Bank Problems Aren't Over, But It's Not 2008

Yes, we have banking problems. No, this is not 2008. It’s much more like the 1970s Savings & Loan problems. In other words, we do not have credit problems today, we have duration (asset-liability) problems. These are exacerbated by the fact that Quantitative Easing inflated total deposits in the banking system.

In the 1970s, the Federal Reserve held interest rates too low for too long. From 1974 through 1978, the federal funds rate was below inflation most of the time, and the “real” federal funds rate averaged -1%. At the same time, because of strict regulations on lending, branch banking, and other issues, S&Ls only made, and held, long-term fixed-rate mortgages.

So, S&Ls were paying relatively low short-term rates to depositors (even though they slowly rose as inflation picked up), while earning higher returns on long-term mortgages. As the 1970s progressed, and with Paul Volcker taking over the Fed, short-term rates rose above rates on loans. By the end of the 1970s, the entire S&L industry had negative net capital.

Today, in some ways, we are facing the same problems. Between 2008 and 2021, the Fed held the federal funds rate at close to 0% for nine years, and below inflation 84% of the time. At the same time, because of QE, the M2 measure of money has increased by 188%. And because of COVID and financial panic (2008/09) borrowing; total government debt has grown massively as well.

In other words, banks got stuffed with deposits at the same time government debt (of all kinds) exploded. And banks, because of the Fed, could pay depositors very little, while favorable capital rules on Treasury, FNMA, GNMA, and SLMA debt encouraged them to hold long-term bonds.