The Fed Is Putting Your Money At Even Greater Risk

New article by our team:  The Fed Is Putting Your Money At Even Greater Risk

Before we move into the relevant banking issues we currently see, I want to make sure everyone is clear about the purpose for which we're writing these missives. Some of you seem to believe that we are claiming that banks are about to go under imminently. That's not the purpose for which these are articles are written.

We see the risks on bank balance sheets as potentially even exceeding those that were present before the Great Financial crisis of 2007-2009. But these risks will only begin to become evident to the public once the stock market moves into the bear market we expect will become quite oppressive and exert stress upon our banking system. But, by then, it may be too late for many of you.

Therefore, we're writing these articles now when there's ample time for you do the appropriate due diligence on the banks that house your hard earned money. And, if need be, there's time and opportunity to move your money to stronger banks that may survive the next banking crisis which clearly seems to be on the horizon.

So, now let's move into the latest concerning issues we see in the banking industry.

We have already published several articles about the powerful banking lobby, led by the largest U.S. banks, and its efforts to water down regulation and protection for the public depositors. For example, last May, the Bank Policy Institute, which represents JPMorgan (JPM), Citigroup (C), and Goldman Sachs (GS), launched an unprecedented campaign against changes in the capital requirements for the largest banks which were proposed by the Fed. The Bank Policy Institute reportedly hired one of the country’s top trial lawyers and was planning to sue the Fed if the Fed did introduce those changes.

Furthermore, according to Reuters, Goldman recruited dozens of small business owners from all over the country and escorted them to meet senators in Washington. Goldman Sachs told them to urge the senators to ask the Fed to reconsider the proposed changes in capital requirements. The banking lobby even used billboards and launched an ad campaign on TV, suggesting that every American has an opinion about the Basel III regulation when very few even knew about the issue.

This campaign was apparently successful as the Fed vice chair for supervision, Michael Barr, announced that the regulator had cut a proposed increase to capital requirements for the largest US banks by more than half. According to Barr, the Fed will increase capital requirements for the largest U.S. banks by 9%. As a reminder, the initial plan was to increase the requirements by 19%, which was later cut to 16%.

Mr. Barr also said the following:

I plan to recommend to the Board that we calculate fee income on a net basis in calculating its contribution to the operational risk capital requirement. The original proposal would have measured the contribution of fee-based activities based on gross revenues instead of net income, which is revenues minus expenses.

These changes will give investment banks a lot of room to engage in accounting games to lower their operational risk requirements as they are able to reclassify some parts of trading losses into fee expenses.

A couple of weeks ago, the Fed also issued a statement, which suggests that the regulator is going to make changes to its annual stress test, which would likely be favorable to big banks.

The mainstream media said that the proposals announced by Mr. Barr and the recent Fed’s announcement are a huge win for the largest U.S. banks. Yet, it looks like even these major concessions are not enough for the lobby. The Bank Policy Institute and the American Bankers Association, which is another banking lobby group, are suing the Fed over its annual bank stress tests. Several days ago, the American Bankers Association provided additional details about this lawsuit. In particular, the bank lobby groups declared “that the Fed’s stress test regime is unlawful.” As a result, the lawsuit requested the following from the court:

Vacate and set aside the 2019 and 2020 Fed actions that established the current stress-test regime; declare the models and scenarios used in the 2024 stress tests, as well as those planned for the 2025 and 2026 stress tests, unlawful; and require the Fed to subject the stress-testing framework, including its scenarios and models, to notice and comment before starting the 2026 stress tests.

If you follow our banking work, you know that the Fed’s tests are already ignoring many issues sitting on the balance sheets of the larger banks, which we have previously discussed in prior articles, such as loans to shadow bankers, a rising exposure to CLOs (collateralized loan obligations), a high share of non-U.S. lending, and others. Yet, it seems that even this is not sufficient for the banking lobby, and the Fed will likely further loosen regulation, which would make balance sheets of the largest banks even riskier.

We believe this is another reminder that you should not rely on the banking regulators to protect your bank deposits because, as we see, they are under significant pressure from the very powerful banking lobby.

Bottom line

Believe it or not, there are more major issues on the larger bank balance sheets as compared to smaller banks, which we have covered in past articles. Moreover, consider that there was one major issue which caused the GFC back in 2008, whereas today, we currently have many more large issues on bank balance sheets. These risk factors include major issues in commercial real estate, rising risks in consumer debt (approaching 2007 levels), underwater long-term securities, over-the-counter derivatives, and high-risk shadow banking (the lending for which has exploded). So, in our opinion, the current banking environment presents even greater risks than what we have seen during the 2008 GFC.

Almost all the banks that we have recommended to our clients are community banks, which do not have any of the issues we have been outlining over the last several years. Of course, we're not saying that all community banks are good. There are a lot of small community banks that are much weaker than larger banks. That’s why it's absolutely imperative to engage in a thorough due diligence to find a safer bank for your hard-earned money. And what we have found is that there are still some very solid and safe community banks with conservative business models.

So, I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you: The substance of that analysis is not looking too good for the future of the larger banks in the United States, and you can read about them in the prior articles we have written.

Moreover, if you believe that the banking issues have been addressed, I think that New York Community Bank is reminding us that we have likely only seen the tip of the iceberg. We were also able to identify the exact reasons in a public article which caused SVB to fail. And I can assure you that they have not been resolved. It's now only a matter of time before the rest of the market begins to take notice. By then, it will likely be too late for many bank deposit holders.

At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money.

You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And if you're relying on the FDIC, I suggest you read our prior articles, which outline why such reliance will not be as prudent as you may believe in the coming years, with one of the main reasons being the banking industry’s desired move towards bail-ins. (And, if you do not know what a bail-in is, I suggest you read our prior articles.)

It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. Review our due diligence methodology here.