We Study Billionaires - The Investor’s Podcast Network - TIP539: The Banking Crisis Explained w/ Shawn O'Malley

Starting point is 00:00:00 You're listening to TIP. On today's episode, I sit down with Sean O'Malley to provide an update on the banking crisis. Sean is the chief editor and writer of our daily financial markets and investing newsletter here at the Investors Podcast Network. Sean aims to bring a value investor's perspective to understanding current events. For many months, many have said that the Fed will continue hiking interest rates until, quote-unquote, something breaks. Well, in today's episode, Sean breaks down why it feels like the Fed has, has broke something and what it means for investors. In this episode, we cover what led to the recent bank failures of Silvergate, Silicon Valley Bank, and signature, how the Federal Reserve responded

Starting point is 00:00:41 to prevent a collapse of the banking system, how each crisis is setting a precedent and making impacts in the crises that follow, why Credit Suisse was forced to sell to UBS for pennies on the dollar, what the recent drop in treasury yields mean for markets, as well as how investors should view money market funds in light of recent events. Sean and the newsletter team have done a fantastic job covering the banking crisis for the readers of our financial newsletter, so I figured there'd be no better person to cover this particular topic. If you're not yet subscribed to the newsletter, you can click the link in the show notes to get yourself subscribed. With that, I hope you enjoy my episode with Sean O'Malley. You are listening to The Investors Podcast, where we study the

Starting point is 00:01:27 financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the Investors Podcast. I'm your host, Clay Fink. Today I'm joined by Sean O'Malley, one of our newsletter writers on our We Study Marcus team here at the Investors Podcast Network. Sean, welcome to the show.

Starting point is 00:01:55 Hey, Clay. It's a pleasure. Really excited to be on. Let's dive into it today. Today's a little bit different of an episode than what I traditionally do here on We Study Billionaires. with all the craziness happening in the world, with what feels like bank after bank running into financial issues with, you know, the stock market overall really hasn't even flinched with all

Starting point is 00:02:16 this happening. So I wanted to bring Sean on the show as his team has done extensive research on the banking crisis and really kept our newsletter readers informed as these new issues came to light day after day. So starting from the beginning, Sean, the first bank that got hit was Silvergate on Wednesday, March 8th. they announced that they would be winding down their operations and liquidating the bank. Could you give the audience a rundown on what exactly happened at Silvergate? And then we can cover some of the dominoes that followed. Yeah, it's been a really fascinating story to follow.

Starting point is 00:02:52 Honestly, I've probably been addicted to Twitter and reading the news, keeping up with all this. So, yeah, just get started. The first thing to know here is that Silvergate Capital is the publicly traded parent company of Silvergate Bank. So there's a slight distinction there. and basically they announced they would cease operations in response to, quote, recent industry and regulatory developments. What happened there is that for years, we had this quickly growing crypto industry that was essentially completely unbanked.

Starting point is 00:03:18 The issue really came to a head in 2016 and 2017 when Bitcoin went mainstream, and that was when a lot of people really kind of heard about it for the first time. There was a lot of excitement around blockchain technology, if you can remember, and I mean, there still is. And it was finally at a scale that appealed to traditional financial institutions. and Silvergate sort of saw an opportunity to carve out their own niche there. It became the face of crypto banking, and that was honestly a really good bet to make for a while, too. The bank's assets grew quickly, and it IPOed in November 2019, and just two years later,

Starting point is 00:03:47 its share price had risen by an incredible 1,500%. Part of its appeal for companies to work with them was the fact that it operated this real-time payments network called the Silvergate Exchange Network, and it was primarily for cryptocurrency exchanges and other crypto-based institutions, and it enabled them to quickly transfer fiat currency. Funny enough, they also even acquired META's DM technology. If you remember, that's what Facebook named. It's Libra Currency project that regulators sort of ultimately shut down.

Starting point is 00:04:15 So Silvergate was increasingly entrenching itself in this emerging industry, and it was really well positioned to benefit in the good times. Unfortunately for them, and this is really going to be a theme for most of what we discussed today, is that the Fed began hiking interest rates in 2022, and while that, that's changed everything. So that crushed the stock market and weighed even more heavily on digital assets. When rate was zero, there was a really strong incentive to pile into tech stocks and Bitcoin, but as rates rose, that opportunity costs increased. You know, why own any asset that doesn't produce cash flows when you can get a four or five percent

Starting point is 00:04:47 yield on government bonds? That's essentially risk-free, or at least that's what they tell you. That reality popped when some, you know, what they call the everything bubble. You know, this euphoria we saw throughout 2020 and 2021. Of course, Warren Buffett says when the tide washes out, we see who is swimming naked and taking excessive risks. And in this case, it wasn't just risk, but actual allegations of fraud over at FTX, which at this point, I think we're all pretty familiar with the story there.

Starting point is 00:05:12 Crypto companies like BlockFi and Celsius went down one by one as digital asset prices fell almost 80%. And for a bank, when these firms represent a large swath of your deposit base, this is a pretty devastating thing to have happen. Silvergate actually saw over 70% of its deposit base. get drained and because banks primarily fund themselves with deposits, that's virtually impossible to survive. At the same time that its deposit base was drying up, its assets were losing value due to rising interest rates. So it really just got squeezed from both sides. The risk here, which I really

Starting point is 00:05:44 want to emphasize is distinctly different from 2008, is a failure to diversify their deposit base. You don't want to be in a position where your depositors maybe all adversely affected at the same time, which is why banks typically try to diversify their deposits across a broad spectrum of clientele and industries and Silicon Valley Bank, which I'm sure we'll talk about one under for similar reasons. I think you hit on a really good point there, and that's that many of the assets these banks are holding are falling in value due to rising interest rates, you know, call it treasuries, mortgage-backed securities.

Starting point is 00:06:17 The values of these assets naturally fall as interest rates rise. So Silvergate had two issues where they had declining deposits as, you know, you know, you mentioned, and then they're also dealing with the balance sheet side where the balance sheet is being impaired because of the higher interest rates. So when you look at an asset like a treasury, it's not really considered risky in terms of the credit or the person who purchases that treasury, the risk that they're going to be paid back on that bond. The risk with the treasury is that the value of it declines in value. And then, you know, if the bank needs to sell it, then they could run into a mismatch of their assets and their liabilities.

Starting point is 00:06:54 So there's a lot of pressure put on banks right now. And what's also putting additional pressure on banks is that depositors can also put their money into something like a money market fund. On average today, the average checking account pays close to 0%, and then maybe a savings account pays 1%. But, you know, I look at Vanguard's money market fund and it's paying over 4%, 4.4% after fees. So that is such a widespread when investors are looking at the opportunity costs of where they can park their cash. So we'll be talking a little bit more about money market funds later.

Starting point is 00:07:27 But pivoting back to Silvergate, Silvergate's collapses on Wednesday, March 8th. And then two days later, we see Silicon Valley Bank was the next domino to fall on March 10th Friday. And Silicon Valley Bank was the second largest bank failure in history, in nominal terms at least. So please give the audience a rundown on what happened with. Silicon Valley Bank. Yeah, you raised some really great points there, Clay, and I don't disagree with any of that. To answer your question, really in the same way that Silvergate had carved out a niche pretty successfully in the crypto industry, a Silicon Valley Bank or SVB, as I'll probably call it,

Starting point is 00:08:03 had for years both the reputation that it was the go-to place for venture capital-funded firms and other startups. Some reports suggest that half of all startups in the U.S. had a relationship with SVB, which is a pretty mind-blowing statistic when you really think about it. And low interest rates created this boom in the venture capital space as investors wanted to push further and further out the risk curve to find returns. And these VC firms poured money into those startups. But companies just don't spend all that money immediately, right?

Starting point is 00:08:30 They have to, you know, store it in a bank. They draw it down over months and years between fundraising rounds for things like payroll and inventories. And they have to keep at least some of those funds in a bank account. And servicing these companies is really where SVB specialized. They saw massive inflows through 2020 and early. early 2021, and their balance sheet actually tripled. They essentially had to buy something with all that deposit funding, though, to protect their net interest margins. So right as they had more

Starting point is 00:08:56 funds and they knew what to do with, they piled into, you know, and this is a theme again for today, supposedly risk-free government bonds, really at their peak prices. And as the Fed began removing liquidity from the economy, as we know, with rate hikes, the venture capital space hit a wall. Investor funding collapsed and companies spent down their cash balances, draining the bank of its deposit funding. So while on paper, SVB might have looked diversified, catering to thousands of different companies. In reality, most of those companies were backed by a handful of the same venture capital firms. It's the sort of thing that a bank's management should have been well aware of, though. What sparked the brewing crisis in my mind was that for SVB, the fact that its suppositor base

Starting point is 00:09:34 was drawn to down and it had to sell off holdings of primarily government bonds at a $1.8 billion loss to raise funds to meet withdrawal requests. The bank had marked these bonds interestingly as being held to maturity on its books. This is a bit of an accounting trick, but it meant that SVB didn't have to show any unrealized losses on its income statement as rates rose. So at that point, when it became apparent that it had to sell bonds, that it intended to hold for maturity and made those unrealized losses realized ones, confidence in the bank was pretty much shot. To offset those losses, the bank announced a share sale to raise $2.25 billion. But let's be honest, an emergency share sale isn't the sort of

Starting point is 00:10:14 thing that inspires confidence in investors, especially not at a bank. And in some sense, confidence and trust is kind of a core challenge for all banks. Without trust, you can't operate a fractional reserve system by definition, really. At this point, it was pretty clear that the bank was in trouble. Its shares fell 60% in one day and fell another 20% in after-hours trading. And really what happened is prominent VC firms panicked and advised their portfolio companies to withdraw funds from SVB. And at that point, the bank's fate was essentially sealed. Regulators, responded the next morning to probably the fastest bank ground in history, which is really remarkable to watch. And honestly, it played out all on Twitter. A lot of people got to see it happen in real

Starting point is 00:10:52 time. So state regulators and the FDIC took control of the bank. And then we had two days of this tension and uncertainty over what was going to happen. It had a lot of calls for essentially a deposit or bailout as the realization set in that most of the bank's depositors were uninsured and that there were thousands of companies and even more thousands of employees that were at risk of losing their deposits. Now, let's just follow right through with the weekend. Signature went under on Sunday, March 12th. And then Monday, President Biden made a statement ensuring everyone that depositors would be made whole. And the investors in any of those banks that failed won't be made whole.

Starting point is 00:11:34 So that gives us three large bank failures in just five days. Silvergate, Silicon Valley Bank, and signatures. So I'm curious, what's the overall magnitude of these three? banks in such a short period of time? Yeah, so honestly, it's a surprise whenever banks fail, and I think it caught everybody off guards. Signature was a bit of a surprise. There were rumors that signature was in trouble, but when it was announced that depositors

Starting point is 00:11:58 that SVB would be fully protected, they also announced the same for signature, which hadn't actually been declared as a failure up until that point. So on the one hand, it was reassuring that depositors would be protected by the FDIC, but on the other, it was alarming that another bank had quietly failed, and they tried to just slip that into an announcement that was expected to only be about SVP. What the government did, though, was enable all those VC-backed companies and other depositors to access all their money Monday morning thanks to the FDIC. And this is where it gets political because everyone has their own definition of a bailout. Strictly speaking, this wasn't directly a taxpayer-funded bailout

Starting point is 00:12:32 because the funds are coming from the FDIC, which raises money from fees that it charges to license banks that essentially pay into an insurance fund. And regulators were quick to point out that the management at these banks have been terminated and that their stocks are now worth zero. So it wasn't a shareholder bailout per se, but a depositor bailout backed by the entire banking system, essentially. And the magnitude of this really shouldn't be understated. We saw regional banks across the board get hit with panic selling and uptakes and withdrawals, even after authorities set the precedent of guaranteeing all deposits. Banks like First Republic, which authorities are now working desperately to save, lost over $70 billion of its deposits to withdrawals, which amounts to

Starting point is 00:13:11 nearly half of its deposit base at the end of last year, which is just remarkable. Even big names like Charles Schwab were being hit by contagion concerns. The problem, though, is that structurally all banks face the same issue to varying degrees from a decade of near zero interest rates. If you combine that with record deficit spending during the pandemic, there is this tremendous amount, about $2.7 trillion worth, if you count mortgage-backed securities, of government bonds just sitting on banks balance sheets that have lost value on paper. They were purchased at a time when bond yields were around 1%.

Starting point is 00:13:42 So with yields on new bonds being issued closer to 4% today, their prices on older bonds have to fall so they can offer competitive returns. But if you're the one holding those COVID-era bonds, unless you can hold them for years until they mature, then you're going to have to sell them at a discount. And that's kind of a quick synopsis of the problem. Banks are seeing broadly and where we're at. At scale, we're talking about hundreds of billions of dollars and unrealized losses across the entire banking system. Now, every bank has different levels of exposure and ability to

Starting point is 00:14:12 absorb those losses. But when three banks fail, investors go into panic mode, they sort of throw the baby out with the bathwater. There's not enough time to do a deep audit on every bank. And that's how you get a contagion. People begin thinking that all banks are unsafe outside of maybe the five biggest clients withdraw their money and investors sell shares in the stock and bonds. And then this actually creates a crisis because the banks have to realize losses on their assets. What we should remember is that bank depositors are actually a very risk-averse customer base. If you think about it, the incentive to stay at a bank where there's any hint of risk is pretty low. There's some stickiness with their products, maybe lines of credit for businesses and debit

Starting point is 00:14:49 or credit cards linked to accounts. But for the most part, losses or even just a delay in accessing your funds at your primary bank could be catastrophic. So even if a bank gets a bailout, just the fact that it was needed is enough to make people afraid. Just to show the point, even after First Republic got an injection of $30 billion worth of deposits from the country's biggest banks to stabilize it, you know, ask yourself, would you open an account there tomorrow? The answer is probably not because why would you? Why not just go somewhere that isn't making headlines for bank grants? I'm not opening an account at First Republic anytime soon.

Starting point is 00:15:22 There's just no reason to. It's easy enough to open an account elsewhere. If there's any whiff of risk and, well, that's essentially what we've seen. Ultimately, these banks failed from a crisis and confidence inspired by granted real issues in the business cycle and tightening from the Federal Reserve, which is worsened by poor risk management on their end and specifically a lack of depositor diversification, at least for SVB and Silvergate in particular. I think you bring up a really good point there that I think we're going to be touching on, too,

Starting point is 00:15:52 is that people aren't going to want to be going to these banks that they perceive as risky because there's really no reason to when you can go to a larger bank. The Federal Reserve and government might be more kind to or more sympathetic too. So now that we've covered many of the dominoes that fell during those five days, let's talk a little bit more about the response by the FDIC, the Federal Reserve, and the Treasury. Originally, the FDIC implied that those who had over 250,000 in deposits would get wiped out. But within just 48 hours, it was announced that all deposits from those bank failures would be guaranteed. And the Fed also announced that they would guarantee every deposit in the

Starting point is 00:16:34 U.S. banking system to prevent fears of, you know, bank runs and anything else that might happen in the banking system. So Silicon Valley Bank is not the only bank with this issue being underwater on their bonds. A ton of banks are running into these issues because they really don't have much of an option of where to park their cash. So the Fed announced that these banks are now able to post their bonds at par value as collateral at the Fed. While the value of the bonds might be trading down 10 to 20%, now they're at 80 or 90 cents on the dollar. The Fed will recognize these treasuries as collateral as if they're trading at 100 cents on the dollar. So here's the stat I also wanted to read to you that I got from Zero Hedge. According to the Washington Post, the total capital

Starting point is 00:17:19 buffer in the U.S. banking system totals $2.2 trillion. Meanwhile, the total unrealized losses in the banking system based on a pair of academic papers is between $1.7 trillion and $2 trillion. So in other words, if banks were suddenly forced to liquidate their bond in loan portfolios, the losses would raise 77 to 91% of their combined capital cushion. What this essentially means is that a large number of banks in the U.S. are terrifyingly fragile. So that's what I got from Zero Hedge. And then there's another piece here. a second report by the Wall Street Journal cites a study from Stanford and Columbia universities

Starting point is 00:18:00 that found that 186 U.S. banks are in distress. Turning back to the Fed and the government's response specifically, what are your thoughts on this and what second order effects do you think this might lead to? Sure. Yeah. Those are some incredible stats. Really disturbing to think about. My biggest takeaway, really, though, is that the rules of the game aren't fixed.

Starting point is 00:18:22 finance and life itself is sort of one big game in many ways. And what we're seeing clearly now is that for better or worse, when needed, the rules can be rewritten. Whether it's changing deposit insurance limits or emergency lending facilities, we shouldn't underestimate how many different levers the government can pull to stabilize things. And on a day-to-day basis, when we can look at things like regional banking ETFs, credit default swaps, bond volatility indexes, kind of pick your choice there. We can see them as a real-time scorecard of how well authorities are managing the crisis, the more they can tamp down volatility right now, the better. What's interesting about banks is they're essentially private investment institutions that are

Starting point is 00:19:01 based on this distributed public deposit base. And what we've seen recently and even more so in 2008 is that when they fail, they sort of threaten to take everyone down with them. They profit in the good times, but in the bad times, you know, suddenly it's, hey, if our bank goes down, 2,000 companies go under in the next week because we hold 80% of their cash deposits, which are mostly uninsured and they won't be able to make payroll. I hope you don't get me wrong. You know, banks are absolutely critical to any modern economy, but you can also see why people despise them. People are citing moral hazard here and I think that's fair, but ultimately these failed banks are dead and the only winners are the bigger banks that might bid on their assets at a

Starting point is 00:19:42 discount and are absorbing their customers, which we've seen a lot of in just in the last two weeks. That said, it probably does incentivize more risk-taking on the margins just because they know, especially now that the worst-case scenario is sort of capped by the U.S. government, which has made it clear that depositors will not suffer from bank failure. So even if they blow themselves up, they're hopefully not going to blow up the entire economy. Funny enough, though, I think the moral hazard or maybe complacency is a better word for it might exist on the flip side with depositors. Everyone has known about FDIC insurance limits.

Starting point is 00:20:16 It's not a secret. In fact, it's common knowledge. There really is no excuse for a corporate treasurer to pretend like they don't know better. Sure, we shouldn't expect depositors to run due diligence on every bank they work with, but if you have $30 million in your corporate bank account that only has $250,000 in insurance coverage, you should probably know that you risk losing $29,750,000 if that bank fails. You could, as an alternative, keep, say, $1 million in that bank account and another $1 or $2 million at a different bank, spread the risk a bit and hold whatever amount you need to tap to sort of meet your

Starting point is 00:20:52 weekly bills and then split up the rest in money market funds or short-term treasury bills. Right now, though, around $8 trillion or about 40% of all deposits are uninsured. So clearly, a lot of people did not do that. They have not split up their deposit risk. And there's an argument that maybe they should face consequences for that. But now there are talks of this emergency extension of FDIC insurance coverage to cover all deposits. And it's hard to say what will happen.

Starting point is 00:21:18 But my guess is that if we see another bank failure, this. This is probably the next step that has to happen. And if you look at it, regulators are already trying to figure out whether they have the powers to do this or whether they'll need an act of Congress. But I think we probably end up raising FDIC limits once things have calmed down since it's been a number of years since their last increase. But in my mind, this just furthers the precedent for what people call privatizing gains and socializing losses.

Starting point is 00:21:43 It falls to society to protect depositors while private banks benefit from that protection. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year, bringing together activists, technologists, journalists, investors, and builders from all over the world. many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse,

Starting point is 00:22:29 using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to, but end up having to. having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech, and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June.

Starting point is 00:23:07 If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedomforum.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference. It's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. Nesuite is the number one AI cloud ERP, trusted by over 43,000 businesses.

Starting point is 00:23:51 It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the Netsuite AI connector, you can use the AI of your choice to connect directly to your real business data. This isn't some add-on. It's AI built into the system that runs your business.

Starting point is 00:24:20 And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide demystifying AI at netsuite.com slash study. The guide is free to you at netsuite.com slash study. NetSuite.com slash study. When I started my own side business, It suddenly felt like I had to become 10 different people overnight wearing many different hats.

Starting point is 00:24:49 Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all ecommerce in the U.S. from brands just getting started to household names. It gives you everything you need in one place. inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with

Starting point is 00:25:24 helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing, sign up for your $1,000, per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show.

Starting point is 00:26:00 A lot of people are understandably becoming concerned about depositors fleeing from smaller banks, local banks to the too big to fail banks, because they know historically, you know, the too big to fail banks are going to be, made whole, depositors are going to be fine, and your capital might be at risk at one of the other banks that aren't one of the top big five banks. So does this incentive only exist for those that have over the FDIC limit of 250K, or should your regular everyday person be concerned about you know, where they park their money and what bank they're at? Yeah, I'll just, I'll zoom out a bit before answering that. Before the creation of FDIC insurance, banks failed a lot more than

Starting point is 00:26:45 9,000 banks failed in the four years before deposit insurance went into effect in 1934. That's at least according to a paper from the FDIC themselves. The FDIC maximum has only been raised seven times in its 90-year existence, and the last two times were because of similar financial turmoil. So FDIC insurance is a good and very important thing. But the other thing we should know, though, is the less volatility there is in the banking system, the better that is for society. I don't believe most people need to be worried about their checking or savings account at a bank going to zero,

Starting point is 00:27:18 specifically for those who hold balances below $250,000, which is the vast majority of Americans. Like I said before, the rules of the game can be continuously rewritten, and the government can do a lot to prevent doomsday scenarios from coming true. The way I see it, this is really a question for wealthier folks with large cash balances in their bank, and even more so for companies. Instead of maybe your savings going to zero, the risks that authorities have been responding to here is that maybe the small business you work for was at risk of losing access to funds. It needs to pay the bills each month. Even here, it wasn't that people and companies with uninsured deposits

Starting point is 00:27:52 would lose everything, but rather that in the panic of a bank run, it could take weeks or months for the banks to liquidate enough assets to meet those requests. But if you're a mid-sized company with maybe a few dozen employees, you've got bills to pay and you can't afford to start defaulting on payments or not paying employees because your deposits are tied up for two months. Even if you get 100% of your money back at a two-month delay, your business is still going to be devastated. So, everyday Americans are at risk, but not in the way I think most people think. We're talking about the 60 million Americans who work for small businesses and might have lost their job or their business if regulators hadn't stepped in.

Starting point is 00:28:25 The reason now that bank deposits are flowing to the big banks is because of the precedent we set back in 2008. These big institutions think Bank of America and JP Morgan have been designated as systemically important globally, meaning that they can't be allowed to fail. And with each crisis, we set a new precedent. That sort of carries into the next one. We just saw this play out with Credit Suisse, too. They're one of the 30 banks globally that are considered systemic, and Swiss regulators responded swiftly and accordingly. They announced $50 billion in liquidity support for credit sues to essentially buy themselves enough time to find a buyer with a better brand name

Starting point is 00:29:03 who could absorb the bank and its deteriorating image, which really fell apart recently, but had been declining for many years due to scandals and mismanagement. And ultimately, they did find a buyer. It was by no means a good deal for Credit Suisse, but they were well beyond the opportunity for that. Swiss regulators push UBS into this shotgun marriage with Credit Suisse for a $3 billion price tag, which was a huge discount to the $8 billion market cap. It traded out just a day or so before. To make the deal happen, what they essentially had to do was wipe out $17 billion worth of Credit Suisse's bonds. And they provided $9 billion. and guarantees to UBS, meaning that basically they're removing all the risk from the deal for

Starting point is 00:29:43 UBS, who gets to buy its rival at a discount, while having much of the losses it incurs for doing so subsidized by the government. So in many ways, for UBS, it's sort of a sweetheart deal. You can't imagine carving up much better for them, I wouldn't think. So even the most mismanaged bank, if it's systemically important, can be backstopped by regulators and a solution we all know will be found. As a depositor, especially a company with a large corporate account, of course you want to hold your money at a bank that essentially can't go under. And that really is going to hurt hundreds of

Starting point is 00:30:13 smaller banks across this country. So you mentioned Credit Suisse there and how there's been more recent developments with them as well. So Swiss regulators wiped out $17 billion worth of Credit Suisse bonds so they could close out their sale to UBS for around $3 billion. These bonds are called AT1 bonds, which I've never even heard of. Maybe you could talk a little bit about what those are and what exactly is going on with Credit Suisse and why the listeners should be aware of what happened with these bonds and with the sale to UBS. It'll make for a great script in future movies that document this saga. You know, we're going to be watching movies for sure about this in maybe two years. Sort of with the stability of global markets on the line, you know, going down

Starting point is 00:31:00 late into Sunday evening. UBS Credit Suisse and Swiss regulators reached this last-minute deal that valued Credit Suisse at just 0.76 francs per share, which is a 99% fall from its peak, which is honestly a stunning collapse for this 166-year-old banking institution that's supposed to be globally systemic in its importance. So Credit Suisse, you know, the reason why this was necessary is because it was reportedly losing $10 billion per day. in its deposits, so things are getting pretty desperate. And what happened was around the $17 billion, as you said, of what's referred to as additional Tier 1 bonds or AT1s needed to be wiped out to make the deal attractive for UBS.

Starting point is 00:31:45 And these bonds or these types of bonds were introduced after the 2008 financial crisis to transfer banking risk away from taxpayers and onto bondholders. At Credit Suisse, they were popular investment products to sell that could seemingly boost returns on portfolios at quote-unquote low risk. And many European banks issued AT1 bonds despite their higher industry because they had this what was called a bail-in feature, which reassured regulators. They had enough capital buffer to protect against a crisis. And in a crisis, these bonds could convert to equity when certain triggers were reached, such as capital ratios falling below a certain level or if regulators have to intervene on a bank's behalf. But finance 101 tells us that bondholders,

Starting point is 00:32:27 the lenders of capital to a business should sit above shareholders who are the owners of a business and in a company's capital structure, meaning lenders should get paid back first, while shareholders who stand to gain more in the good times should probably lose the most in bad times. And well, we're definitely in the bad times. Unlike other European banks, so Credit Suisse's AT1s included this provision where bondholders could lose their entire investment before shareholders did, and now AT1 holders will get nothing, at least that's how it seems, while shareholders receive UBS stock in exchange for their shares that they held in Credit Suisse. Ironically, a 2021 report from Credit Suisse themselves suggested these bonds were very safe

Starting point is 00:33:08 because the average European bank would need to lose almost two-thirds of its capital to breach contractual triggers. And they said, in their view, this is a relatively remote scenario. And while remote as it may be, here we are that happened. The complete write-off of Credit Suisse's bonds from one of the largest issues, issuers of AT-1s will weaken investors' appetite for these types of securities going forward. And basically, that would make these bonds more expensive for banks to issue in the future, which reduces their ability to make new loans into the real economy. Another thing that's sort of caught my attention throughout all of this was watching bond yields

Starting point is 00:33:46 just like drop like a rock with all these bank failures. And maybe that means many investors are going to safety and buying more treasuries, anticipating that the Fed's going to lower rates. But I saw a chart that showed that the drop in the bond yields, the chart was referencing the two-year. But the daily change in the yield was one of the biggest changes we've seen in decades. And that kind of points to just the volatility we've seen overall in the markets as, you know, U.S. treasuries are kind of the foundation of the financial system. And if that's not stable and it's very volatile, then it's going to send ripple effects throughout the rest of the economy. So I wanted to ask you about bond yield specifically. I just pulled

Starting point is 00:34:27 up the 10-year today. It was around 4% at the beginning of March, and today it's around 3.5%. It's come back and rebounded a bit since it dropped really fast. So what is your interpretation of these interest rate moves? Yeah, good question. Things are moving fast, but it feels like expectations are resetting and investors anticipate that the Fed will have to sacrifice its fight against inflation to basically prioritize financial stability. Two-year bond yields fell at their fastest pace in decades and part as a flight to safety, but also because of a changing outlook in the Fed's hiking trajectory, which I can touch on a little bit more here. At the same time, rate hikes may be less needed anyways, though, because the banking crisis fears have already tightened financial conditions and ways that the Fed

Starting point is 00:35:11 failed to, such as widening the spread on yields for corporate bonds. And central banks are in emergency response mode to halt financial contagion, which to me makes the prospect of, you know, meaningful rate hikes at this point in the future pretty unlikely. Funny enough, we're chatting right before the Fed announces its next rate hiking decision. So I don't want to say anything that'll, you know, make me look poor one way or another. But this is sort of the most uncertainty for sure we've seen around any Fed policy meeting in a while. And I don't think anyone knows what will happen. But a few weeks ago, just to show out things have changed, people were entertaining the idea of a jumbo 50 basis point hike. Then a week ago, in the midst of the crisis, traders placed around a 30% chance on the Fed

Starting point is 00:35:51 being forced to pause, which is a huge swing from expectations. And then as things have seemingly come a bit under control, fingers crossed in the last couple of days, the consensus is that it'll probably be 25 basis points. Like I said, we'll see. Maybe they pause now or maybe they try to make a point to markets that they're committed to fighting inflation and they'll do another hike. But I think we both agree that hiking isn't sustainable. And they may even be cutting rates. this year, if the economy turns down as banks pull back on lending, in response to everything we've discussed. But markets had been essentially tallying the Fed via an inverted yield curve, which we've talked a lot about generally, is that for months, they were tightening too quickly and the terminal

Starting point is 00:36:30 rate would be lower than official estimates coming out of the Fed. So you could argue that a pause was already justified, or at least that's what markets were sort of banking on. Ironically, the U.S. government is in this position where it has relied on American banks to fill the void and purchasing treasuries to fund deficit spending since 2013. That's when central banks around the world began moderating their demand for treasury bonds and in response. Regulators encouraged the American banking system to hold those government bonds on their balance sheet and to even treat them like cash, except for the glaring reality that they're not cash. Treasuries have duration risk and can lose value when interest rates rise, which is what we've seen over the past year at a pretty

Starting point is 00:37:10 unprecedented pace. Now the U.S. government is in this really awkward position. where it sort of relied on the banks to fund its spending and it, in a way, put them in this position. And that reliance has made banks vulnerable, especially to the rate hikes that the Fed has sort of inflicted on them, you know, at a time when the Fed is desperate to preserve its credibility by proving that it can bring inflation down towards its 2% target. I think if we kind of pull all the pieces together, the release valve is likely to be inflation and the U.S. dollar's value, which means that in my view, the hiking cycle is probably done, or at least very close to pausing.

Starting point is 00:37:46 We'll see what happens next, but risk assets are jumping at the chance that the Fed may be returning to the good times of lower rates and quantitative easing. We've seen the NASDAQ lead the way there. Just in the past week or so, the Fed has expanded its balance sheet by around $300 billion to support banks. And this offsets about half of the progress it had made in an entire year with quantitative tightening. And just to show how bad things have gotten, borrowing at the Fed's discount window, which

Starting point is 00:38:12 which for not familiar with, it's very taboo to borrow from typically in good times, at least. That's for sure. Borrowing there jumped from $5 billion in the week ending March 8th to $152 billion last week. And that's more than any week during the 2008 financial crisis. So I don't think that means mass insolvency for the banks, not necessarily the point I'm trying to make, but it does show just how elevated fears are. And nobody wants to be caught off guard by a bank run. And everybody's trying to position themselves. Even in a, you know, borrowing from the Fed discount window, which might have been previously taboo, they would rather take that risk than essentially get swarmed by a bank run.

Starting point is 00:38:49 Man, you made a really good point there of, you know, banks and maybe other financial institutions treating U.S. treasuries like cash. My mind instantly goes back to 2020, 2021, whenever it was where they were saying, we aren't even thinking about thinking about raising rates. So when they're buying bonds at those times, they probably aren't too concerned about those bond values going down. Now, a lot of institutions are in trouble for maybe even listening to the Fed and their outlook on rates. So I'm a little bit hesitant to ask it, but I'm going to anyways, what is your outlook on

Starting point is 00:39:22 interest rates and where you maybe see things going in your research? It seems to me that Powell was pretty adamant on keeping rates high. And like you mentioned, a continued attempt to tamp down inflation. In my mind, he would rather err on the side of potentially being too tight with monetary policy than being too loose in order to try and keep inflation from spiraling out of control. So what sort of outlook are you seeing in light of the recent events? Well, my view has been at the Fed will hike until it breaks something. And well, it sure feels like they broke something, doesn't it?

Starting point is 00:39:56 Which raises the question of, okay, what now? And I think that's what you're getting at. With Powell, we know that he takes very seriously the mistakes of past Fed chairman, in the 70s and 80s when inflation was prematurely thought to be under control. So Powell doesn't want to be the guy who has to hike rates into the double digits because he underestimated how persistent inflation can be. At the same time, though, there's just not a lot of room to hike more in a world built on debt.

Starting point is 00:40:24 The more debt you have, the more sensitive you become to rates. In my view, honestly, the Fed is backed into a corner. Hike rates and you threaten to blow up the financial system, pause rate hikes and maybe even cut and you jeopardize losing credibility over fighting inflation. And credibility is one of any central bank's most important policy tools. So they can't afford to lose that. In my opinion, we're probably heading into a recession now if we're not already in one. I think this temporarily bails out the Fed in its inflation fight since banking crises and recessions are definitely disinflationary, at least typically. For example, we've seen oil prices fall off below $70, fears that the global economy will

Starting point is 00:41:05 sees up and falling energy prices is disinflationary because, well, energy is an input into everything. So I don't put a lot of weight on the idea of a soft landing because I think any slowdown and price growth that brings inflation down to 2%. It's probably going to be the result of some sort of prolonged economic weakness. If it becomes clear in a recession that we're in a recession, you can imagine how the Fed might even be tempted to cut rates in response. Then we're just in a similar position in a year or two from now when we come out on the other side of a recession. The same structural factors causing inflation will be there and will rear their head when economic growth starts to accelerate again and rates would have to once again go higher. Yet we would face the

Starting point is 00:41:45 same challenge of having too much debt, making us very interest rate sensitive. So to summarize, I wouldn't be surprised if rates fell over the next year in response to a recession while disinflation temporarily picks up. But I think that would be a head fake. I expect inflation to structurally be higher over the next decade for a lot of reasons. But to put it briefly, inefficiencies have just been injected into the global economy from COVID to war in Europe, sanctions increased defense spending, which is very unproductive, underinvesting in the energy sector and reshoring of production to places where you have more expensive labor costs. These are all inflationary problems that you're not going to fix by manipulating interest rates

Starting point is 00:42:24 or, you know, an 18-month recession is going to fix. And if inflation proves persistent, short of doing yield curve control, interest rates would also need to be higher over the next few years to account for that. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC to or running an enterprise GRC program, VANTA keeps you secure

Starting point is 00:43:04 and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Riter spend 82% less time on audits with VANTA. That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place. Get started at vanta.com slash billionaires. That's vanta.com slash billionaires. Ever wanted to explore the world of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments. The S&P 500, NASDAQ, Bitcoin, gas, and much

Starting point is 00:43:57 more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity. You'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charge. and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus.

Starting point is 00:44:49 Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise Income Fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com. slash WSB to invest in the Fundrise Income Fund in just minutes.

Starting point is 00:45:30 The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. There's a lot of talk now that the Federal Reserve raising interest rates may impact the demand side of the equation and lower demand, which is obviously what they want, but it may even exacerbate and make the supply side of the equation even worse as the cost

Starting point is 00:46:14 of capital increases and all these supply chains are just so concentrated into a select number of players. I'd also like to touch on how investors can potentially prepare themselves for this type of environment. Some of the staples of financial wellness that come to mind include having a strong emergency fund and cash savings, be prepared for market volatility, both financially and emotionally. What sort of things do you believe that investors should consider here? As people have joked about online, we're at the point in the cycle where the government and banks are calling up Warren Buffett to address this crisis. And that's not because they're looking for advice per se, right? He's not really necessarily a banking expert. It's because they wanted to

Starting point is 00:46:58 contribute funds towards backstopping banks and preventing crisis. He's got one of the biggest rainy day funds out there, just waiting for the optimal time to be deployed. And he famously did that in 2008 when he invested $5 billion into Goldman Sachs. He arguably saved the bank and made a $3 billion profit doing so. So my point there is just to say, there is just to say, there is a $5 billion. these periods when great investors step up and find assets to buy when a market panic has put them for sale well below their intrinsic value. But to do this, you have to have cash on hand. And really, that's harder than you'd think because when markets were soaring in 2021, people thought you were a total moron for not investing every penny you had. And now it looks pretty smart to actually have

Starting point is 00:47:39 some cash stored away to capitalize on mispracings and fear in the market. Of course, to someone like Buffett, he's mastered this behavioral paradox, right? He doesn't. let FOMO misguide him and the good times. And he certainly doesn't panic in the bad times. And really, if you feel panicked now, and a lot of people do. I had moments where I was just feeling very anxious, you know, I would say take 24 hours to reset, go for a walk, get some sleep, log off Twitter. That doesn't mean we shouldn't be concerned, but we certainly can't make good decisions when we're blindsided by fear. So really, just by listening to podcasts like these, in many ways, you're off to a great start. You're informing yourself. And the better you understand

Starting point is 00:48:16 a situation, the better you will be at making calculated unemotional decisions. Still, that's easier set than done. But my point is really twofold. Be financially and emotionally prepared for a crisis. With just one or the other, I think you're still doomed for trouble. An emergency cash fund that you hold that you're too scared to deploy isn't very helpful. And on the other side, if you're a master of Zen, but you have no spare savings to invest or even cushion losses, well, I don't think that's particularly really helpful either. I'd encourage people to focus on being informed, preparing financially to take advantage of crises, sort of like having a rainy day fund with Warren Buffett, as we mentioned, and practicing emotional discipline. It's also really a great opportunity to review your portfolio.

Starting point is 00:48:58 Maybe you don't want to be holding so many biotech or Chinese stocks, whatever it is. Make sure you know why you hold what you do and just be intentional about it. In my opinion, this is about all anyone can really do in anticipation of crises, which we know will happen generally, but might not know the specific trigger for. I think it's important to keep in mind that when fear spreads nowadays, it spreads faster than it ever has in history because of things like social media and technology. You know, it's really easy to just get caught up in that. You see the headlines.

Starting point is 00:49:31 You see your friends texting you. You see all the capitalized tweets trying to get your attention and trying to spark that fear. Fear can spread really fast. So we, like you mentioned, we need to be emotionally prepared for that. markets can and probably will move faster today than they ever have before, especially when you consider all of the leverage in the system and leverage can lead to contagion. You know, one bank failure going down the next day, another bank can go down and that contagion can happen really fast and that fear can be sparked really fast. So I think you bring up a good point when your cortisol levels

Starting point is 00:50:05 are high and you're anxious and you're fearful, maybe turn off your phone, go on the walk, and maybe occupy your mind with other things. Maybe just have checks in place that prevent you from making silly mistakes, like panic selling or whatever else. I think that's why it's really important to just have a strong emergency fund or a strong cash position. So you're able to meet any near-term liabilities. It reminds me of a Napoleon quote where he talked about military genius. And I think it applies to investing as well.

Starting point is 00:50:34 He says, the man who can do the average thing when everyone else is losing his mind. So just stick to your investing strategy investing plan and don't just change it, you know, all of a sudden. And then I also had this another tip I wanted to share that I picked up from Godham Bade's book, The Joys of Compounding. I've been going through that book on the show. He had this chapter that's about journaling. And he talked about how when we're going through these market periods of volatility and these market gyrations, he'll journal about the headlines and some of the things he's reading. Maybe people are messaging him more than usual.

Starting point is 00:51:09 And he'll just kind of journal about what's on his mind, what he's seeing, and maybe what his emotions are at that point. And then I think that can be really helpful in the future when you look back. Because when those types of periods happen in the future, you can be like, okay, I'm recognizing patterns here. And what's happening then is very similar to something that's happened in the past. So that is a really good tip I picked up from that book. when you put things on paper, you can't really lie about it. When people try and recall the past, it's kind of a distorted version of the past. So putting the pen to paper can be really helpful.

Starting point is 00:51:44 One thing I've been utilizing in my own investing in personal finance strategy is parking some of my cash in a money market fund. Like I mentioned earlier, Vanguard offers 4.4% interest on cash, but there's no FDIC insurance on that. So I'd like you to expand on that and maybe what risks. investors should maybe be aware of if they park some cash in a money market fund. Agreed. Yeah, you make some great points. And like we were talking about, I would encourage everybody to have a rainy day fund to some extent, whether it's your personal life or investing.

Starting point is 00:52:15 But the products offered differ by institutions in terms of ease of withdrawals and among investments, fees, stuff like that. But money market funds or high yield savings accounts are great options for a rainy day fund, especially if you open one. And I think this is really important. at an institution that isn't where you do your primary banking and keep your checking account. There can be some behavioral advantages to this where you see it as a separate pot of money that you might avoid tapping into for regular living expenses. I think it works great for saving for something intentional, you know, maybe a wedding, a vacation, or just storing cash in the event of a big downturn where risk assets become

Starting point is 00:52:52 attractively priced. That's how I think about it. The key difference between them, you know, money market funds and maybe high yield savings accounts, is that one has FDIC insurance and one doesn't. So high-yield savings accounts do have the insurance, whereas a money market fund doesn't have the same principle protection with insurance. Both are very safe, but high-yield savings accounts or really any savings account at a bank is just going to have that extra layer of insurance protection. And a money market fund, you're taking slightly more risk,

Starting point is 00:53:18 but you can also earn a slightly higher return. If you have a lot of cash, you want to store conservatively, you could consider keeping $250,000 maybe up until that, insurance limit and a high-yield savings account. And then any cash beyond that, if you're really concerned about uninsured deposits and maybe some of the things we've talked about today, I freaked you out, you could put the rest in a money market fund to earn a bit more income than, you know, for the risk you're taking granted that you wouldn't have the insurance protection. And then any cash beyond that that you keep, you could hold in just a money market fund

Starting point is 00:53:49 and earn a little bit more income and essentially get compensated for the extra risk you're taking more so than you might in a bank account. Yeah, you make a good point pointing out. the high yield savings accounts. I know some offer higher rates than others. So maybe just look at what you know, sort of rates your bank offers and consider maybe a money of market fund if you want to take a little bit more risk and step outside that FDIC insurance limits. So we've covered a lot today, Sean, covered a lot of ground. I really appreciate you joining me to help flesh out what's happening. Before we round out the episode, I'd like to give you the opportunity to tell the audience a little bit about we study markets and the great work your team is doing with the newsletter here.

Starting point is 00:54:28 at TIP. I really appreciate the opportunity to be on. It's been a ton of fun today and hopefully we've been able to provide some value and maybe clarify things for people in a very uncertain time. In terms of the newsletter, it's sort of my passion project a little bit. I feel like I've poured my heart into it. And fortunately, I have two great co-writers, Veronica Pysik, who is on our YouTube channel and then Matthew Gutierrez. And they both joined in the last few months. And really, I think we're doing a great job of covering the market each day, Monday through Friday. to have very markets focused news coverage, explaining two to three important stories for people understand that's unfolding in sort of the financial news, giving people a snapshot of what the

Starting point is 00:55:08 markets are doing, at least in terms of prices. And then we try to, you know, because we're a long-term oriented company here and we're all value investors, we try to do a deeper dive into a specific topic that might be relevant for people to know about. And so those tend to be a little longer. But yeah, each day, I think there's something for everybody to find that they like in reading the newsletter, whether it's looking at the market chart, reading the news, reading the deep dive. And then even on the weekends, we try to be less news focused and a little more lifestyle, thinking about things like having a rainy day fund and how to hedge, you know, strategies for making sure that you don't panic and sell up the wrong time in markets and stuff like that. So I've had a lot of fun

Starting point is 00:55:44 working on it. And I hope people are interested in subscribing. And yeah. That's great. We'll be sure to get the link to sign up in the show notes for those in the audience who would like to join the newsletter. They can also go to The Investorspodcast.com slash we study markets to get signed up as well. Sean, thanks so much again for joining me today. I really, really appreciate it. Thanks for having me on, Clay. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts, or courses,

Starting point is 00:56:21 go to The Investorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP539: The Banking Crisis Explained w/ Shawn O'Malley

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.