Moneybeat: How to pick a good bank

MARY REICHARD, HOST: Next up on The World and Everything in It: the Monday Moneybeat.

NICK EICHER, HOST: It’s time to talk business, markets, and the economy with financial analyst and adviser David Bahnsen.

He’s head of the wealth management firm The Bahnsen Group and he’s here now.

David, good morning!

DAVID BAHNSEN: Good morning, Nick, good to be with you.

EICHER: Well, David, the only way we’re going to stay on top of our listener questions, I think, is to start with listener questions, so we’ll do that today. And I think it helps that they’re all bank- and Fed-related, so they’re certainly connected to the news of the week.

So let’s begin with Bethany Gutman from Southern California:

BETHANY GUTMAN: Hi Nick, Hi David. I’m hoping you can help me to understand the bank failure headlines. Can you define simply what a bank failure is and why it matters? Additionally, what, if any, effect could bank failures have on credit unions? Thank you!

BAHNSEN:  So in a nutshell, a bank failure is simply when the assets of a bank become less than the liabilities of a bank. And because a bank’s liabilities include the deposits it’s holding for customers, which is money that may be demanded to be returned to their depositors at any point, it’s a tricky deal because banks don’t know when customers are going to want their deposits back. They have to keep a lot of their own capital liquid to always have enough assets and enough liquidity to meet the demands of their customers.

Bank failures are rare, because you don’t generally have depositors asking for their money back all at once. But almost always, a bank failure follows a situation in which customers demand their money back all at once, and almost always, customers are only doing that because the underlying assets of the bank are perceived to be—or really are—in trouble. The banks which experienced failures in 2008 were holding a lot of bad loans related to the housing market. There’s been over time a lot of commercial real-estate loans by certain banks that focus on lending, and doing business loans to certain sectors of the economy that get in trouble can create impairment in the value of the assets the bank is holding. And if those assets drop below the level of liabilities, then the bank can fail.

I believe that what happened was Silicon Valley Bank more recently is extraordinarily weird, because there wasn’t a credit impairment. And yet, there was still a run on their deposits for other reasons, all of which makes the situation unique. I don’t think that there’s a particular connection as far as this situation having any large effect on credit unions. There’s the general worry that confidence in any financial institution could be undermined by the present worries about smaller banks, but a credit union is essentially a bank that is owned by its customers and that is set up as a not-for-profit. It has different rules and regulations, but the economics or the math of it are still the same. They bring money in and they lend money out and try to capture a spread. But they don’t do it to the benefit of their shareholders; they do it to the benefit of the entity which is owned by its own customers.

EICHER: Next question, David, comes from T.J. Menn. He has a series of questions on what the Federal Reserve calls its “interest on required balances” rate.

My understanding, he says, is this rate did not exist prior to the financial crisis [in 2008], but now that it does, and now that interest rates have increased quite a bit from zero, is the Fed having to pay massive amounts of interest on these reserve balances?

By paying interest, is the Fed essentially restricting the money supply and suppressing inflation because the banks are less willing to lend this money than if the reserves were not earning interest?

But, by paying interest, is the Fed not just increasing reserve balances—thus making it easier for banks to lend?

If the Fed were to lower the rate or stop paying interest, would it not result in banks lending more money?

[Bottom line:] How should we think about the Fed’s interest on required balances?

BAHNSEN: Just to give listeners context: The Federal Reserve began doing something called quantitative easing after the financial crisis. They would buy treasury bonds and in some cases mortgage bonds, like Fannie and Freddie, from financial institutions. So in those cases that financial institution would get the cash from the federal government and the Fed would get the bond. There’s no new money created one way or the other, except for the fact that the Fed is buying it with money that didn’t exist.

But then the United States government still has to pay back for that bond, right? And so they’re holding these bonds receiving the interest income. And they are crediting and paying interest to the banks for the banks holding extra monies in their reserves, and they’re able to finance this from collecting interest on the bonds that they own from the government.

And so the listener who asked this question is exactly right. That in a sense, by paying interest on the money that the banks are holding in excess reserves, it’s motivating the bank to avoid lending that money out. The only time you get new money creation is when you get new loans; when there’s new money being borrowed, there’s new money being created. So many people who predicted inflation out of QE one, QE two, QE three, and it never happened: This is the part they were getting wrong. That money was not circulating in the economy, it was staying on the excess reserve of the bank’s balance sheets.

And yes, one of the many reasons why this is is because the banks were receiving interest from the Fed. They had an incentive to not lend that money out. They could either lend the money out and get a little profit while assuming the risks, or they could not lend the money out, take in smaller profits, but without taking on risk. And that’s really what that kind of tension was all about.

But then the other astute point in the listener’s question is that right now, interest rates are much higher than they were before. It was one thing when the Fed was paying out a quarter of 1%, but now they’re having to pay out more money. But at the same time the Fed is collecting more money, because they own all these bonds that themselves have a higher interest rate.

So yes, they’re paying more money out now in reserves. Yes, the reason is to keep that money from circulating. And, yes, the rules have changed dramatically since 2008. And I think all of it is just a silly exercise of a very creative monetary policy that would be wholly unnecessary if the Fed was not intervening so much into the economy.

EICHER: Final listener question: Tim Turner, Taylors, South Carolina.

In light of Silicon Valley Bank and the apparent weakness of other seemingly sound banks, he asks, how does the average person go about performing due diligence on the soundness of a bank to determine the safest place to place money?

BAHNSEN:  The consumer doesn’t need to do their due diligence about the soundness of a bank in this sense. First of all, deposits of under $250,000 are insured by the FDIC (I’ll withhold the obvious comment that apparently even deposits over $250,000 are insured by the FDIC. That isn’t the law of the land, although it has been the practical application in recent weeks.)

At this point the primary factor that should drive a customer decision about a bank is the service and the experience that they’re going to have. I am a big fan of having a relationship with the bank that you work with, and if you’re going to be borrowing money from them for a home purchase, or if you’re going to be running family accounts or business accounts through your bank, then you want ease of experience and customer service. I think those things matter. You have to say, “Okay, well, I need to know that the bank is doing good things with the money.”

And I think that the FDIC limit is unnecessary too as a concern, because if one wants to hold over $250,000 there are plenty of other options for what they do with the amount that exceeds the limit. I don’t believe that it makes any sense for a customer to go do due diligence on the bank. Because first of all, from Silicon Valley Bank to Washington Mutual to some of the IndyMac to some of the other high-profile banks that ended up getting in trouble, every depositor ended up being fully covered. 

In those situations, had a customer done incredible due diligence—like banking analyst level due diligence, like we do at my firm—they wouldn’t have found anything wrong. The banks would have had ample liquidity, the banks would have found ample deposits, ample credit equality: Right up until they didn’t have it. And that’s the key: When it comes to a bank run, it comes at you fast, and that’s what Silicon Valley Bank found out the hard way.

EICHER: All right. speaking of bank news and central bank news, let’s wrap up with the two big stories of last week: First, a huge bank transaction in Europe, UBS purchasing Credit Suisse. Quick thought on that, David.

And then second, the rate hike by the U.S. Federal Reserve, its ninth straight increase, and then Fed chairman Jay Powell gave some commentary on where he expects the economy to go the rest of this year.

BAHNSEN: Well, essentially, a week ago, UBS did a rescue acquisition of Credit Suisse. UBS has a trillion dollars of assets, Credit Suisse had over $500 billion of assets. So two major major global banks have now merged together to become one massive bank. And now if we didn't believe it was too big to fail before, I assure you, it's too big to fail now. And a potential big crisis was averted for European banks.

As far as Jay Powell this week with the Fed, they did exactly what was predicted: they raised rates a quarter of a point, and more or less said that they're done.

The thing I would point out, is it the Fed is saying that they believe the economy is going to grow at about 3%, this quarter, annualized, which I think is close to correct, even if it's two or two and a half. But then they're predicting it's going to grow at point 4% for the whole year, which means that they're predicting a recession, they're predicting somewhere in between the economy is going to be dropping enough. You can't get from three to point four without there being contraction along the way. And yet, they're saying they're not going to be cutting rates at all this year. So there's a contradiction in what they're saying. They're not going to go into recession and not cut rates. And so I think the Fed is telegraphing that they'll end up easing monetary policy by the end of this year. Not I don't think it'll be until the very end of the year. But I think the Fed’s done raising rates, and I think the Fed sees the incredible damage they've done. I think they think there was for a good cause I disagree with them. But I think that their content that they did what they did, but they also know that they've now broken something. And what they broke was a little bit of a surprise. It was the banking system potentially, that they there's such an incentive Now Nick to pull money out of banks to go get a higher yield somewhere else. And yet in pulling money out of banks, you've tightened the financial system and you've made the banks less steady, sturdy and reliable, which undermines the stability of the financial system that the Fed is there to protect. So I think that they're very likely done tightening monetary policy. I think Jay Powell made that pretty clear this week.

EICHER: Alright, send your questions to us. If you can record your question in your voice on your phone’s voice memo app and attach the file, so much the better. The email address is feedback-at-world-and-everything-dot-com.

Thanks this week to Bethany Gutman, T.J. Menn, and Tim Turner.

Thanks to David Bahnsen, founder, managing partner, and chief investment officer of The Bahnsen Group.

If you want a deeper dive on the UBS acquisition of Credit Suisse, I do recommend David’s current Dividend Cafe, available at DividendCafe.com.

Bahnsen.com is where you can find David’s books, his podcasts, and his economics course. Getting smart about money and economics is not a bad idea these days. And grounding that understanding in a Biblical worldview is what David does. And it’s why he invests the time each week with us and we’re grateful.

David, thank you.

BAHNSEN: My pleasure, Nick, have a wonderful week.

WORLD Radio transcripts are created on a rush deadline. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of WORLD Radio programming is the audio record.