Another Unstable Finger

Balancing Act
Systemically Unfair
Fighting the Last War
Travel, SIC, and Loans

“There’s an old saying: Whenever the Fed hits the brakes, someone goes through the windshield,” said Michael Feroli, chief economist at J.P. Morgan. “You just never know who it’s going to be.” (The New York Times, March 16, 2023)

For years I’ve used a sandpile metaphor to describe complex systems like banking. Keep dropping grains of sand long enough and you will eventually trigger an avalanche.

“Eventually” is the key word. Exactly which grain will do it, you can’t know.

But before the collapse, the sand grains accumulate to a larger and larger pile. They form “fingers of instability”—small weaknesses where a larger failure could begin. Sooner or later, one will break but no one knows when. Will it cause a small avalanche or “the big one?”

These unstable fingers seem to be piling up lately. Last October, the UK had a brief bond crisis when some budgetary changes revealed rather questionable pension fund activities. Then the bankruptcy of crypto exchange FTX showed how supposedly “trustless” assets can require a lot of trust.

In just the last week we’ve seen the second- and third-largest bank failures in US history: Silicon Valley Bank and Signature Bank. Several others look shaky. Authorities responded swiftly (and I think correctly) to stabilize these situations. I see no need to exit 99% of banks, but everyone should definitely pay attention to make sure your bank is not in the 1%. Important things are happening.

In short, this isn’t 2008. But it’s also not nothing.

By sheer coincidence, I’m also happy to announce registration is open for our 2023 virtual Strategic Investment Conference, the theme of which is “Thinking the Unthinkable.” We’ll have 40+ speakers talking about how to be truly defensive as we imagine the chain of risks that lie ahead. Neil Howe will tell us how The Fourth Turning will bring several more years of turmoil—and not just financially. You really don’t want to miss this SIC, which I promise will be the best ever.

Let’s start with what we know. Silicon Valley Bank (hereafter SVB) had problems on both sides of the accounting ledger.

When you deposit money in a bank account, you aren’t simply giving it to the bank for safekeeping. You are lending your cash to the bank. It is a loan transaction, with you as lender and the bank as borrower. Your deposit appears as a liability on the bank’s balance sheet.

This is how modern banking works. In simple terms, the bank borrows money from you then lends it to someone else. If all goes well, the bank profits from the difference between its cost of funds (the interest it pays depositors) and interest received on the loans it makes.