With March and April tax season for me, I largely defer to Phil, our portfolio manager, and Alexi, our head of operations and compliance, on market research. However, there has been too much going on and too much to digest to hear things second-hand, so I have been reading and listening to as much as I can as these are truly fascinating times. The banks are under a lot of stress right now.
What is causing this stress? It really boils down to not taking inflation seriously enough at the outset, and, then, combating it very aggressively and very quickly. For the past year, we have had the fastest interest rate tightening in our lifetimes. Quickly tightening rates to fight inflation has more adverse effects than just making borrowing more expensive—there is a domino effect. Suddenly, higher interest rates have incentivized savers to take their money out of banks and invest in treasuries and money market accounts yielding a much higher return (around 4%+). To fund these higher-than-normal bank withdrawals, the banks are suddenly having to sell traditionally safe assets, such as T-Bills and long-dated bonds at a loss. These safe assets have suddenly become problematic assets in the short-term because their value has diminished in terms of their purchase price. You can refer to Alexi’s post from earlier this week on why the price of bonds have declined due to rising rates.
In the short term, the Fed’s aggressive policy is causing the current stress on banks. But the Fed’s actions are just a reaction to a longer dated issue – fiscal policy and inflation. Part of the inflation we see today is certainly a side effect of COVID lockdowns, the war in Ukraine, and labor shortages as the largest US generation (the Baby Boomers) retires. Though, some blame must be laid on fiscal policy (Government spending). Every presidential administration this century has driven higher deficits than the administration before them. Bush, Obama, Trump, Biden. It is not a Republican vs. Democrat issue and should not be considered a political issue. There have been some key missteps by the recent administrations and the Fed in being, at minimum, a year late to combat the price inflation all the excess spending and money creation has brought.
In 2021, there was too much continued quantitative easing and fiscal stimulus (i.e., printing money) as the economy fully reopened. The economy overheated – it was great for those invested in the S&P 500 with a 27%+ year, but bad for prices in the economy as a whole. The resulting inflation was termed “transitory” and was not taken seriously. Huge deficit spending and easy monetary policy continued when it probably should not have, and it was not until Spring 2022 that steps to combat inflation actually got started. This condensed the rate hikes of what should have been 2+ years into less than one year. David Sacks, founder of PayPal, made an interesting analogy to describe it all which I tend to agree with. He said it’s like driving your car at 50 mph and then increasing the speed to 100 mph even as traffic is getting heavier. You suddenly have to slam on the brakes and that causes unintended consequences for anyone driving behind you.
The US Federal Reserve came up with a solution to deal with the current banking liquidity crises. The solution seems great in the short-term, but problematic in the long-term. I will post more thoughts on that in the coming weeks… Stay tuned.