Bank failures: Unsettling but not unusual
Every news item these days seems to be a “hair on fire” event, i.e., the best or the worst ever seen in history! We’ve joked that we’re seeing an unprecedented use of the word “unprecedented.”
Of course, a constant stream of extremes is not reality, but investors are nonetheless faced with the difficult task of sifting true investment information from the harrowing cries of impending doom.
Historically, investors have been better off remaining dispassionate and objective during such hyperbolic periods. A clear-eyed review of history and of fundamental data will likely be investors’ best guides to maintaining portfolio sanity during these…ahem…unprecedented times.
The current bank failures are typical
The whole point to tightening monetary policy is to make banking less profitable and discourage lending and risk-taking. The Fed raises the cost of funding specifically to disintermediate the banking system and make lending to the economy more expensive.
Raising interest rates effectively raises the entire economy’s hurdle rate (i.e., the minimum required rate of return of a financial or capital investment), which makes cash more attractive relative to longer-term investments. That, in turn, curtails both financial and real investment. Because funding becomes more expensive, lending growth slows, and asset valuations decrease, marginal and poorly managed banks tend to fail subsequent to the Fed tightening monetary policy.