The 18th president of the United States and the Commanding General of the Union Army, Ulysses S. Grant, spent the final year of his life in a desperate race to write his memoirs. Complaining of a sore throat in the summer of 1884, Grant delayed seeing a doctor until mid-autumn where it was confirmed he was suffering from throat cancer.
Grant completed his memoir on July 5, 1885, and died five days later. The book was a financial and critical success. Thanks to a 70% royalty contract offered by Mark Twain, Grant’s widow received around $450,000, a considerably large sum of money for the 1800’s.
What prompted this race against time? Grant was broke and feared leaving nothing for his wife. Surely, such a notable person would have accumulated some wealth into his seventh decade? Yes, but Grant had invested $100,000 into a brokerage run by his son and his business partner, Ferdinand Ward.
Unfortunately, Ward was a scoundrel and running a ponzi scheme through the brokerage. Happy with their initial returns, the Grants’ due diligence was sorely lacking, and when Ward told Grant Sr they were experiencing some funding difficulties, Grant borrowed another $150,000 to keep the business going. It failed regardless, setting off a financial panic which prompted bank runs and failures across New York.
As this short slice of history illustrates, bank runs aren’t new, or even rare in the US. There have been over 450 bank failures since 2008, with 2018, 2021 and 2022 the only years in recent memory not to see a bank failure in the US. Back a little further, during the savings and loans crisis of the 1980’s and 90’s, over a third of savings and loans associations went under.
Back then it was a combination of poor risk management, deregulation, and fraud. The 1980’s was characterised by high inflation and swift increases in interest rates. Many savings and loans institutions had issued a lot of longer-term fixed rate loans that ended up being lower than the cost the institutions could borrow at, and they couldn’t attract enough savings to cover shortfalls.
In the case of the Silicon Valley Bank collapse seen in recent weeks, the bank had put cash into longer term bonds at low rates which then lost value when interest rates sharply increased. When depositors came calling, there wasn’t going to be enough money to pay them out. Another risk was it served a specific industry with large deposits. The news spread fast among the tech industry that confidence was gone and money was being withdrawn, meaning the bank was terminal very quickly.
The other two banks that failed in the US, Signature and Silvergate, were both friendly to the cryptocurrency space. There have been suggestions that regulators had no problem closing the banks as a warning to other banks to keep away from cryptocurrency business. Investors can come to their own conclusions, but it may highlight how governments view cryptocurrencies.
At Credit Suisse, confidence had been low for some time. It had been hit hard by losses suffered through the collapses of Archegos Capital Management and Greensill Capital. Ongoing speculation saw many wealthy depositors pull money and deposits fell 40% last year. When its largest shareholder, the Saudi National Bank said they weren’t tipping more money in, it became a code red situation and $10 billion in deposits were pulled last week. While the Swiss National Bank was prepared to provide liquidity, regulators pushed the other notable Swiss investment bank UBS into acquiring Credit Suisse to stem further problems and restore confidence.
Confidence means a lot in banking.
Confidence also means a lot in financial markets. Things that seem unusual occurring in financial markets can prompt some concern. What should investors do in response? As always: nothing. Sometimes that’s easier said than done, but having some knowledge at hand is always useful. Here are some things to know and understand.
Rough Financial Conditions Mean Bad Returns?
One thing worth remembering is riding out a concern or crisis can mean decent returns over the long term. The issue is investors may have to take a few kicks in the teeth to get those returns. Discipline and patience are essentially a mouthguard that allows an investor to stay in the game. Not wearing a mouthguard often means an expensive lesson, sitting out the second half of the game when the returns show up.
The 1980’s are an example. They were chaotic. Inflation was high. As noted, the US was going through the savings and loans crisis. There was a recession in the early 80’s across much of the west. The S&P 500 in the US had a return of 12.45% per annum after inflation for the 1980’s. Like any other decade there were rough periods and 35% of months in the 80’s saw a negative return, but that’s quite common.
In Australia the ASX All Ords delivered a 9.39% per annum return after inflation for the 1980’s. As in the US there were rough periods, with 35% of months also in the red.
It’s important to highlight the negative months so investors are aware, but on the flip side, 65% of months were positive across the 1980’s. That’s where the growth comes from. Waiting and being there for the majority of months in a decade that are positive.
The Guy Who Predicted the Last Thing
The moment there’s some market volatility or the hint of something serious afoot in the financial world, eyes quickly turn to someone who might have predicted something previously to see what their insights are.
The problem is all these people are akin to the boy who cried wolf. The wolf turned up one time, meaning they got one forecast right and they’ve continued to dine off it with further crisis predictions. Unlike the fable, no matter how many times these people cry wolf, the media still platform them and plenty of people still listen to them.
Assuming motives are pure when there is money to be made can also be a mistake. Attention doom can pay well. Giving speeches to financial institutions, industry bodies and investment conferences is often an unseen, but lucrative business. Quite often someone is trying to get headlines for whoever has them speaking that month or a product they’re launching.
Then there’s those who may have a trading position they want to pay off. The case of hedge fund manager Bill Ackman during the initial Covid outbreak illustrates this. Ackman famously phoned into CNBC, in tears, suggesting hell was coming and the USA would cease to exist. No surprise Ackman was short the market at the time and betting it would fall. Arguably, his whole goal was to incite further panic to ensure his trades paid off.
Ackman’s hedge fund made $2 billion from the market falling during the initial panic, before promptly changing his position and buying stocks again. During the Silicon Valley Bank failure Ackman appeared on social media proclaiming regional American banks were all potentially on the brink. After his Covid performance, many speculated Ackman was again playing an underhanded game to spook investors and ensure his trades paid off. His true intent will be revealed next time his hedge fund reports. Unfortunately, there’s no way of dealing with people who want to shout “FIRE!” for their own benefit.
Our suggestion to deal with such predictions is google. You can take the power back and check out someone’s record. Enter their name and various years and see what comes up. They’ll likely have a record of misses or dubious behaviour going back years.
Finally, remember the majority of market selloffs start outside the financial world. A volcano in Iceland, airplanes hitting tall buildings, a war, an earthquake, a tsunami, a nuclear reactor melts down, a pandemic. No one forecasts those.
The Crisis Vacuum
One of the strange things that occurs with a predicted crisis, potential crisis, or actual crisis, are the assumptions that are made about it. There have been a lot of doomsday scenarios made over the years and they often leap from a potential problem directly to the forecast disaster. The assumption is any potential problem will occur in a vacuum. Problems will begin, and continue to cascade, while those with any influence will remain hands off and won’t lift a finger to respond.
The actions of Central Banks and large commercial banks in the US and Switzerland in the last few weeks underline how wrong this is. Problems weren’t left to fester. Swift action was taken and those in charge will continue to ensure liquidity and support is available in the system.
A notable example of vacuum and response was Kerry O’Brien interviewing economist Steve Keen on The 7:30 Report in October 2008. Keen laid out how bad he thought things were: Australia was on the brink of disaster and the housing market was in trouble. It formed the basis for O’Brien’s interview with PM Kevin Rudd on the program the following night. O’Brien was wound up about the state of the world economy and the frightening implications for Australia, peppering Rudd on national TV with Keen’s concerns about debt levels and the housing market.
Two days later the government announced a bank wholesale funding guarantee and a deposit guarantee. The next week they announced a large stimulus package focused on pensioners, families and first home buyers. Steve Keen is often derided as a fool in real estate circles because none of his doomsday scenarios came true, but ironically, he may have played some role in ensuring the government acted swiftly to ensure his predictions didn’t come true!
Are You Covered?
Australia’s Financial Claims Scheme covers amounts up to $250,000 held in authorised deposit taking institutions (ADIs). A list of ADIs can be found here. One thing important to note is what constitutes an ADI, for example Westpac also has St.George, Bank of Melbourne and BankSA operating under its license. If someone has one million dollars split evenly between those four banks, only $250,000 would be covered because it is considered one ADI.
This would be a consideration in the event of a property or asset sale. Someone may have well above the $250,000 limit sitting in cash for a period, so knowing where that money is and isn’t covered will be important.
Non-bank lenders are another consideration. These are not ADIs and do not take deposits, but they may offer an “offset account” type product attached to a mortgage. For anyone who has a mortgage with a non-bank lender and has money sitting in one of these “offset accounts” it’s important to read the fine print regarding these products. One non-bank lender’s “offset account” is accompanied by the following disclaimer:
Please note the ‘offset’ is a sub-account of the loan and not a separate deposit account. As such, the funds in the ‘offset’ are not covered by the government guarantee for deposit accounts.
Cash within superannuation is another consideration. This may be the first time you have heard this, but cash sitting in superannuation is almost not covered by the deposit guarantee. Firstly, some cash options in super funds are actually short-term money market securities and some short-term bonds, not deposits, so these are not covered at all. In the case of actual deposits, we’ll let Macquarie explain from their Super & Pension Manager II Product Disclosure document.
The Wrap Cash Hub is a deposit held with MBL by the Fund’s custodian, which forms part of your Super and Pension Manager II account. Your interest in the Wrap Cash Hub will not be directly protected by the Federal Government’s Financial Claims Scheme. You may have a pro-rata entitlement to the Fund’s aggregate cap amount of $250,000 per deposit account per authorised deposit taking Institution (ADI). However, this entitlement ranks in proportion with all other members’ Wrap Cash Hub holdings which, given the number and value of other members’ holdings, means that your pro-rata entitlement is likely to be negligible.
Essentially, a superannuation fund is a trustee and akin to one entity holding assets on behalf of many people. An entity that has an account with an authorised deposit taking institution only has $250,000 coverage with that institution. There could be billions of dollars sitting in cash at a super fund, but only $250,000 will be covered per ADI it sits with. This is the same for every superannuation fund, from an SMSF with only one member to a large industry fund with millions of members.
There is some irony here that many superannuation investors want to rush to the safety of cash during a crisis, but aren’t fully versed on whether that cash is protected or not. Regardless, it still shouldn’t be a worry.
Should This Concern You?
When interest rates are increased swiftly, things can break. Assumptions made about how long cheap borrowing would go on for tends to catch up with some people. Non-bank lenders, mortgage funds and private debt may have the potential to see some trouble, and as we’ve seen with markets there will be some volatility. As an investor, or someone with cash sitting idle somewhere, it’s important to have an understanding about what is going on, what is and isn’t covered by the guarantee, but it shouldn’t concern anyone.
Could any of the big four in Australia withstand a run. No. If every depositor demanded their money in a few days any bank would be in serious trouble. Regulators do have detailed plans in place for the course of action they would take, which is common in every country, but the reality is no big banks are going to fail in Australia. If one of the big banks in Australia went down, it would require a cataclysmic event. Something that would almost guarantee life as we knew it was over. Society wouldn’t be functioning and there would be much bigger problems than money.
We’ve noted in the past that no one can plan for such dire scenarios because they are unimaginable. Life’s for living, not fretting about it turning into a disaster movie. Football’s back. There are books to be read. Gardening to be done. Dogs to be walked. Beaches and parks to be walked on. Friends and family to spend time with. The problems occurring in the banking sector will be dealt with, so put them aside and enjoy life.