Surveillance: Bank Turmoil with KBW's Michaud

In this banking crisis, you need somebody that is so knowledgeable on it. And at Middlebury College a few years ago study back the ten banking crisis, back to Jackson. That would be Thomas Machow. Thomas showed is CEO of kbwor thrilled he could join us this morning here within the crisis perspective as well. How's a week then, what's the biggest sweat this week for you on a day to day grank? Well, first of all, it's been NonStop. You know, you really can have markets work and economy work.

At the banking system's not working, and it's really it's a step beyond that because it creates a lack of confidence. You mentioned earlier about a history of bank panics. You can argue whether it was eight, nine or ten, but let's say roughly ten bank panics in the history of the United States. It's not it is. Look, banks made mistakes. We just had the second and third largest bank failure

in American history. But the banking industry is built on confidence, and when confidence is shaken, it could absolutely impact the whole economy. Eighteen thirty one National Bank of Middlebury, perfect example of a small bank going, wait, they're gonna come in here, cash out and give it to James Diamond explain to us the dynamic right now of the National

Banks of Middlebury out there, scared stiff of those top five. Well, first of all, so it's not only National Bank of Middlebury, which actually is a bank that you mentioned specifically, but it's but the big banks lead the global banking system. This is an industry where the American big banks lead the global financial system. That's number one. But it's really the midsize banks that I think we want need to

talk about. And if let's just say for around numbers, the big banks today have sixty percent of the deposits in America. There is they do not make sixty percent of the loans to Middle America and small America. So if the deposits are going to the big banks but they're not the ones making the loans to middle and small America, it's going to have an impact on the economy. And I think long term down the road, we're not

going to be in a good place. But the last thing is you would say, why is that happening, Tom, because there's this implicit guarantee that banks can be too big to fail. We just saw it with Credit Suiee. There was really no worry that counterparties or credit suite weren't going to be made whole. And if that is the sense of the land, it's going to drive business away from these midsized banks, and I think is going

to have a detrimental effect on the economy. So why haven't the steps that the FDIC, that the Federal Reserve, that the Treasure Department already have taken to basically de facto ensure all deposits for most midsized banks been enough to really garner that support that they're backstop two. We got close, Lisa, but we didn't go the distance. So Secretary yelling when she spoke still left the door open

between implicit and explicit. And look, if you saw what the first reaction was at the FDIC with Silicon Valley, it was to give certificates, not deposits, money back. So I think that actually accelerated the outflows of banks on that Friday, and I think what we need is orderliness.

My preference would be the administration came out right now and said we're going to use our authorities and we're going to say that any bank that fails of any size the next year, we're going to guarantee the deposits while we figure this out. I think it would be very good for the economy. Putting long standing solutions aside for a minute. You talked about how a lot of these smaller banks punch above their weight when it comes

to lending. How much have you actually heard of tightening of lending standards, of actually retracing some of the loans that some of these regional banks have been making. It's going to be the story of the second half of twenty twenty three that that is happening. It was happening before we had the recent bank run. It was happening

before that, and I'll tell you that story. As soon as COVID started, the first thing that happened over twenty four months was about five trillion dollars of deposits came into the banking system. We had thirteen trillion go to eighteen. Never in my career has I seen the deposit system grow that quickly. That was the COVID relief and the stimulus coming into the system. It's now being drained as

a purposeful part of our policy. So we are probably, according to our number, still ten percent too high in terms of surge COVID deposits. So the industry sort of fighting two competitive elements. Number one is FDIC deposits are shrinking as a part of government policy. That's going to be a tightening effect in the economy. And then number two, we have this confidence which is a little bit shaken,

which by the way, it's gotten better. I want to make sure it's gotten better, but it is still shaken and that is driving deposit flows. Two, so it's really turmoil in the economy, which is going to slow the economy. Keep talking, you're lifting the two year yield. I got bad news time I showed for you, You're not the

most important person at Keif Brietton Woods. Jade Romany is right now when you look at commercial real estate and his work in mortgages and your security analysts, what you guys are known for for decades At KBW, Jade Romany is the guy on what's going to happen with commercial real estate? What's he telling you when you call him? So about a month ago we came out with this call because the other thing is this banking issue is not just the banking. It's not specific just the banks.

What we're dealing with is when interest rates go up this fast, there are implications and there will be other implications. So we wrote a report about a month ago that Jade Lee led the author Good Memory Tom, and he said, basically, he thinks there's thirty percent downside in office buildings in major markets around the country, with about half of that due to the cap rates, and about half of it do just the factors of other factors around occupancy and inflation.

You're already seeing it. This is a more slow motion event. It's going to take two years to play out. But that's the next. That's the next. What's it means for Global Wall Street. What's it mean? I'm selfish here. What's it mean for the people in Manhattan, including Bramo, And what's it mean critically for our viewers and listeners. If

we're going to see a thirty percent negative. I just think it's gonna I think it's going to impact economic growth, and I think it'll just mean that we're not going to have a in my opinion, I think that will be a headwind for economic growth as all the industries adjust around that, and it is going to cause banks to tighten their lending criteria, which in and of itself is a big form of at least you just see

this in car loans right now. I mean, I'm reading about it percolating and you can't go out, you know, there's a general statement you can't go out in an auto loan nut because they're tightening up. Yeah, and I think there was something like the lending that a lot of them have been rejected Tom But but don't remember too. We just came through a period where zero interest rates

was the rocket fuel for shadow banking. So and now we're we're gonna dial that back somewhat too, in my opinion, which will be will be an effect for slower growth. There's a confluence of a lot of different factors here, and teasing out all of the different interconnected pieces can be tough. I want to go back to something that you said that we're still about ten percent elevated when

it comes to the deposits. The cash sort of a wash in the banking system, and you talked about how that's going to get withdrawn and that that's going to have a sort of accelerating tightening feature to the economy. Is that deposit base going to disproportionately leave those regional banks? In other words, it might be ten percent of overall deposits, but a much greater portion of just the specific smaller

and mid sized banks. Given the consolidation of deposits in some of the big vehemence, it actually was going to leave the bigger banks more because they're bigger. So, for example, our estimate is roughly sixty billion dollars I think we were going to see come out of JP Morgan this quarter, and now it'll be less because of this remixing. But even Jamie Diamond's been in his calls talking about the fact that he saw hundreds of billions of dollars of

shrinkage in his deposits. But I don't want to alarm anybody by that because the industry has been planning for that and knew that that was going to happen. And remember when we talk about it, what is that, Well, that's the FED shrinking the money supply. It's also depositors buying Treasury bonds because they yield more rather than bank deposits.

That's cash sorting. So I think it's navigable, but if we put a crisis around it, it just makes it trickier, given the likely increase in it flows out of some of these deposits, given commercial real estate and the stress there, given the shadow banking system and potential fractures that people are expecting there. Do you think that this banking crisis is over? I think every day that goes by, we're getting more stability. I think Washington wants it to stop.

I think, barring any other major shocks, I think it's behind us and that we can now deal with some of the more challenged institutions. But also too, if we had more time and I laid out the statistics of Silicon Valley, it was off the charts on a couple of risk measures. I mean off the charts. And remember we have forty seven hundred banks in the United States. Two of them have failed spectacularly and quite large, so we're not underestimating the impact. Ways to go here, I

got time for one question. Somebody emails in here and one hundred to play at Middlebury years ago when Wendell Forbes was coaching. When in God's name is Middlebury going D one hockey? They were born to play D one ecac hockey? When does this happen? You're in charge. Middlebury is good and I gotta tell you now, baseball's made a run at Middlebury. But when I played baseball, we got our fans when they walked past the field to go watch lacrosse. But now get all the visibility. When

do you guys go D one high? It was made to happen. I would support that We've got a great there we go. That's the news we need to have today, Thomas show to Middlebury or the support uproot seven And of course a small matter at KBW definitive. I'm banking research stumbling through a Wednesday. Edward als sin He joins us right now. Senior interest rate strategist of Columbia thread. You know, I'm really being in the news with a

nice write up. I believe in the ft recently, and I'm going to cut to the chase, and you nail this working in international economics at Harvard years ago. So much about these moments, in these crises is fear of making a mistake that invades monetary policy, including Martin Wolfe's wonderful essay today, what are we afraid of making? Is a mistake in our new central bank policy? Yeah, it's

difficult as you're balancing three different elements. You don't know what's going on with inflation, you know, not quickly monitoring policies filtering into the real economy. And now I don't know what's happening with the banking sector and the extent to which that's going to affect growth in inflation down the line, and you have to prioritize these unknowns. Inevitably, in my mind, defense going to prioritize inflation. If they prioritize inflation, we've got to dual mandate. Maybe we have

a triple mandate. To Steve Roach invented talking about financial stability, Can financial stability way in on a May third FED meeting debate very unlikely in my mind. They've done really good job of separating the two, at least on paper. In practice, more than anything, they've been looking in the sense that this particular banking crisis hasn't spiraled, particularly hasn't

spiraled into credit markets. So I think they can take comfort in the fact that the liquidity facilities they put in, what the FDIC is down, that's rig fence some of the issues at least at this point. And again, one they get to the May meeting, it's more likely than not that the lab we focus on inflation once again, Does it make sense to you that we've priced in at one point almost a hundred basis points of rate cuts by early next year. We've retraced that a little bit,

but not that much. It's been very violent, it's very it's been exceptionally violent. Right, So we went from you know, a peak grade of five to seven and the FED on hold in the second half of the year just three weeks ago to now defend entering and aggressive easing cycle in the second half. Um, you know which scenario is most appropriate to the data. I would say something

that's closer to a whole. But but now that you know the banking system genies out of the bottle, it's it's exceptionally difficult to price out an easing cycle in a recession of being brought forward. And that's that's what markets are really struggling with. So here's the dissonance risk ass it's a rallying perhaps because you're seeing perhaps a slower pace of rate hikes or rate cuts. Does this make sense if the only way that we get that is with the pain that comes with some sort of

either crisis or massive credit tightening. Yeah, it's been interesting, you know, risk again to some extent as reflecting two things in my mind. One, the underlying strength of the economy and the underlying strength of corporate balance sheets is still with us. That's something we entered the year with. We've we've talked to that, you know at length. Um has been actually been one of the frustrations for the FED.

The other thing is interest rate politility, which exploded in the course of the asked a couple of weeks, is starting to cool down, particularly in the longer part of the curves. That's a positive backdrop tos gassets. We see let's say an investment grade markets. Markets starting starting to open up, not quite so primary markets in high yield. So it's a different degree of tension that's priced across risk and rates at this point, I would expect those

two stories to connect in the coming months. If the Fed does cut rates, as the markets pricing in, do you start to get less constructive on ten year treasuries, which you have been perhaps overweight. We like them, I mean, look at the fat cuts. One of the things that the last couple of weeks as illustrated to us is that treasuries once again play a very very effective role

as a buffer against risk. That negative colation between rates and risk returned in the course of the past three weeks as people sought a hate to safe avid acid in the face of heightened possessions. That's fantastic. So if the Fed's cutting, they are seeing something on the horizon that's disinflationary, that's bringing down inflation, that's potentially bringing down roth.

That's a really good story for treasuries. We can argue about where you want to be overcurved in that kind of environment, where you want to be long duration and long interest rate risk in that environment. H ed great to catch up as always and our Sonny there of Columbia Threadnadol ed, thank you. Let's get to Jeff, you

senior market is trying to just at bmy melon. Jeff, I think reflecting gone yesterday and thanks for being with It's Jeff reflected on yesterday, just trying to work out whether we have a regulatory problem or an enforcement problem. Which one is it? Well, I think the regulators, politicians, all of them, they are going to be looking at this and globally. You know, Tom, you mentioned after each events over the last few decades. You know they do.

You know, they do have the discussion at least now. I'll just point you to what Sam would you ahead of the PIRA said yesterday, already calling for a tightening of liquidity rules, so liquidity coverage ratios to make sure that all banks you have enough cash. Right So, I think it is going to be a bit of a both, you know, looking at in the global situation, but crucially for central banks right now, they also really want to steer the discussion away from the impact of monetary policy

as well financi stability, priceability, they are separate. There's if you your London school of economics. This warning in magdal lords Lord desided down with a piece of chart in his hand and he's lecturing on the general equilibrium of the system. Are we super restrictive right now in our general equilibrium? Are we at a point of over restriction? Well, you know, as part of a dynamic process. It really depends on where your starting point is. Right. I think

all of them would agree with that. But the problem is you only find out you are too restrictive, you know, after the fact. But based on all of the communication we've had in global central banks, and everyone's taking a leak out of Madam the guards, but right now they're still comfortable hiking rates, inflation, managing priceability. That has to remain a priority. And as long as that's the messaging and looking forward to hearing from that lineup. As you mentioned,

I don't think we are in fully restrictive territory. Yet. You look at credit spreads, you know, you look at where the dollar is. I think policymakers will say they can do more. When will we start to see, Jeff, the effects of potential credit tightening from some of these regional banks. When will we get that data? Well, I think the data we really have to monitor the twofold. No one is just basically the credit data is loan demand, loan growth, and loan officer surveys. Are they picking up?

Are they showing a clear material sign of things been coming off? But at the same time, then the realized data, the hard data, our mortgages, are they starting to come off in mortgage approvals, things like that globally that that will take time. There is a lad process, as Governor Baby has highlighted. But let's be clear, the events over the last few weeks has been an equivalent too tightening or be different in different jurisdictions, but this certainly has

slow the overall process of rate heights. Are you sympathetic, Jeff, to the stack balls who are saying, if you look around right now, still look good and if the FED cuts rates, that will make things only look better. So perhaps you can worry, but you're just worrying in a sort of vacuum of information. Yes, I am sympathetic to

risk on, but nothing to do with the FED. If anything, I think the FED and global central banks, so they will keep rates higher for longer, not super high as we've feared in the past, but they will be higher for longer. The reason we can be positive on risk data aside cash on the sidelines, there's just so much sitting there. Looking at our investor flows, and we've put out a report on this recently, there's no conviction people

at almost like limit underweight risk assets. And it's quarter end rebalancing month and rebalancing we've had another adjustment lower. People are underweight risk relatives to benchmark. We're seeing that in our data, and that in itself is a tactical reason to see risk on across all astic pasts. So I think the NASTAC has had one of the best quarters going back to twenty twenty. Jeff. Now this quarter

has still got a couple of days to go. But based on what you just said, Jeff, where's your favorite place to take risk at the moment? Well, right now, I think well within FX. You know, we are looking at emerging markets. You know, this is the area which is heavily sold last year. I look at our month

tend to be a balancing Nobles. You know, we're looking at being positive on the Mexican pay so you know, for example, we're seeing buying in Eastern European sovereign debt and that's where you get good nominal yield, maybe good real yield up ahead inflation in Europe's slows as well. So really I would favor EM. But if you look at the n data too, and tech for example, you can see that they're probably quite aligned right now. And that's why we are seeing risk radio across the board.

For let's be clear, this is less of a fundamental story, more of an aff allocation story. Hey, Jeff Aha, thank you for that, sir, Jeff you there, I we and wind Mellon right now, the balance of power shifts to privadens. Rude Island, Wendy Schill are absolutely definitive at Brown University and American history. Wendy, when you watch these hearings in the baille and the political pasturing, how close are wed to the debate at Andrew Jackson Learning the ninete century.

We've been doing this, not for decades, We've been doing this for centuries. This distrust of fancy people on Wall Street. Yeah, Tom, we can go back to Thomas Jefferson and Alexander Hamilton, right. I mean there are big fights really centered around the role of private industry, private economy. How much should the

government subsidize incurred debt, backstop debt. This is all Alexander Hamilton versus Thomas Jefferson at the very beginning, and in the end Alexander hamiltons one and Jefferson lost in the sense that we did have a centralization of financial power and we do have governments of debt as we've seen a bad mistakes, justa and you know, Ron Wine, Senator

Winden's you know, it's not an accident. This is coming out today because the Democrats really need to show that in other realms they're going after rich people, they're going after bank let's mess up, right, So this is not

an accident. This is coming out today, as I just said, because the Democrats are really are in trouble here in some ways, right, and many Democrats are more than a few voted with the deregulation or the loosening of regulations in twenty eighteen and the Trump administration for banks like SVB, and you know, this is a problem for them. They

can go after, you know, somewhat the banks. But on the other hand, they allowed them, you know, they participated in the deregulation and so now that and they're now that has to clean it up. It's clearly documented the Swiss people are livid over the Swiss failures in banking. Here bring it to the present. Are the American people engaged not so much in these hearings, but in the

debate about our collapse financial systems center around to collapse banks. Well, I think the American people, you know, are starting to think the government just doesn't work on any dimension we've seen sort of. They can't keep us safe, they can't keep our money safe. We just went through this. And when I say we, you know, there are the vast majority of Americans remember the Great Recession and the banking

crisis is not that long ago. So this just compounds the sort of distrust and lack of faith in the federal government. And if you are a party that believes in government, like the Democrats, that's a real political problem for you when you are in charge. Yesterday, there was a lot of finger pointing at the Federal Reserve and their lack of really enforcing some of what they saw at Silicon Valley Bank, at least in the US side of things. What is the policy implication of some of

that finger pointing. Well, least that's a fantastic point because we have on some quasi private massive bank right overseeing other banks. It's not a really adal system for enforcement of regulation. And you know, Elizabeth Warren will call for the Federal Reserve to do something, or the executive branch, but the end of the day, Congress has to redo or pass another law, and then regulations have to be issued. And we all know regulations can be influenced by lobbying

or court cases. So it's a long road to actually beefing up enforcement. In the end of the day. The simple picture is that the federal government did not properly oversee what DOES Bank was doing and didn't stop them before it was too late. Let's say that they do successfully shunt the blame over to the Federal Reserve as they're trying to do, and basically the lack of oversight there this is my question. Then what does this basically

remove some of the independence of the Federal Reserve. Does this call for some sort of increased scrutiny or increased muscle, I mean, what is the natural step with respect to some of that criticism. Well, at least this is where you have to go to the power of the banking and investment industry. Particularly in terms of campaign contributions and lobbying, very powerful forces and voices, and say, listen, don't blame us for you know, the laziness or the carelessness or

the greed of one bank or two banks. You know, the rest of us, especially the big banks, we do what we're supposed to do. So I think what the American public might yeer towards this sort of giving bigger banks. They trust them more, they seem to be stable. Government bailed them out already once, maybe giving them more power in the system, which would, of course, we know, would

be very bad for regional lending. So I think this is a case where the federal government, meaning the Biden administration, has to pick a side. Are you going to try to intervene and control the Fed? Trump actually tried to control the bed and some might say he did in terms of interest rates. So that's the big question mark. Do you try to exert more control but then fail again?

And that's the puzzle for the Democrats. The irony of this is not lost on a lot of people that basically we have gone from emphasizing a decentralization of banking to now the big banks are better and the bigger the better. I mean, can you give a sense of the potential political read through of that, Well, I think again it's one more layer I think of government, or one more layer of sort of people feeling you know, disempowered that they now they have to go to the

big bank. Those restrictions might be are they may not know the banker they're dealing with it, maybe just on the phone with somebody they never met, you know, closing regional branches, which big banks seem to be doing. These are all ways in which the average American feels less connected. And if you start to feel less connected to the economics system I was in or Hamilton's said this, you

will then feel less connected to the political system. So it causes problems not for the economy, not just for the economy, but also to the democracy. Wendy, wonderful to hear from you and sign those things together. When the shit of that a Brandy University, someone who's studied this, of course, is the gentleman of that interview. David Rubinstein joining us now co chairman and co founder of Carlisle Group. It's a happy David Rubinstein is. He joins us today

from his Duke University. Thank you, David for joining us from Duke this morning. So much of this is a distrust of these major banks. How did Jane Fraser frame that you can trust us this time in this big crisis. Well, for those who don't know Jane is it's hard to believe, but after two hundred and fifty years of our country's history, she's the first woman that had a major money center bank.

She's a native of Scotland, but educated here at Harvard Business School, worked her way up at City over many many years, and for the last two years has been the CEO of the bank. Her views of the banking systems in pretty good shape. Obviously, there are a few problem childs and they're being dealt with, like Silicon Valley

Bank and maybe you could argue First Republic Bank. And I think what she's saying is that the banking community is coming together to figure out how to solve some of these problems, are not relying only on government assistance. We've spoken today David Rubinstein of say there were three big Swiss banks in her childhood, and now there's one. I guess we'll see how that works out. There's also

been the turmoil and American banking. Do you suggest in your conversation with Jane, and for that matter, all of your contacts, that things are being sped up now for the major banks that they're going to have to move and act strategically faster in the coming months. Well, in the crisis of ten years ago or so, the major banks were to some extent, with one or two exceptions, undercapitalized. Now the banks are major banks are well capitalized. Leaving

Credit Swiss aside. They're well capitalized and therefore they have more of an ability to help other banks. And so, as you saw in the case of a First Republic, the major banks put together money that would go into First Republic as deposits, and I hopefully that will shore

up the situation until a more permanent resolution. But I don't think we have a crisis where JP Morgan or Wells Fargo or Bank of America have financial problems or a city, but they clearly everybody's always nervous when there's a banking problem, but I think this one's reasonably under control.

Do you think that this is the best pr move that ever happened for big banks because they can basically come to the rescue, be the good golden children, and all of a sudden have politicians coming out and saying, you guys should all be more like them. Well, I'm sure that that might have been in the back of their mind. But the truth is the US government used to come in and kind of resolve these things. But this case, Jamie Diamond, though he's working with Johnny Yellen,

have taken has taken the lead. So you have banks putting in the money in First Republic, and that's unusual. You don't usually see that in a kind of voluntary basis. But I think it's good for the system and it shows how support of the major banks are of any problems that they see in the banking system. I love that you are the one interviewing Jane Brazier because you're two behemoths in the industry, two behemoths and the financial system that really is the focal point of so many

prognostications at this point. From your vantage point, with your discussion with Jane, do you get the sense that there truly is a mass wave of credit tightening that is coming upon us that is going to really become clear in the second half of this year. Well, interest rates have been going up steadily as we know this year, and as a result, their consequences. One of them is supposed to be a slowing down the economy and higher unemployment.

But one of the other consequences, obviously is some banks are hurt by this. The general occurrence when interest rates go up is it probably usually helps banks a bit because they can charge more than otherwise going to charge

for loans. In this case, what you're seeing is that some banks had a lot of securities which become worth a lot less when interest rates go up, because say they had bonds or treasury bills which go down in value as interest rates go up, and that produced a credit hole, obviously in Silicon Valley Bank and probably in some other banks, or some modest credit holes. So raising interest rates has not been an unvarn good thing for the banks, though generally when interest rates go up, it's

not that harmful to banks. Right now, I think the banking systems in reasonably good shape. Though, David, you grew up basic in Baltimore. There's going to be a House Committee meeting today going after guys like you, the vetcats out there of Global Wall Street. I want you to speak to House Republicans today with their immense distrust of the kind of people that blew up SVB. What do you say to people representing a broader middle class of America that say, who are these guys and why are

we putting up with them? Well, whenever somebody loses money, government's always come in and say who's at fault? Certainly it's not the government. The government would say it's never at fault. So I'm not surprised that somebody will go after somebody that's lost money for shareholders and so forth. But beating up on Wall Street types or finance people is a relatively common experience. I don't think people are

going to be shocked by it. In the case of Silicon Valley Bank, they clearly did some things that the regulators should have been more on top of, and I think the under the banking regulations and laws, the Federal Reserve Bank in San Francisco was aware of it and was working on it. But I don't think they did enough quickly enough to take care of the problem. Oh that's the question, David, the quickly enough of it. Can

we legislate the courage to be quickly enough? Whenever you have a financial problem and something goes wrong, you always try to have a fix, so Dodd Frank or Sarbanes Oxley. But the ingenuity of mankind as such that they can always figure a way around some legislator or regulatory constraint. And so I don't think wherever in our lifetime or anybody's lifetime going to solve all these financial problems. There's always going to be somebody taking advantage of some rule.

So I don't think we can fix it overnight, and we can't just point a finger in somebody and say it's your faught alone. David Rubenstein, thank you so much from Duke University this morning. An important conversation mister Rubenstein with Jane Fraser. Subscribe to the Bloomberg Surveillance podcast on Apple, Spotify and anywhere else you get your podcasts. Listen live every weekday starting at seven am Eastern. I'm Bloomberg dot Com, the iHeartRadio app, tune In, and the Bloomberg Business app.

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