Taps Coogan – May 5th, 2023

Hugh Hendry, founder and Chief Investment Officer of the now-defunct hedge fund Eclectica and famous for making big profits during the 2002-2003 recession and the Global Financial Crisis, recently spoke with Bloomberg about the regional banking crisis:

 

Hugh Hendry:

“The panacea of the Treasury announcing that all deposits are federally insured doesn’t solve this problem. There is… deposit flight from the banking sector seeking yield. I don’t say this lightly but in 1934 the Federal Reserve confiscated gold from US citizens. We’re at the point where the Fed and the Treasury officials are having to consider a gate, a lock, on US bank deposits… Hedge Funds, they put a gate, which is to say that when you want your money back, they go ‘Ah, we’ll call you.’  …It can take two years to get your money out… Money is coming out (of banks) because banking CDs were priced at 10 basis points and the Fed’s giving you 500 basis points… What that revealed was the conceit and arrogance of kind of a cool idea. The cool idea was… the Treasury, we’ve got a ton a treasuries to sell, what if you (banks) hold them in a treasury security portfolio and you don’t have to mark it to market, just ignore it… Nice idea, except when you get the deposit flight, suddenly it is untenable… you have to sell it… the mark to market loss is bigger than the shareholder funds…”

When asked (correctly), don’t we just solve this problem by cutting rates:

“That’s what was so off about (Wednesday). Jay and the Fed actually aggravated the problem… Hello, is anyone there?… What I would recommend is honesty and transparency: ‘You know what folks, I’m speaking to you on behalf of the Federal Reserve. We got a little carried away. We raised rates with a magnitude and a rapidity which we regret. We’ve come to understand that taking rates to 5.25% when debt, and I’m approximating, is four times the size of the economy… So my promise to you is we’re going back to ZIRP.’ This system only lives when rates are zero.”

Eccentricities aside, we couldn’t agree more with Hugh Hendry’s diagnosis of the problem, though perhaps slightly less so for his prescription for investors (ultra long treasuries already bottomed back in November).

As we’ve been arguing over and over, this economy can’t support rates this high and the Fed’s quest to see how high they can get them before blowing everything up risks a return to zero instead of pausing at something sustainable (3.5%?) 

While bringing rates back down to something the economy can sustain is the only ‘real’ solution to the regional bank crisis, in leu of the Fed lowering rates, regional banks need to increase deposit rates, even if that means taking losses. SVB, First Republic, etc… have proven that the alternative, hoping they can sell off securities at big mark-to-market losses to skinny down as depositors flee for money market funds just leads to more depositor flight.

At the time of writing, the rate on a savings account at the local bank in my town is still just 0.03%. You’d be insane to put your money there. You can open a free checking account at a national brokerage bank that offers treasury money market funds yielding nearly 5%. That local bank makes zero economic sense and unless they raise deposit rates (or the Fed cuts), they will eventually cease to exist.