Every US Bank is at Risk and Yellen's Deceiving Depositors by Saying They are Safe: Economist

By telling people that the US government could shield depositors at smaller banks if the latter face a crisis akin to the Silicon Valley Bank collapse, Treasury Secretary Janet Yellen has set a precedent that is going to exponentially make the problem worse, Mark Frost, an economist, professor and consultant, told Sputnik.

The First Republic Bank, a California-based commercial bank and provider of wealth management services, appears to be teetering on the edge of collapse, with its shares falling 47% on Monday, despite some of the Wall Street's biggest players providing a joint $30 billion to rescue it on March 16.

Up until recently, First Republic boasted $176 billion in deposits, but its future is now murky. The development exacerbates fears of a possible domino effect that could shatter the US banking system after the collapse of the Silicon Valley and Signature banks. On Tuesday, Treasury Secretary Janet Yellen pledged to protect depositors at smaller US banks from "contagion."

"What Yellen is doing is she's setting a precedent that is going to exponentially make the problem worse," Frost told Sputnik. "The problem is literally a moral hazard. We've created a system called fractional reserve banking, [in] that it's impossible for even one bank to be solvent if everybody comes and wants their money from that bank. So by definition, every bank is at risk. There are no banks that are not at risk. Take the top bank in the United States. And if enough people get it in their head that they're in trouble and they go get their money, that bank doesn't have enough money to give them. It's the nature of the beast."

When Yellen comes out and says that the government will protect depositors at smaller US banks she is trying to calm down the panic and prevent further capital withdrawals, but in reality the US government does not have enough money to save everybody, according to the economist.

"Janet Yellen has made an econometric equation in her head and she believes she'll pay out less money if she deceives the public than if she takes them through," Frost pointed out.

According to the US press, as many as 25 regional and mid-sized banks with between $15 billion and $200 billion in assets are close to failure.

Another study, released on March 13, presents a gloomier picture, claiming that almost 190 banks could face the fate of SVB if half of their depositors decide to withdraw their funds, with potentially $300 billion of insured deposits at risk.

The problem is that these financial institutions have a significant amount of their assets in interest rate-sensitive financial instruments like government bonds and mortgage-backed securities. The Federal Reserve's aggressive rate hikes have had a tremendous impact on these instruments by eating away at their value. Some financial experts have suggested that SVB's billion-dollar investment in "super safe" US government bonds was at the heart of its collapse.

However, others claim that SVB - as well as some other US banks - have long been implementing risky schemes while having lax risk management. As a result, the Fed has become a catalyzer of the crisis which has long been in the making.

"SVB was doing (…) risky things from a banker's perspective," Frost said. "Nothing was matched. In fact, they weren't even matching anything. Often they were just taking warrants and spinning the wheel at Vegas, hoping that, okay, this company, this company and this company probably aren't going to do anything. But we'll spend that. We'll roll the dice and see what happens. So, all Yellen is doing is rewarding behavior, rewarding bad behavior. And if I was a well-run bank, meaning I matched my maturities, I watched my reserves, I made sure that I banked properly – I would be angry because what SVB has been able to do is offer their depositors higher-than-market rates of return, whereas other banks couldn't do that."

For more sharp analysis, check out the latest episode of Sputnik’s podcast Fault Lines.