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Don’t Ignore the Banking Crisis

The health of the banking system is critical to the health of the economy.

Key Takeaways

  • It would be a mistake to assume that the banking crisis will only impact banks and not other industries.
  • Which areas of the market should investors focus on?
  • How might the Federal Reserve react to the banking crisis as it prepares for its next meeting?

Ivanna Hampton: The current banking crisis is triggering flashbacks to the financial one of 2008. Silicon Valley Bank SIVB and Signature Bank SBNY have collapsed. Federal regulators have seized control of both regional banks, and there are several reasons why investors should pay attention. Morningstar’s chief markets editor and Smart Investor newsletter editor Tom Lauricella is here to explain why.

Tom, investors might think that this is just about banks. Why would that be a mistake?

Tom Lauricella: The reason is because banking crises are never just about the banks. Banks are the critical linchpin in moving money through the economy, and without money moving through the economy, everything breaks down. The health of the banking sector is one of the most important things for any investor to consider. So, when we start to talk about the health of banks, it’s something that has potential implications far beyond the banks.

Hampton: Well, if that’s the case, how does something like this spread?

Lauricella: The word that people don’t like to talk about is contagion, but that’s the question here: Will we have contagion from this? Is there a knock-on effect from the banks where this has begun? That’s what happened 15 years ago when the financial crisis kicked off. It started off with Bear Stearns, and then it took a while. That was 15 years ago, and Lehman Brothers didn’t collapse until the fall. So, these things can trickle through the financial system for quite some. And the issue is with banks because they’re so interconnected with the economy and with each other. Banks are linked to each other, they lend to each other, they support each other. A problem with one bank can quickly spread to another, if investors begin to get worried. The worry here is fear. And going from one bank to another.

Hampton: What areas of the market should investors focus on then?

Lauricella: What we should be looking at are the indicators within the financial system of money moving around, of the ability of banks to lend to each other, of banks to borrow. We can watch signs of this. Some of this stuff is a little bit hard for the typical investor to see, but you can see clear signs in something like the U.S. Treasury bond market, where we’ve seen this week a rush to safety, as people would call it a flight to safety. Bond yields have dropped sharply, that’s because investors, and probably a lot of banks, are rushing in to buy the safety of government bonds because they know this is money good. When you start to see that, people avoiding riskier parts of the markets, it tells you that there’s warning signs out there that people are really beginning to get concerned.

Hampton: What could this crisis mean for the economy?

Lauricella: This is a really big question here. The idea is that if banks start getting worried about protecting themselves. So, if you’re a bank and you have to shore up your own deposits, you have to shore up your own financials, what you’re going to do is you’re going to stop lending. You’re going to stop lending first to the riskier borrowers and start working way through the system. They’ll stop lending to other banks, and as that begins to happen, you choke off the supply of credit to the economy. That’s when the real problem starts. If the supply of credit gets choked off, then businesses can’t borrow money. Businesses can’t repay money that they already have. Maybe they have debt that they need to roll over. They need somebody else to loan them more money. If the bank won’t lend them, they’re out of luck. Or if somebody wants to open a new business, a small business, you know, they want to get money to start up a dry-cleaning business, then they’re not going to get that loan, and gradually it just pinches things off, pinches off economic activity.

Hampton: The Fed is scheduled to meet next week. How does this affect the outlook for their policy and interest rates?

Lauricella: This is a very open question. We’re not really sure. The Fed’s in a blackout period, which means that Fed officials aren’t talking right now. We don’t know what they’re thinking. There’s different ways to look at this. In the financial markets, the thinking is that this has taken a much more aggressive series of interest-rate hikes off the table. We had another bad inflation reading just this morning. It was as expected, but it’s not good news. Inflation is stuck at 6%. The Fed doesn’t want inflation at 6%, it wants inflation at 2%. We had a very strong jobs report. All things being equal, up until the middle of last week, it looked like the Fed was going to raise rates more and keep it there for a lot longer. Now people are calling that into question, saying that the Fed might only raise rates just a little bit and in fact begin to cut rates in the second half of the year, which is a completely different outlook. However, there’s another way to look at this, and Morningstar’s economist Preston Caldwell thinks that if the Fed and other regulators are successful in containing this banking crisis that it actually gives them room to go along with more aggressive interest-rate hikes. It will be very interesting to see the messaging out of the Fed right now. We just really have to wait for the meeting.

Hampton: What’s the final takeaway for investors?

Lauricella: The final takeaway is pay attention to this. This is important. It could turn out to be nothing. But this is the type of event that tends to have ripples. This is the kind of event that tends to happen at this point in the economic cycle. Interest rates have risen a lot more than people expected, and you’re starting to see things break out there. So, it’s time to really pay attention and make sure portfolios are the way you want them to be, that you can handle any losses that might come up if things do get worse. But it’s really just not the time to close your eyes and think this doesn’t bother me.

Hampton: Well, thanks Tom for breaking down this banking scare.

Lauricella: Glad to be here.

Tom Lauricella does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.