The only cure for the bank-run contagion is time, but the damage is already done

THE current banking crisis proves that – even after reforms brought on by the Great Depression and the global financial crisis – the financial system has few defences against periodic bouts of primal fear.

I covered the last financial crisis from a front-row seat. In 2008, I was working for Dow Jones Newswires and The Wall Street Journal in New Jersey, punching out market reports with a panoramic view of New York’s gleaming skyscraper canyon of a financial district.

The day Lehman Brothers died, I heard my sources become untethered: old-school traders watching their touchstones, their culture, their whole world, blown to smithereens.

One guy I knew who used to joke about watching the weekend traffic to the Hamptons as an economic indicator put it this way: “We have moved from a Lockean to a Hobbesian world.”

The Lockean, rules-based order had been swept away. The only hope for the world’s biggest banks – and hence the future of the global economy – was the arbitrary actions of the powerful. All trust in public institutions had broken down, forcing the Leviathan of the state to move without any popular support.

The experience that prepared me best for today’s banking crisis, however, was watching the scene in the 1946 film, It’s a Wonderful Life, in which the lead character George Bailey (played by James Stewart) notices something going on at the Building & Loan (an organisation that provides loans to members for buying homes) and diverts his honeymoon.

The panic that went on at that fictional Building & Loan is the same type of panic we saw at Silicon Valley Bank (SVB). The way the panic spread along Main Street in the film is similar to how it spread to Signature Bank, Credit Suisse and, now, Deutsche Bank and First Republic Bank.

In the case of SVB, the problem began with over-allotment of its reserves to long-term Treasuries. These plunged in value due to the US Federal Reserve’s interest-rate hikes.

It doesn’t really matter what starts the bank runs, though. It is the runs – what the late former US president Franklin D Roosevelt called “fear itself” – that matter. Everyone, everywhere, wants their money back all at once.

Deposits in American small banks slipped by 1.5 per cent in the space of a week in mid-March. That might not sound like a lot, but the fractional reserve banking system, which has been in place for hundreds of years, cannot withstand many weeks like that.

“Your money’s in Joe’s house,” Bailey reminds one man trying to empty his deposit account. “Right next to yours. And in the Kennedy house, and Mrs Macklin’s house, and a hundred others… I beg of you not to do this thing.”

The digitisation of banking made the onset of the current panic particularly swift. Not only did technology speed up the bank run contagion, it amplified the spread.

In the film, Bailey is able to talk the depositors out of their rash actions. It’s possible that, if SVB clients went to branches rather than online banking, their bank managers could have talked them down, too.

It’s possible that, if the Fed wasn’t committed to fighting inflation, it could use the tool that eventually restored confidence in 2008: interest-rate cuts.

There has been a lull in recent days but, the banking panic is not yet over. For stock investors, it’s a game of whack-a-mole: watching for the next troubled bank to pop up on their screen of the biggest daily losers.

Last Friday (Mar 24), that bank was Deutsche Bank, which, like Credit Suisse, has a long history of taking big financial risks.

The price of insuring Deutsche Bank against default suddenly shot up late last week, in another throwback to the 2008 crisis. Credit-default swaps were the gauges used to assess who would be next in line to go under.

Analysts who had followed Deutsche Bank’s fortunes for years threw up their hands. It made no sense to suddenly fear for the German lender’s survival. With interest rates rising, many of its businesses were practically printing money. Also, it stands to gain from higher interest rates worldwide. The selling was irrational.

There’s an old adage that the market can stay irrational longer than investors betting on a “return to normal” can stay liquid. Shares of Charles Schwab have tumbled more than 30 per cent because of concerns that the bank run would spread to the sweep accounts, where clients park cash between stock trades.

Those short-term cash accounts have become an increasingly critical part of Schwab’s trillion-dollar assets under management. One former executive at the company said the fears made no sense. But the fear itself is dangerous for Schwab.

The only cure for bank-run contagion is time, said Quincy Krobsy, chief global strategist at brokerage LPL Financial. Fortunately, it’s been more than two weeks since the last outright collapse. There’s a palpable sense of nerves subsiding among investors and bank depositors. Still, the series of runs may have already done economic damage.

“The risks of 2008 post-Lehman are low because they know they have to protect depositors,” said Lorenzo Di Mattia, manager of hedge fund Sibilla Global Fund. But the probability of a 2008 pre-Lehman recession is very high, he said, and that would be bad enough to cause another 20 per cent sell-off in the broad S&P 500.