The current situation is more worrisome than the previous one that occurred last spring. At that time, a few banks were involved in activities they shouldn’t have been engaging in, such as purchasing a large number of long-term bonds, and handling it in an imprudent manner by failing to protect themselves from the financial impact of rapidly increasing interest rates. This was not great, but it was easy to attribute the issue to greedy management and slow regulators.
The banks currently facing trouble got into this situation by carrying out exactly what they were supposed to, but performing poorly. While we don’t require banks to possess a significant amount of Treasury bonds – individuals can manage that on their own – we do rely on them to provide financing for New York City office buildings, solar farms, and startup businesses. In other words, the banks that failed last spring did so mainly because the pandemic caused unprecedented events to unfold. There was a significant increase in savings accounts, inflation soared, and the U.S. Federal Reserve hiked interest rates at an unprecedented pace. Silicon Valley Bank essentially underestimated the actions of Fed Chair Jerome Powell.
However, banks like NYCB are now in a precarious position because they misjudged their own borrowers, either by extending loans to businesses that lacked creditworthiness or by not charging them sufficient interest to offset the risk. This goes to the core function of a bank and lends this turmoil a more unsettling outlook than the last time.
One important point to note is the potential embarrassment for regulators in this situation. They considered NYCB to be strong enough to acquire the assets of another failed bank last spring. Therefore, for Moody’s to identify “multi-faceted financial, risk-management, and governance challenges” just a few months later presents a negative image for regulators.
