More Cracks in the Banking System… (And One Really Bad Chart)

April 28, 2023

Last week it was all good and full steam ahead from certain corners of the Fed:

Of course opinions are like… well you know. Everyone’s got one. But sometimes those opinions just don’t match what’s going on in the real world.

Like now for example…

Fake Economies are Fragile Economies…

Last July I wrote a piece called Living in a Fake Economy. It explained how we had evolved (or devolved) from a value-driven economy to a financially-driven (fake) one. Effectively an economy whose prosperity is entirely dependent on debt.

I often link back to it here because I think it’s an important point for you to remember when it comes to the reality of the world you’re investing in. Today things are way different than the 1950s, the 1970s, hell… even the 90s. (And I’m not just talking fashion and hairstyles.)

Today our economy exists primarily on “credit” — a promise of money (often misunderstood as “wealth” or “value”) in the future. 

Interest rates are sometimes referred to as the cost of credit — i.e. the price of “money.” Last year, the Fed raised the price of money substantially. 

And after a decade or more of money being free, that change meant pretty much everyone — both lenders and borrowers — were going to feel it in one way or another.  

The banking industry (and certain non-bank entities known as “shadow banks” — VC funds, hedge funds and the like) stands in the unique position of being both a borrower and a lender. 

The other day — in my free letter — I explained about a specific challenge they face, known as an asset/liability mismatch, and the threat it posed to the banking industry (and the economy). 

…And So Are the Banks that Fund Them

Take a look at the chart below. It’s the S&P Regional Bank ETF. It’s off some 38% since its high in February of this year. 

SPDR S&P Regional Banking ETF (KRE)


The collapse at the regional level indicates a huge loss of confidence in the sector.  And a loss of confidence at that level generally leads to even more problems where deposits go. I wrote about that just a month ago.

Specifically how the Fed hikes had put certain banks at risk by putting the value of assets they were holding underwater. Assets they would now have to sell at a loss if they had to fulfill depositors’ demands for their money.  

You can see it happening in real time…

This past week, First Republic Bank (FRC), which was teetering at the brink yet somehow survived during the SVB / Signature collapses last month, was back in the crosshairs.

It’s not like this happened completely out of the blue. Last month I noted the bank’s massive credit downgrade by Standard & Poors:

On Wednesday, First Republic was downgraded by S&P from A- to BB+ (that’s four notches to basically “junk” status).

But the shake up came on their quarterly earnings report. Overall, revenue, income and earnings all beat expectations (actually they were less negative than the street was expecting — take your wins where you can). But the real hit came in terms of their deposit/loan exposure (their asset/liability mismatch).

The bank reported that depositors had pulled out roughly $100 billion of their money. ZeroHedge noted the specifics:

…deposits at March 31 were down 41% from $172BN as of year end to $104.5BN at quarter end (including $30BN from a consortium of banks, so really $74BN), [note: which means they actually lost $100BN] and then dropped another 1.7% through April 21, which is if nothing else a silver lining: at least the pace of outflows is slowing.

To shore up that $100 billion drain (including the $30 billion they owe the TBTF banks that floated them last month), they went back to the well.  Again from ZeroHedge:

“In response to the unprecedented deposit outflows, the Bank enhanced its financial position through access to additional liquidity from the Federal Reserve Bank, the Federal Home Loan Bank and JP Morgan Chase & Co. Total borrowings peaked on March 15, 2023, at $138.1 billion. At that time, the Bank had $34.0 billion of cash on its balance sheet. Total borrowings totaled $104.0 billion, and cash and cash equivalents totaled $10.0 billion as of April 21, 2023.” 

So now they’re in the hole another $100 billion. The interest they pay on this loan, for however long they hold it, will likely erase any net income interest they receive. Which turns them into what’s commonly known as a “zombie bank.” 

First Republic Bank (FRC)


I’ve pointed out before that regional banks fund a helluva lot of the economy…

Just last week I noted the $2.5 trillion commercial real estate refunding bomb that’s coming due in the next five years that’s also threatening the entire sector…

On the other hand, small bank CRE loan originations have been on the rise since mid-2021.

And where that bank lending goes, according to a recent report from Goldman:

…small and medium-sized banks (<$250bn in total assets) account for ~80% of total commercial real estate lending

A separate report from JP Morgan would tend to confirm that data:

JPM calculates that per the Fed’s weekly H.8 data, small banks have accounted for the lion’s share of CRE lending relative to larger banks. …as of February 2023, small banks account for a staggering 70% of total CRE loans outstanding excluding multifamily, farmland, and construction loans.

So that asset/liability mismatch appears to have become a real threat to smaller sector money centers…   

But what about their big brothers?

Today, TBTF Banks Aren’t Impervious Either

Looking at the “Too Big to Fail” front, things would seem to look considerably different. Charts suggest that while they’re all feeling some pain, they’re basically treading water.  Here are a few of the biggest:

JP Morgan Chase (JPM)


Bank of New York Mellon Corp (BK)


Citibank (C)


Morgan Stanley (MS)


But the truth is there’s some bad news starting to shape up in big bank-ville too!

According to the Federal Reserve Board of Governors, deposits have been dropping off at large domestically chartered banks…

Source: The Federal Reserve Bank of St. Louis

Why is this happening?

No doubt some of this drain was due to people spending the stimulus money, which they had previously deposited, to keep up with their rising costs of living. But another, maybe more significant factor, would be because of the Fed’s tightening cycle. 

As the Fed hiked rates, other short term rates rose with them. Today you can find short term money market funds paying upwards of 5% annually. Compare that with what the TBTF crowd continues to pay their depositors…

This is how the big guys dominate the banking landscape. Right now, the treasury yield curve is inverted. But as big banks are still flush with cash they don’t need to compete for deposits. That lets them keep paying their depositors next to nothing. And given that they, like all banks “borrow short and lend long,” it means their yield curve is still very much positive.

Right now, the only reason this deposit flight hasn’t sounded the alarm here is the massive amounts of deposits (what makes them TBTF) they have relative to the smaller banks. (JP Morgan Chase has well north of $2 trillion.)

So what does all this mean?

Money Supply’s Big Comeback

A couple years back, I wrote about how to interpret economic reports. The premise was that an economic report doesn’t matter… until it matters.

As an example, I explained about how back in the 1980s, “money supply” was a huge report. It came out every Thursday at 4PM ET — while the S&P 500 futures market closed at 4:15PM ET. An out of line number would send the market into convulsions with traders from everywhere firing in futures orders to hedge the following day’s open.

It was an important report back then because, at the time, it was widely considered the Fed’s job to manage inflation by controlling the amount of money in the financial system. But as financial conditions eased over the decades — and the money supply exploded by a factor of 10 — traders and investors stopped caring about it. 

Today that report might be making a comeback!

Money supply is essentially just another name for bank deposits. If you look at the chart below, you can see how commercial bank deposits have basically tracked M2 for decades…

Source: The Federal Reserve Bank of St. Louis

…and the direction of that track has always been up!
Today, however, the level of money/deposits has started to contract across ALL banks…

Source: The Federal Reserve Bank of St. Louis

Year-over-year levels of deposits have actually gone negative

I believe this is significant

Deposits at both large and small banks have never done this in tandem before. Take a look at a longer view chart below…

Source: The Federal Reserve Bank of St. Louis

Over the years, the rise in deposits (expansion in money supply) has slowed across the banking industry. But it has not contracted! To be clear, from August 1994 to June 1995 large banks did lose deposits, but smaller regional banks did not. And the economy was nowhere near as dependent on free money as it is today. There was always money to lend.

We’ve never seen anything close to what we’re seeing today. So what does that mean?

For one thing, without money, it becomes more and more difficult for regional banks to service depositors. But more importantly, without money, banks can’t lend. And in an economy that is almost entirely financialized (fake), the ability to lend is like oxygen.

And consumer lending across the banking spectrum is taking a turn too…

Source: The Federal Reserve Bank of St. Louis

The odds of the Fed raising its funds rate another 25 basis points is almost guaranteed. But if Jim Bullard is still favoring more hikes, we’ve got yet another important metric to track…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential