OT: if you have money in a Western Bank...

[Laeeth Isharc]

Hi.

Sorry for the offtopic post, but I figure in the context it's 
better to risk annoying some people than regretting that I didn't 
say something when it might have helped.

You've probably heard about the difficulties with Silicon Valley 
Bank, regional US banks and then Credit Suisse.

I think there's still too much of a focus on the direct effect of 
rising rates on the assets held by banks.

When the central banks drive interest rates too low then 
investors become desperate for yield and they persuade themselves 
that it's okay to take what seems like just a bit more risk it it 
will get them the return they need.  It's not like an investor 
working for a conventional institution has a choice because you 
can take reckless amounts of risk for years and not get into 
trouble and after a while you just look like a fuddy duddy 
conservative guy who is out of touch with the times and at best 
you will get sidelined.  I've seen this in the early 90s, in the 
tech wreck post 2000, in the credit bubble going into 2007 and 
again in recent years.

Cycles alternate, perhaps because memories are short but not that 
short and people obsess with avoiding a repeat of the mistakes 
that led to the last episode, completely ignoring the new risks 
that will cause problems in the next downturn.

So last time the problem was with residential real estate and I 
guess this time it will be in commercial real estate, maybe 
private equity and private funding of companies too.

There are two factors that go into the valuation of an asset - 
the discount/interest rate and the future cashflows (about which 
there's always a degree of uncertainty).

Commercial real estate means offices, shopping centres, storage 
and the like.  Landlords buy a building, borrow most of the cost 
locking in terms (including the cost of borrowing) for a few 
years and then they sign leases for a few years.  When the loan 
reaches maturity they need to refinance at prevailing rates and 
hopefully rents still cover the cost of financing if the latter 
has gone up and hopefully rents didn't go down and hopefully you 
can find new tenants to replace those that leave.

If on the other hand you can't cover the costs of the loan with 
rents then maybe you can work out something with the bank, but if 
not then you give the keys back to the bank (maybe your vehicle 
goes bust in the process) and now the bank owns the property and 
it can sell it for what it will fetch when it can find a buyer.

Because there's a cycle in lending and building there's not an 
even distribution through time of loans coming due.  Lots of 
loans come due from 2023 for a few years and rates will be 
considerably higher because risk free rates rose a lot and the 
spread of the commercial lending rate over risk free rates also 
widened.

So the discount rate isn't looking good for valuations.  
Unfortunately neither are rental prospects.  Many buildings are 
now half empty at best thanks to hybrid and remote working (and 
companies are going to start hiring remote more because access to 
talent is better that way - like I told my institutionally minded 
colleagues a few years back, no Goldman don't do what I am doing 
but I think they will be copying me in a few years).

Corporate tenants can't just get out of their leases because they 
don't want them anymore.  I mean you can negotiate hardball - 
stop paying like Twitter did and force a conversation (and in 
future there will be many such cases).  But ultimately it's a 
contract to which you are bound.  You can sublet space and that 
will drive down the spot market for rents and as old leases come 
to expiry you can get out of your space that you no longer need.  
All this is happening when there's been a decline in quality of 
life in big cities but it hasn't really hit hard yet.  I think it 
will continue and it will hit hard soon enough.

So I think there are going to be major problems in commercial 
real estate in the US and Europe and maybe elsewhere.  There was 
a report from the European regulator on commercial real estate 
lending practices and reading better the lines of a carefully 
written report it made lenders seem like a bunch of buffoons who 
had abandoned the most basic disciplines of the field.

It's more than just that though - some of the banks most exposed 
to commercial real estate are critical in providing liquidity to 
the bond repo market and the repo market is the lifeblood of 
modern finance.  If that seizes up there will be very big 
problems and even behemoths like JP Morgan may have some 
difficulties.

Mostly in 2008 nobody lost money in the banks that defaulted and 
people sort of assume that will be the case this time around.  
Unfortunately the authorities changed their approach.  Their 
bluff will be called and what happens is uncertain but their 
intended policy is that deposits exceeding the insurance 
threshold won't be protected by that amount.  It's about 85k per 
institution per person in the UK. That's not much for a business 
especially that has people to pay and the like.

Under conditions of uncertainty sometimes it's more about f(x) 
than x.  In other words maybe it's very unlikely that you lose 
money held as a bank deposit or maybe it's quite likely.  That 
doesn't make much difference to the right action because the 
consequences dominate the exact probability (which of course can 
never be known).

If you have money above the insured maximum in a bank then you 
might want to think about that. In the US you can put money with 
Treasury Direct in bills or short dated bonds (they might be late 
in paying if there's a technical default over the debt ceiling 
but I think they will be money good in the end).  In the UK you 
can open up a national savings and investment account.

A business can open up an investment account and in dollars buy T 
bills, SHY ETF or in gbp buy gilts or in euros buy German paper.  
I'd avoid Schwab and keep an eye on the health of my brokerage.

Some people might want to own some precious metals.  You can buy 
a physical ETF (platinum and silver are more volatile but cheaper 
than gold) or for larger sums buy precious metals and keep them 
in a vault.

Longer term the risk is inflation but right now I think the risk 
to having too high a bank balance isn't justified by the meager 
rewards.

Might be worth gently mentioning to friends and family too.

You know longer term we don't need banks - fractional reserve 
banking has truly become a vampire squid.  You just need 
somewhere safe to make payments - and you already have services 
that do this, that don't speculate with your money - and there 
needs to be a way for lending to happen.  Large institutions like 
Black Rock already do lending and we don't need banks for this.

European Banks are like 16x levered before derivatives.  That 
doesn't take much of a downturn at all to completely wipe out 
their capital base.