Pointing fingers and looking for someone to blame has become all too commonplace, and the current economic situation is a great example.
The United States and most of the rest of the world is dealing with inflation. Thanks in part to the war in Ukraine and the resulting avoidance of buying Russian oil, gas and diesel prices are high--although they have declined from the much higher prices a year ago. Now the second and third largest bank failures in US history are causing many to become even more convinced that we're in for a big recession.
Republicans blame President Biden and the Democrats for the higher gas prices and inflation; some also blame them for the bank failures, saying that the Federal Reserve's big increases in interest rates are responsible for the banks' problems. Democratic Senator Elizabeth Warren has appeared on multiple tv shows proclaiming "I told you so" as she blames the bank failures on the reduction of controls on bank investments that happened when the Dodd-Frank law was amended to lessen restrictions.
The truth--as is often the case--is not as simple as many would claim.
The bank failures of the last week are reminiscent of the scene in the Jimmy Stewart movie "It's a Wonderful Life." The run on banks that happened in 1932 following the stock market crash of 1929 was an important part of what created the Great Depression.
The Roaring Twenties were roaring quite loudly in the summer of 1929. Herbert Hoover had become President running on Coolidge-Hoover prosperity. The total wealth of our country had almost doubled over the previous eight years. But the rampant speculation, often involving borrowed money, set the stage for the October crash.
What happened in 1929-1932 is less likely today in part because of steps that were taken in the aftermath to avoid a repeat of the calamity that saw unemployment surge to 25 percent and prices of goods and services deflate rather than inflate.
By 1933, a dozen eggs cost only 13 cents, down from 50 cents in 1929. At least a third and perhaps half of all US financial institutions collapsed, wiping out the lifetime savings of millions of Americans.
What part did the banks play in the decline in the US economy? First, in the '20s, banks extended too much credit. Businesses (and individuals) kept borrowing, convinced that things would only get better. Items that had been luxuries enjoyed by only a few came to be considered necessities. Cars, radios, refrigerators and more were bought on credit. Business inventories soared (300 percent between 1928 and 1929 alone), but Americans’ wages stagnated. Some actually saw their real income decline--increased wages or return on investments weren't keeping up with inflation. Farm income, in particular, actually diminished just as the Depression began--in part because of the Dust Bowl drought that wiped out farms in the Southwest.
Many banks ignored the Federal Reserve's warnings that they were becoming over-extended. The Fed did in 1929 just what it did recently--attempted to slow things down by raising interest rates.
Just like that happened with Silicon Valley Bank and Signature Bank, those banks from 90 years ago didn’t maintain adequate reserves. In normal times, banks count on their ability to borrow from other financial institutions, or from the Federal Reserve, to cover any unexpected shortfall in reserves if their customers start demanding their deposits back. The FDIC didn't exist until 1933 and even now, it has nothing close to enough money to guarantee all deposits in the event of a 'run' on banks. When Franklin Roosevelt became President in March 1933, one of the first things he did was to declare four days as national bank holidays. Then he did his first 'fireside chat' on radio, urging Americans not to demand their money from their banks--money they didn't have because like Jimmy Stewart explained in the movie, it had been loaned out, or more common now, invested.
Roosevelt knew that a 'run' on the banks, if extended, would totally destroy the whole US economy. But that wasn't the only danger. In 1931-1932, the banks started trying to correct their previous mistakes: where they had been too loose with lending, they stopped lending money. Businesses couldn’t get access to capital, and closed their doors, throwing millions of Americans out of work. Unemployed workers couldn’t keep spending, and the toxic downward spiral continued.
The failures of SVB and Signature banks was in part due to the increase in interest rates that left them holding government bonds which had seemed a safe investment but were now not keeping up with inflation. The same reduction in Dodd-Frank restrictions that had allowed SVB and others to grow rapidly had also enticed them into relying too much on the mistaken idea that interest rates, which had been historically low, would remain that way. They didn't.
Inflation--fueled in large part by government spending by both the Trump and Biden administrations--forced the Fed to increase rates. Some say they over-reacted, raising the rates too much and too quickly. They're likely to increase them again, but they're now talking about a quarter percent increase instead of a half.
The spending programs had a predictable effect. The infrastructure spending was long overdue and much needed, and the American Rescue Plan did keep the economy going during the pandemic. Those stimulus checks, first under Trump and two more times with twice as much under Biden, did what they were supposed to do--they stimulated the economy, and hence fed inflation.
The increase in interest rates has helped reduce inflation, but not end it. Price growth cooled to an annual rate of 6% in February, according to data released Tuesday by the Bureau of Labor Statistics. The annual reading was lower than January’s 6.4% year-over-year level and in line with economists’ forecasts. On a monthly basis, prices rose 0.4% in February from January, down slightly from January’s 0.5% increase, the latest Consumer Price Index reading showed.
Energy costs continued to fall, with prices 5.2% higher in February year-over-year compared with an 8.7% increase in January. Food price increases also cooled, rising 0.4% last month since January compared with 0.5% the month before, but they were still up 9.5% since last February.
As most readers are surely aware, President Biden promised that all depositors in SVB and Signature banks will be able to get all their money. Stockholders in those banks will suffer losses, but not depositors. This action wipes out a sizeable chunk of the FDIC's $125 billion reserve intended to protect deposits of up to $250,000. A special additional fee will be paid by other FDIC members to take care of the amount of deposits in those two banks over the $250,000 guaranteed deposits. Unlike the action in 2009 in response to the so-called Great Recession, the 'bailout' will not include money from taxpayers.
Many, including the right-wing John Locke Foundation, have questioned whether the US banking system is on the verge of collapse. Just as it was true in the early days of the Roosevelt administration, that depends very much on whether people continue to panic or 'keep calm and carry on' (to borrow a phrase from Great Britain during WWII).
Most of the local and regional banks with whom you may have an account--including those over the $250,000 guaranteed amount--are not likely to suffer the same kind of problems as those two failed banks. They, too, have invested your deposited monies--some in loans to businesses, industries and individuals, some in bonds, etc. Most of them have been fairly conservative in their investments, and while they may suffer some downturn, they won't collapse.
The truth is that America itself is always subject to failure on a variety of fronts and that our future depends on the confidence our citizens have in our institutions--government, business and other. Roosevelt's famous phrase is just as appropriate today as it was in 1933. While fear may not be the only thing, it is certainly the one that can cause us to make decisions haphazardly instead of carefully.
We have survived two World Wars, the Great Deprssion and the Great Recession, and while it has its problems, our economy is still the strongest in the world. We'll get through this, too.