Bank Failures: The Case Against Speculation

TruePoint Capital

This week’s big news was bank failures, which weren’t minor. No less than two banks have collapsed this week, with a third teetering on the brink.

Last Friday, Silicon Valley Bank (SVB) collapsed when California banking regulators closed the bank and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver for the disposition of its assets. The SVB failure was followed shortly after that when state regulators closed New York-based Signature Bank on Sunday. The SVB collapse was the second biggest failure, and Signature Bank was the third biggest in U.S. banking history. These were the biggest bank failures since the Financial Crisis of 2008.

The banking bloodbath would not be over before the week was done. A third bank teetered on the verge of collapse before a group of the nation’s biggest banks stepped in to shore up its deposits. San Francisco-based First Republic Bank will receive a huge injection of deposits from other lenders to stave off a collapse, the banks said on Thursday.

Four of the country’s biggest banks — JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo — agreed to contribute $5 billion each. Goldman Sachs and Morgan Stanley will contribute $2.5 billion each, and BNY Mellon, PNC Bank, State Street, Truist, and U.S. Bank will each add $1 billion. These banks weren’t doing this out of the goodness of their hearts. They were trying to stave off the contagion from spreading to the entire banking industry.

You don’t hear about banks failing much because most lenders follow a tried and true formula for stable operations and success. The bulk of a traditional bank’s business revolves around lending to home buyers, commercial real estate developers, and investors and companies looking for a capital infusion to fund their operations. This type of lending is based on sound banking principles, including backing the loans up with secured assets and personal guarantees. Following this formula has been a recipe for success for long-standing banks and credit unions.

Dig a little deeper, and the bank collapses of 2008 and the most recent ones have a common thread: all these banks strayed from traditional banking practices and dabbled heavily in speculative assets and loans.

In 2008, the major bank collapses were all due to the banks’ involvement with subprime lending and investment in mortgage-backed securities. Subprime lending strayed from basic economic fundamentals, and the mortgage-backed securities based on these subprime loans were all highly speculative. When the subprime loans collapsed because borrowers with sketchy creditworthiness started to default, the whole enterprise collapsed, and the banks were suddenly in hot water.

Fast forward to 2023, and this week’s three banks at the center of the storm have all strayed from traditional banking fundamentals. SVB and First Republic Bank cater heavily to the Silicon Valley startup crowd. This is an unsustainable banking model, with startups suffering around a 90% failure rate.

On the other coast, Signature Bank catered to crypto firms that have taken a beating since the start of 2022. The collapse of crypto exchange FTX didn’t help matters as the perception of the prospects and security of crypto sunk in the public’s eyes.

Like banks who have weathered storm after storm by sticking to basic economic fundamentals like financing tried and true real assets and income-producing businesses backed by tangible assets, the same holds for individual investors. Investors who speculate and chase shiny objects are most likely to fail at achieving financial independence and are most vulnerable to market crashes.

Smart investors have always clung to boring investments to maintain stability and reliable portfolio performance. These investors can generate recession-proof and insulation-insulated returns by sticking to a few basic foundational objectives.

So what are the pillars sophisticated investors build upon when investing?

  • Think long-term. Base decisions on creating and sustaining long-term wealth for current and future generations. Thinking long-term eliminates speculative investments from the equation.
  • Invest in assets with a long track record of success. Why reinvent the wheel if there are assets like real assets that have a history of performing and withstanding downturns?
  • Seek illiquid assets. Private assets not traded on public exchanges and markets insulate portfolios from broader market volatility and contagion that can spread quickly and devastatingly.
  • Seek out tangible assets. Investments backed by hard assets prevent total losses and appreciate over time – providing solid risk-adjusted returns. The banks in the news have comparatively fewer loans secured by hard assets like their more stable counterparts because of the speculative nature of startups and crypto, with few tangible assets to secure loans. As a result, investors were left with nothing when these banks collapsed.
  • Passive Income. Passive income is the key to financial freedom. When your passive income exceeds your current expenses, you are no longer dependent on a job and can walk away.

This week’s banks in the news have left investors devastated, but there’s a lesson to be learned here. These banks got in trouble for their speculative lending and straying from banking fundamentals.

​​As an investor, if you can avoid speculation and stick to basic fundamentals like the ones listed above, you’ll go a long way in creating and sustaining long-term wealth.

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