really shouldn’t worry, because if your bank fails, FDIC is going to come in on a Friday afternoon, and your banks gonna be open on Monday, you’re gonna get your money back, and you can decide whether to keep it in the new bank or walk it across the street to another no harm, no foul. Are there other things that you would recommend people do on the individual side of things to build resilience here?
John Maxfield 1:03:34
Yeah, there are, but let me kind of share my screen. I do. Yeah, I’m gonna show you. Because your your point about the your point about the let’s, let’s look at this one. The population of banks, the United States is really good point. Okay. So here is this is if you take the population of banks going all the way back to the beginning of the United States in 1800. So 10 years after Washington was inaugurated, for the first time, okay, this is what the population of banks looks like, okay, sees these huge buildup this huge, so it’s a kind of flat flat, flat, flat flat, in around the 1860s 1870s, it starts to turn up, and then there’s a relatively sharp turn up in the 1880s 1890s. And then it just shoots higher, right, mastered exponential look at that, as the shoots higher, and then that top point there is around 31,000 banks at that point. Okay, that’s 18, that’s 1921. And then in the 1920s, there was this, there was a drought across the United States. And so just 1000s of banks were failing every year in the agricultural areas. So that starts to go down. And then the Great Depression when we had all those bank runs, and 3031 and 33. And we have a bunch of failures then and then you know, FDR had the bank holiday and then we didn’t open up a whole bunch of banks after that. So then that’s when that comes down and it goes on that flat kind of there’s been a flat flat toe that goes across see that that plateaus, known as the Great moderate Asian, that plateau is a function of risk appetite in the banking industry is like nothing, right? Because all these people live to the Great Depression. They’re like, we don’t want any more of that.
Adam Taggart 1:05:10
The generals are all fighting the last war. Exactly. We’re like,
John Maxfield 1:05:14
No, thank you. Yeah. So they’re like, they’re they’re pedestrian profitability, they’re not taking any risks, blah, blah, blah, blah, blah, right. So no failures, nothing else is really going on there. No bank, not a lot, a lot of bank creation. But then when you see that tail, that kind of spikes up right there. That’s after that oil crisis, right. And that’s when you have all that money building up in another place to see these, all these banks flooding in because interest rates are going higher, so you can earn more on your loans. And then at that peak of that tail is 1985. And that year is significant, because that was the year that’s a Supreme Court said the banks have the the banks that that states can give banks the right to merge like to have interstate banks within regional compacts. So like, like Connecticut can agree with Delaware that the banks can bank across Interstate lines in those two states. So when that that was a dam that broke, and then that opened up the way for all the consolidation, so then the laws were changed. So then you can bank across Interstate lines, you can have branches, all those things. So then that’s what opened the way for, for the consolidation that you’re talking about right now. Okay. But here’s the important thing to recognize about this whole chart. So there’s those individual kind of movements in each of the chart and that chart, but then there’s the whole, you got to step back and look at the whole thing. Look at like the whole thing, okay, and what that whole thing is, is a huge bubble that was brought about by the birth of disposable income. That’s what this whole thing is, okay. That’s the story of banking in America, banking, disposable income was born here. All these banks shoot up, since the feds are founded to like, arbitrage that money, and we are still coming down from that. Now the question is, how far down do we come? And this is like a big question in banking. And here’s what everyday people just like, throw at these random numbers, these like what a thought leaders are ever like anybody who calls himself a thought leader, of course, like, you got to wonder about that. But like, yeah, when you they throw out a number, like, what are you basing it on? And here’s what you should base it on. Okay. The reason we still have so many banks in this country, relative to other countries, and we do have probably too many, right, because it’s a fungible product. So it’s like it’s really competitive. Right.
Adam Taggart 1:07:29
And that is true. Just interrupt, folks, if you’re watching this in the US, you know, we’ve been hearing a lot from our Canadian counterparts recently, when we talk about being concerned of ending up with just a few banks, they’re like, Yeah, welcome to our world. You know, we’ve got just like, you know, single digit number of banks, you can bank with here in Canada,
John Maxfield 1:07:45
but look at their economy and look at our economy, like half of Canada’s covered on ice. This is like,
Adam Taggart 1:07:52
Hey, pick a fight with the Canadians in the comments.
John Maxfield 1:07:57
I’m not picking a fight with them. I’m just saying like, you don’t need banks in those areas, making loans. We have all this farmland where you need banks on the ground making loans. And so the thing that will, that will dictate the number of banks that we end up with in the United States is the consolidation in the ag sector. That is the thing that will dictate it. If these big companies move all the way down, and they pick up these all these individual farms, there’s the no reason for a bank to be the one that spreads the risk, because the risk of the spread within the industry, right? But so long as you have all these individual farms all over the place, we will there still going to be a demand for 1000s of banks, the United States just because like you need to make those bespoke loan products for those for those banks. So that’s, that’s what this is it this is about a bubble coming off of the birth of disposable income, and how far we go will be dictated by consolidation in the ag sector.
Adam Taggart 1:08:51
All right, interesting. So for those that are concerned about bank consolidation inside the US, you really have to understand the story of agriculture in the US to see where the puck is headed.
John Maxfield 1:09:01
That’s exactly right. That’s exactly right. Yeah. Let me show you one other chart in here that you might find interesting. Let’s see, where am I going? Okay. This goes to your point about the Federal Reserve. Okay. And, and the, and the, the regulators and the policymakers responses and crises. Okay. So this is this is all the major bank crises in the history of the United States. All right, it starts back in 1809. Then we have one in 1819 1837 1857, the Civil War, then you have 1873 8093, the Great Depression, and then over on the far right, you have the there’s like all those crises that struck in the 80s and then you have the financial crisis. Okay. What do you one thing you notice when you look at all these crises is what you notice a double bump, right? Bump, bump, bump, bump, bump, bump, bump, bump, like, what is that right? What is that double bump? Here’s what it is. You have the so you have a kid credit bubble that expands too far. And then that naturally the economy natural reacts, starts sucking that liquidity out of system, you have bank failures. Okay? So that’s that first spike. But then what happens next, then you have the policymakers come in and change a whole bunch of stuff to try to make the situation better. But almost invariably, they make it worse. And it causes another spike in bank failures. And this is the same thing, all the way through all the crises, but for the financial crisis of 2008. So you say, Well, why was the literally that was the first crisis in the history United States, where we did not have this double bump of bank failures, okay? And why is that it’s because the guy who was running Love him or hate him, the guy who was running the Fed, at the time, was an expert on the Great Depression. And he knew that, like, what you do is you just come in, because the Federal Reserve really screwed the pooch on the Great Depression. Okay. And he and so he knew that what you got to do in situations like this, you just got to come in and give it all you got. And then that’s the that’s what they did. And they just basically took care of it. one fell swoop.
Adam Taggart 1:11:02
Wow, that’s fascinating. It does help you one of the things that I’ve really enjoyed about this conversation is, and if you’ve got another chart to grab there feel free, but is you’re really helping us see through the eyes of the banker in terms of how the bankers think and see the world. So Well, here you start,
John Maxfield 1:11:31
this is just another I think you’ll just find it interesting. Okay. So there are in any industry in any discipline, there are similar charts, right? That are like, you just should just know what this chart is. You should be like, like, burned into your it’s kind of seared into your memory. Okay. But then there are several shapes of charts. Okay. So in banking. One of the simple shapes of charts you’ll see is like this one right here. This is Citigroup’s annual earnings going into the financial crisis, okay, up, up, up, up, up, up, up, and then just crashed overnight. Okay, and they crash way down. Okay. So this is like one of those seminal starts like, in I’d like to think about this as like, you know, everything is fine until it isn’t. And that’s what it is, everything is fine. Everything is fine. Everything is fine. And then it isn’t right. It’s like the leaves Turkey metaphor, right. So this is the extreme version of this, I play this, when I go, I just ran a banking, supposing for the top bankers, the United States and Philly two weeks ago. And so when I go and visit CEOs, I’ll take these, I’ll make these really cool charts about their banks, but I’ll kind of mask them and and make them not immediately apparent what it is. And then I’ll slide them across the table to see Yeah, and I’ll say, what’s that chart. And then they’ll sit there and they’ll process it for a couple minutes. And then we’ll have this like, really rich conversation about it, because it’s my interpretation of their bank. And it’s kind of it’ll be different and variability than their interpretation. And so I did this, this game with this whole room of like these top CEOs, we put up this big chart on the screen, it would say, you know, what’s that chart, then we’d have a conversation about it. And so this is one of those seminal shapes. But this is these are you can find 1000s of these literally 1000s of these in like in the banking industry history. This is the cumulative earnings of a bank that was an Arkansas, okay, cumulative, and is founded in 1994. So that you add each each year’s earnings up. And then in the financial crisis, it lost so much in one year, that it’s cumulative earnings went negative when negative net Yeah, and what this is important to realize, because banks are highly leveraged institutions, okay. Like this idea that banks need more capital. I mean, what’s crazy? Adam is like, we came out of the last crisis. Okay, the 2008 2009 crisis? And what’s the lesson we learn? What is the thing that’s codified in the legislation? We need more capital, right? We need more capital, the banks need more capital, blah, blah, blah, blah, blah, right. And so you can tie that to a specific book that was written, called, I think, as the banker has no clothes. And it was about like, the this is all caused of too much leverage and not enough capital. Okay, so we go and we raise capital requirements. So what do they do like, raise capital from, let’s say, from 10? To 12%? Right? Like, what is that? Like? It does nothing. It has no impact on the banking system. Because why? Because if you’re making bad loans, it doesn’t matter if you have 10% or 12% capital, it’s all going to be gone. It’s all gone. Right? And so when you think about this, it’s like, there’s almost needs to be a level setting of the thought process around banking and how to secure a banking system and it cannot be founded upon capital, because that is just not going to do it. The way I think about and articulate is that like, everybody says, a capitalist King right capitals, King capitals, King capitals king, but the reality is a capital is not King. It’s more like the court jester. Confidence is king. You need people to believe in you and that’s how you secure the banking system is by doing things that secure confidence, not by promoting this idea of capital, which isn’t gonna work, you know, in the worst, and then within the worst case anyways.
Adam Taggart 1:15:08
Alright, so a different way to say that would be to say, to make sure that when things get wonky, you were doing everything you can as the guys running the system to let people know you’ll do whatever you need to, quote unquote, whatever it takes to rescue the system if need be,
John Maxfield 1:15:27
in which is what we’ve seen, right over and over and over again.
Adam Taggart 1:15:30
Okay. Like I said, that you’re really helping us, you know, crawl into the mind of a banker and the central bankers and how they look at the world here. All right, well, so three, three last questions for you as we wrap up here, and they’re all pretty big questions. One is, given what you know, the system right now, we didn’t actually get a chance to talk about Credit Suisse much. But that is a more systemic bank, the risk of contagion of something going bad there is a lot higher than the smaller US banks we were talking about. But given everything you know about what’s going on right now, and what the authorities are doing right now, How worried should people be a little medium a lot?
John Maxfield 1:16:12
I mean, okay, this is gonna sound trite. Okay. But I would say that you’re wasting your time, if you’re being worried, like, Okay, you should go do other things like, Well, what good is it going to do to be worried? Like, are you going to like, this is what I do when I get worried. I like eat like 50 Oreos, as not gonna do me any good. I mean, trust me, my wife will attest to that. Like, the system works, the system is fine. We don’t have huge credit bubbles, like we did in subprime mortgages back in 2007, that led into 2008. We’re just not seeing that. Right. So yeah, we may have a garden variety recession, right? Like those happen all the time, right. But the world doesn’t go into hell, everything’s not gonna break. I mean, everything is just fine. So I would just call for it. And again, this sounds trite. Like, just chill, and just like, go to work, do a good job, mow your lawn, clean your kitchen, like, just do the normal thing that everything will work itself out.
Adam Taggart 1:17:12
Okay. Okay. So again, just from your purchase a guy that has spent, you know, the past 15 years or so following the banking industry, and who talks to bank CEOs for living, you’re not seeing anything that’s making you raise a flag to say, Hey, everybody, we gotta we gotta really watch out for a contagion of Phil bank sweeping across the country,
John Maxfield 1:17:32
doesn’t mean we’re not going to see more failures. Okay, that that
Adam Taggart 1:17:37
is you and I talked about, you know, irregular resetting irregular bust cycle, you’re going to lose banks, right?
John Maxfield 1:17:43
This is not irregular, if anything, if you compare this to all the other past crises, this is a little baby crises. Little baby one. Okay. It’s like this, like, the one in 1884. The one 1907, a little baby one, not a big one. And let’s, I mean, I guess it could get worse, but there’s no reason I like not that I seem to think it’s going to turn into one of those ones.
Adam Taggart 1:18:02
Okay. So then my next question, maybe, maybe you’ve already kind of answered it, which is what comes next? And maybe your answer is not that much. Like, you know, what, we’re just kind of the system will run the way that normally does. Yeah, we might lose some banks and more weaker banks as this goes along. But you’d lose them in every recession. Is it pretty much going to be that way? Or is there anything else? Extraordinary? You think we should be keeping our eyes out for
John Maxfield 1:18:27
inflation, everything will be inflation is the issue? Right? It was inflation that caused the Federal Reserve to raise rates as far as fast and as far as and as fast as they did, which is further and faster than they’ve ever raised rates even faster than 1881. Okay. And so like, if inflation continues at its 5% 6% rate, I mean, that’s that’s problematic. You know, let’s, let’s be honest, because the Federal Reserve as a legal mandate to stop that. And
Adam Taggart 1:18:56
so he’s starting to wrap it, how problematic is it for banks, that Powell is likely to continue hiking from here, right, making that duration problem worse?
John Maxfield 1:19:08
Well, there’s two slugs, there’s two sides of the duration of that of that coin, right. Like, on the one side, you have what’s going on in securities portfolio and how that impacts security prices of securities, right. But a lot of those are in the held to maturity, the majority of those aren’t held to maturity. So like, really, man, just forget about those. Right. So there is that but then we’ve now been through the pain for the most part of what’s going to happen there. They still need some more, but like we’ve been through the pain
Adam Taggart 1:19:37
of the new facilities to help ameliorate it. Yeah, exactly.
John Maxfield 1:19:41
Banks have been waiting for higher interest rates. They’ve been waiting for rising rate environment because their loan portfolios. I mean, one of the problems that First Republic had was he was making loans at like, percent and a half on these junk mortgages. I mean, like, you’ve the bank has got to be able to earn more on that money, or else it goes out and does stupid stuff. Okay, so there’s two sides of the coin, I would say that by and large banks would be better for my rising earnings by by rising interest rates, because the loan books are so much bigger than their securities books.
Adam Taggart 1:20:11
Okay. So then when you go back to inflation is have some we should expect is that is that, is that have an impact on the banking system, per se, you’re just saying is people, we should just be aware that inflation is still around?
John Maxfield 1:20:24
Well, yeah, so like, so. So, then you have in the banking system and inflation, so inflation goes up, like you shouldn’t anticipate a recession will come about if inflation stays high, right? Like, it’s almost a guarantee that the Federal Reserve is doing its job. Okay. Now, the question is, in the banking sector, if you’re, if you’re a bank, and you make good loans, it’s like, I mean, it’s like, it’s like, Christmas morning, right? Because your your portfolio will make it through that thing, just fine. Your competitors who are not as prudent as you are, will not make it through as well. Right, but you can go buy them for like pennies on the dollar, right. So there will be higher credit losses in the banking system. But by and large, the majority banks make pretty good loans. And so the higher the more money they will earn from their their interest, their net interest, you know, their their portfolio of interest earning assets, relative to their interest bearing liabilities, that will outweigh your credit losses over a multi year period. But again, like, there’s the there’s the recession for the individual, and then higher job losses and stuff like that, that’s that’s kind of what I was referring to, but being worried about the inflation.
Adam Taggart 1:21:27
Okay. All right. So just to put a little bow in this sounds like you would say, just sort of as a, a regular citizen of the nation, you know, be more worried about inflation, and its impacts on your particular lifestyle and situation versus, you know, a collapse of the banking system right now.
John Maxfield 1:21:46
Save money. That’s what I always say, save money, always save money. Always save money. Whenever you know that I don’t like, Oh, absolutely, always have money, always have money stored away. There’s this idea in America that like I love America, like I love American anatomy, but like, there’s this idea that like, everybody wants to be rich, but that’s actually not what people want to be right. They just want to spend a lot of money. You know, in their mind, they equate being rich with spending a lot of money. Now, you gotta you hang out with rich people. And what do they do? They don’t spend any money. I mean, like, there’s a reason for that, right?
Adam Taggart 1:22:20
We interviewed William Danko on this program, who was one of the co authors of the seminal book, The Millionaire Next Door back in the 90s. Right, which was a survey of Self Made Millionaires and actually, of all millionaires. But what they found was the single most common attribute of Self Made Millionaires was the fact that they had very frugal lifestyle. Right? frugality was quality number one. All right, well, I jotted this but a really great discussion. Like I said several times, you know, you’re really helping us sort of think about the banking system, the way that the bankers themselves, think about it. And I find that very helpful and instructive. Really appreciate you coming on here. For folks that have enjoyed the discussion. Maybe meeting you for the first time in this interview, where can they go to learn more about you and your work? So I write it
John Maxfield 1:23:07
for a number of different publications. But the best way to find my my work is to on Twitter, Maxfield on banks is my handle. And then the other thing kind of go back to the very beginning of our conversation, Adam, to get back to Mr. Edwin Dorsey convinced me to start a sub stack. And so I’ve started to sub stack. And I’m really producing a lot of I did a lot of research over the last 15 months, this verb proprietary, and I haven’t released it yet. And so that’s going to be the place where I release all that research. So if you’re interested in banking, and really what is on like, the cutting edge, kind of like out on the vanguard of banking, you will want you’ll find your way to at some point. But if you find if you find it through this podcast that that’d be awesome, too. Great.
Adam Taggart 1:23:50
Well, what’s the URL? substack maxvill. Don
John Maxfield 1:23:53
Adam Taggart 1:23:55
Got some stacked.com substack.com. Yeah, great. Okay. So Jonathan, when we edit this, I will put up the URLs to both your Twitter handle and your substack there’s people know exactly where to go. Thanks so much. Very quickly, folks. Just want to remind folks that their Wealthion online conference was this weekend. If you didn’t get a chance to attend live and you’re kicking yourself, don’t worry, you can actually purchase replays of the entire conference over at wealthion.com/conference. And a reminder to that, you know, if you’re, you know, wrestling with decisions about you know what to do with your money, given a lot of the topics that Jonathan I talked about here. If you don’t have a good financial advisor to act as your counsel, in that decision making process. Feel free to talk to one of the financial advisors that Wealthion endorses, just go to wealthion.com Fill out the short form there. We have a free consultation with the guys doesn’t cost you anything. There’s no commitment to work with them. It’s just a free service that those guys offer. Jonathan, thanks so much. Really appreciate Get the time here today and look forward to having you back on the channel again in the future.
John Maxfield 1:25:03
It pleasure Adam.
Adam Taggart 1:25:04
All right then Well folks, look if you’ve enjoyed this conversation would like to see Jonathan back on the channel. Please do me a favor support this channel by hitting the like button and clicking on the red subscribe button below as well as that little bell icon right next to it. Jonathan. Thanks so much again, buddy. Everybody else thanks so much for watching.
Transcribed by https://otter.ai