Too Big to Fail, or Too Reckless to Survive?

Santa Barbara Bankers Say They Toe the Fiduciary Line

A Loomis Armored U.S. vehicle idles at the curb across the way from First Republic Bank in Santa Barbara. | Credit: Courtesy

With more than 4,000 banks in the United States, you might wonder whether the problems of three mid-size banks don’t amount to a hill of beans in this crazy world. The potential for contagion clearly does: San Francisco–based First Republic Bank — which has a branch at the corner of State and Anapamu in Santa Barbara — got a total of $30 billion in deposits on Thursday from the Big Four banks and others like Goldman Sachs and Morgan Stanley, and that was after $70 billion in loans was promised on Sunday from the Federal Reserve and JPMorgan Chase. That $100 billion worth of beans was not only to shore up that bank but public confidence in banks in general.

The events in the current banking debacle mount daily, but in brief, a run on Silicon Valley Bank last week brought to very public attention a fatal weakness among several tech-oriented banks. Silicon and Silvergate Bank of La Jolla voluntarily closed that Friday. Signature Bank, headquartered on New York City’s Fifth Avenue, closed on Sunday. All three held crypto or served crypto companies, and when those funds tanked last year, the banks did a slow walk off a short plank.

“Crypto?” said Peter Rupert, a UC Santa Barbara economist and director of the Economic Forecast Project. “I can see having it if a bank is super well-diversified — it’s super risky, super volatile. What you’re holding could go up 20 percent one week and down 40 percent the next.”

Silicon Valley Bank had an additional weakness, which First Republic shares. Both held more than $200 billion in assets at the end of 2022, and they also have a very large number of very large deposits from a grouping of customers, who were uninsured beyond $250,000. For Silicon Valley Bank, those customers were venture capitalists or people who worked in the tightly knit high-tech sector. Many of them became acutely aware of the insurance limit while simultaneously hearing that their bank was sinking under the weight of treasury bonds — this when their industry had a growth spurt during the pandemic and contracted afterward, leading to employee layoffs.

Silicon Valley Bank had also invested heavily in U.S. bonds during the pandemic, as most all banks did to some degree to place their money somewhere safe during incredibly uncertain times. Those bonds, however, were for a one or 2 percent return; by 2023, bonds were set at about 5 percent. When Silicon Valley Bank tried to raise cash by selling its bonds, no one was interested. The value of those bonds was way down and so was the bank.

“What Silicon Valley Bank did,” Rupert explained, “was forget the first principle of banking: Diversify your portfolio. Obviously, if you have a billion dollars’ worth of bonds, that little spread in interest rate means a lot of money.”

According to media reports, First Republic catered to wealthy clients and had a large proportion of real estate loans. After Silicon Valley Bank’s widely reported issues, First Republic’s were among the balance sheets scrutinized by investors and found problematic. Its stock price fell 75 percent on Monday when it was downgraded to junk status. At $91 on March 10, it was around $21 by the close of March 16.

Inside the Santa Barbara branch on Wednesday, bankers on the floor were engaged in earnest conversations with customers and friendly to a visiting reporter. Their bosses upstairs, however, did not return requests for information.

The wobbliness in bank stocks and public confidence in banks set off alarm bells in Washington. On Monday, President Biden announced that the Federal Deposit Insurance Corp. would cover 100 percent of deposits.

In Santa Barbara

Millionaires and the occasional billionaire populate Santa Barbara, or more accurately Montecito, with many holding their dollars at Montecito Bank & Trust. “We’re a community bank,” said Janet Garufis, who heads the bank, which has about $2.5 billion in assets. “Silicon Valley Bank had all this cash sitting in the bank, billions of dollars.” Her bank’s customers, by contrast, have everyday checking and savings accounts.

“We don’t lend to venture capitalists or start-up organizations,” she said, and the bank keeps its footprint small. “One of our founders, Michael Towbes, would say, ‘If I can’t drive there in an hour, I won’t open a bank there,'” Garufis said. “It’s because we wouldn’t understand the context of the community, know their kids, see them at the grocery store or at church.” And rather than having customers come to withdraw money this week, Garufis said, her bank was acquiring accounts, which was also the case at American Riviera Bank.

“Our total deposits were higher on Tuesday than they were last Friday,” said Jeff DeVine, who heads American Riviera. DeVine added that they had to add a team of employees for new accounts over the weekend: “We have actually been the busiest setting up new accounts for individuals and companies that want to move their money to American Riviera Bank.”

DeVine noted that they’ve been spending time talking with customers and finding ways to accommodate the $250,000 FDIC limit. “The insurance is per unique entity per bank,” DeVine explained. “There are ways for households to obtain multiples of that $250,000 by having an account in different family members’ names, kids’ names, payable-upon-death accounts, or trust accounts with multiple trustees and beneficiaries,” he said.

Will Interest Rates Go Up?

As recently as Wednesday, the plummeting stock of the giant Credit Suisse — with $557 billion in total assets in 2022, down from nearly a trillion the year before — caused the Swiss government to step in with a loan of $53.7 billion to assure the world the bank was good.

It’s exactly what the Biden administration did this Monday, putting the full weight of the Federal Deposit Insurance Company (FDIC) behind the banks. The FDIC fund — which all banks contribute to — contained about $128 billion at last count. With total deposits at $175 billion at Silicon Valley Bank alone — and $88 billion at Signature Bank — the U.S. government is nevertheless assuring that ATMs and debit cards will operate, checks will clear, and loan payments, too, will continue as before. Both banks are now in a receivership under FDIC management. Silvergate is in receivership under California state rules.

At about the same time that Credit Suisse was bailed out, the European Central Bank announced it would increase interest rates by 0.5 percent, which it had planned for about a month. In the United States, the Federal Reserve has increased its interest rate over the past three quarters; in February, it rose 0.25 percent, and the Fed is expected to raise it again next Wednesday. Rupert pointed out, in the case of Silicon Valley Bank, all these rate hikes were well publicized in advance.

For Montecito Bank, Garufis said changes in interest rates was one of the things they tested. In what’s called a stress test, once a month her bankers took their balance sheet and ran the numbers on interest rate increases to see what happened to deposits, loans, and investments. “It tells us what our capital looks like, what does the liquidity look like, are we safe, sound, and secure,” she said. “It’s something we work on regularly.”

The Fed’s stated reason for raising interest rates was to bring inflation under control. Economist Lanny Ebenstein, however, disagreed that the one necessarily follows the other. “The idea that you can raise interest rates to cut inflation isn’t true. Whenever you raise the rate dramatically in a short time, you have an economic downturn.” He acknowledged it was a slim difference, but illustrated an example with the construction industry: “When interest rates go up, construction goes way down. It made sense to build when rates were at one percent; you could make projects pencil out. But here at 4.75 percent — the current discounted bank lending rate — construction has stopped. New construction loans are a fraction of what they were.”

Ebenstein also wondered what the outcome would be with the FDIC’s promise to cover all deposits. “Once the government said it would insure all of the amount, what’s to prevent the circumstances from becoming worse? There have to be other banks in this same situation of having long-term federal bonds at low-interest rates, when shorter-term bonds are at high rates. Silicon bank might be in the 99th percentile of banks,” Ebenstein posited, “but what if it wasn’t? What if it were in the 95th? There are about 4,500 banks in the United States. If 50 were in the same situation, it would be a disaster. The crucial issue is for the Fed to lower interest rates.”

Congress has similar concerns, with some Republicans calling for surety that taxpayers do not bail out bank executives or stockholders. Congressmember Salud Carbajal stated the FDIC fund came strictly from banks, but he, too, had concerns about banking: “We must do everything in our power to ensure that protecting the depositors at Silicon Valley Bank is not interpreted as eliminating risk for an institution’s investment strategies. Furthermore, I believe it is critical that Congress not only reassess oversight and regulatory requirements, but also consider new measures that may better account for the types of digital mob mentality — like last week’s bank run or web-driven stock crazes of recent years — which we’ve now seen have the power to collapse an institution in a fraction of the time seen in earlier eras.”

Carbajal went on to add: “The solution crafted by the Biden Administration ensures that the average American caught in the middle is not punished for the risky decisions of their bank’s managers, and that Silicon Valley Bank shareholders will not see a dime of taxpayer dollars.”

The drubbing that the banks are taking is changing quickly, and it might be a few years before all the plot twists become clear. It’ll take someone like Adam McKay to untangle them for us, as he did in 2015’s The Big Short, where we saw Margot Robbie explain the 2008 mortgage meltdown from a bubble bath.

Janet Garufis thought It’s a Wonderful Life held truer for Santa Barbara: “You know that scene where Jimmy Stewart says, ‘Your money isn’t in the bank. It’s in Joe’s house and in Tom’s house.’ That’s what we do. We take that money and invest it, and we keep on hand what you need to get by today.”

Correction: The CEO and president of American Riviera Bank is Jeff DeVine, not Peter DeVine.