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The Math Behind Deposit Insurance, And Why It’s The Beginning Of The End

The Math Behind Deposit Insurance, And Why It’s The Beginning Of The End

As Simon White writes today, "a full guarantee of all bank deposits…

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The Math Behind Deposit Insurance, And Why It's The Beginning Of The End

As Simon White writes today, "a full guarantee of all bank deposits would spell the end of moral hazard disciplining banks and mark the final chapter of the dollar’s multi-decade debasement." And yet that's where we are headed, even if with a few hiccups along the way, because as White also notes, with the latest banking crisis in the US, it’s the clean-up that could end up doing far more lasting damage. That's because with the failure of SVB et al prompted the FDIC to guarantee that all depositors will be made whole, whether insured or not

And so, the precedent is being set, with Treasury Secretary Janet Yellen commenting on Tuesday that the US could repeat its actions if other banks became imperiled. She was referring to smaller lenders, and denied the next day that insurance would be “blanket”, but given the regulatory direction of travel over the last forty years, this will inevitability apply to any lender when push comes to shove.

Realizing it's just a matter of time before the next systemic crisis tips the banking sector over, over the weekend, a coalition of midsize US banks asked federal regulators to extend FDIC deposit insurance for the next two years, so as to alleviate any fears which could result in a wider deposit run on regional and community banks.

But what would deposit insurance of all $18 trillion US deposits - not just the $11 or so trillion in deposits that are currently "insured" by the FDIC - look like? As BofA's rates strategist Mark Cabana writes, deposit insurance has been a very effective solution to stabilize deposit outflows historically. Deposit insurance can be done in a variety of ways: (1) all domestic bank deposits; (2) increase coverage to a higher amount vs. the $250k currently.

If policymakers consider extending deposit insurance coverage it would impact reserves held in the Deposit Insurance Fund (DIF).

What is DIF? One way the FDIC maintains stability and public confidence in the U.S. financial system is by providing deposit insurance. The primary purposes of the Deposit Insurance Fund (DIF) are:

  1. to insure the deposits and protect the depositors of insured banks and
  2. to resolve failed banks.

While the DIF is backed by the full faith and credit of the United States government, it has two sources of funds: i) assessments (insurance premiums) on FDIC-insured institutions and ii) interest earned on funds invested in U.S. government obligations. The government guarantee of insured deposits is not limited by the amount in the DIF. One can think of DIF as a "first loss" tranche absorbed by assessed bank funds in DIF.

Where does the DIF stand today? The DIF's reserve ratio (the fund balance as a percent of insured deposits) was 1.27% (or $128.2bn) on Dec 31, 2022. The FDIC was aiming to increase the reserve ratio to 1.35% by Sep 30, 2028 or ~$8bn increase.

What % of deposits are insured? Estimated insured deposits stood at $10.1 trillion or 56.8% of total deposits held at FDIC insured institutions of $17.8trn as of Dec 31, 2022. Recent proposals would increase insurance coverage; the extent of insurance increase differs by proposal.

DIF increase needed to provide more insurance? Assuming the 1.35% target reserve ratio is applied to the uninsured deposits, this would imply a reserve build of $104bn.

Cost to insure all deposits? $104bn in reserve build to cover uninsured deposits compares to net income across all FDIC insured banks of $263bn reported for 2022. Obviously, this reserve build would need to happen over several years to limit the impact on industry profitability in any given year. Assuming that this additional assessment is spread over ten years, implies an approximately 50bp drag on annual ROE for the industry.

Of course, all this assumes the DIF is never really used, but the statutory amount is meant to serve as a confidence booster. After all, the total expanded DIF amount of $230 billion would be insufficient to bail out the uninsured depositors of even one TBTF bank like JPM. In fact, if all deposit insurance had to be used, it would mean the US government somehow has to fund a total of $18 trillion in deposits, an amount equal to 75% of US GDP. It's ain't happening.

Is any of this a viable option? While we are skeptical confidence can be restored with some accounting sleight of hand, Mark Cabana is optimistic and sees deposit insurance as one way for policymakers and the banking industry to address sensitivity among deposit customers. Absent such broader insurance, the industry risks losing some deposits to money market funds or the Treasury market as customers diversify their excess liquidity.

Cabana's conclusion:

We believe that the last few days have introduced investors/ banks/ policymakers to the new risk of deposit-runs in the age of social media. We believe that absent a change to deposit insurance coverage, corporate CFOs/Treasurers will likely be proactively looking to diversify their deposits away from any single institution. While this may be viewed as a reasonable outcome by some, regional banks could be at the losing end under such a scenario. If maintaining the community banking structure is a priority for policymakers, a higher threshold of deposit insurance seems worth considering.

Alas, if Janet Yellen is to be believed, this isn't on the horizon, at least not until we have another sharp deterioration in the banking crisis.

Stepping back from the accounting intricacies of how the US can backstop the impossible sum of $18 trillion without actually doing so - because it's simply impossible - and turning to the bigger picture implications, we go back to BBG's Simon White who notes that since the dollar is the primary liability of the US central bank; "this would mean further erosion of its real value, compounding the decimation of its purchasing power seen over the last century."

But why is deposit insurance linked to the strength of the dollar... and by extension its persistence as world reserve currency? Simple: it all has to do with that ultimate backstopper of the US financial system (where deposits are the largest liability) and the assets on its balance sheet. Here are some more observations from White:

The 1932 Glass-Stegall Act was the beginning of the end, allowing the Fed to accept a wider basket of collateral it could lend against: riskier assets such as longer-term Treasury securities. The falling quality of collateral has continued, with the Fed lending against corporate debt in recent years

The end result is the Fed’s balance sheet has steadily deteriorated, and with it the real value of the dollar

Obviously, then, an expansion of insurance to all deposits will lead to a further erosion in the Fed’s balance sheet. Why?

  • First: deposit-insurance schemes typically lead to less, not more, bank stability.  Several studies have shown that countries with deposit-insurance schemes tend to see more bank failures. The more generous the scheme, the greater the instability.

  • Second: Moral hazard instills discipline in depositors as they pay attention to the bank’s credit risk (something many depositors in SVB signally failed to do.) It also imposes discipline on banks, incentivizing them to structure their cash flows so that they match through all time, thus mitigating the risk of bank runs (cue SVB again)

Why, then, would greater banking instability lead to a further deterioration in the Fed’s balance sheet? It comes down to how US banking has evolved over the last century.

Banks must manage cash flows from assets and liabilities, and their preference is to minimize their cash position each night in order to maximize the productive use of their capital. There is always a “position making” instrument, a liquid asset that banks can use to park excess cash or make up for shortfalls each day. In the early days of the Federal Reserve system it was commercial loans and USTs; now it is principally the repo market. A bank can “make position” if it can repo in or repo out securities for funds. But if the market for that collateral freezes up, they’re dead.

This is where the Fed steps in - but as the “dealer of last resort” rather than the lender of last resort. To ensure market liquidity, the Fed must underwrite funding liquidity. And to do that it must be willing to accept as collateral whatever the banking sector’s position-making instruments are.

If it doesn’t, the game’s up.

SVB happened to have a high proportion of USTs and mortgage-backed securities on its balance sheet, making the Fed’s life easy in creating the BTFP (Bank Term Funding Program), which accepts government and government-backed collateral. But this does not get to the heart of the problem. Only a fifth of small banks’ assets are currently shiftable on to the Fed’s balance - less than for larger lenders — leaving them considerably exposed!

Ultimately, deposit insurance only mitigates banks’ vulnerability to bank runs; it does not insulate them from liquidity or insolvency risk; and it certainly does not "insure" that a full-scale bank run will see every depositors' money made whole: after all there is just $128BN in the DIF and there are $10 trillion in insured deposits. At best, the DIF provides a first loss backstop only to those who panic first! 

But the punchline is that SVB et al are very likely not the only fragile US banks, and as the economy slows, asset prices fall and delinquencies and bankruptcies rise - especially in commercial real estate, where small banks also happen to be the biggest lenders - we are likely to see more banks needing support

The logical outcome is that the Fed will have to increasingly accept poorer quality collateral — especially from smaller banks, with their large exposure to residential and commercial real estate. We have been here before, when during the pandemic the Fed began to accept the corporate debt of even junk-rated companies (and when gold and bitcoin hit record highs).

Minsky himself stressed the centrality of banking to financial stability, noting that imprudent banks (read: operating without moral hazard) are more likely to finance unproductive projects, which then leads to inflation.

So there we have it. As White concludes, after the US inevitably implements deposit insurance, what comes next is inflation and much more debasement of the Fed’s balance sheet: "with an abnegation of moral hazard, the long-term value of the dollar doesn’t stand a chance."

Which is also why US authorities are doing everything in their power to rapidly kill-off such counterparty-free money as bitcoin and gold, with headlines such as these now a daily occurrence:

  • U.S. SECURITIES AND EXCHANGE COMMISSION ISSUES INVESTOR ALERT URGING CAUTION AROUND CRYPTO ASSET SECURITIES

...they know very well that during the next crisis - which is imminent - the monetary tidal wave will flow toward them as the bank failure dominoes begin to fall.

Tyler Durden Thu, 03/23/2023 - 11:39

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Homes listed for sale in early June sell for $7,700 more

New Zillow research suggests the spring home shopping season may see a second wave this summer if mortgage rates fall
The post Homes listed for sale in…

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  • A Zillow analysis of 2023 home sales finds homes listed in the first two weeks of June sold for 2.3% more. 
  • The best time to list a home for sale is a month later than it was in 2019, likely driven by mortgage rates.
  • The best time to list can be as early as the second half of February in San Francisco, and as late as the first half of July in New York and Philadelphia. 

Spring home sellers looking to maximize their sale price may want to wait it out and list their home for sale in the first half of June. A new Zillow® analysis of 2023 sales found that homes listed in the first two weeks of June sold for 2.3% more, a $7,700 boost on a typical U.S. home.  

The best time to list consistently had been early May in the years leading up to the pandemic. The shift to June suggests mortgage rates are strongly influencing demand on top of the usual seasonality that brings buyers to the market in the spring. This home-shopping season is poised to follow a similar pattern as that in 2023, with the potential for a second wave if the Federal Reserve lowers interest rates midyear or later. 

The 2.3% sale price premium registered last June followed the first spring in more than 15 years with mortgage rates over 6% on a 30-year fixed-rate loan. The high rates put home buyers on the back foot, and as rates continued upward through May, they were still reassessing and less likely to bid boldly. In June, however, rates pulled back a little from 6.79% to 6.67%, which likely presented an opportunity for determined buyers heading into summer. More buyers understood their market position and could afford to transact, boosting competition and sale prices.

The old logic was that sellers could earn a premium by listing in late spring, when search activity hit its peak. Now, with persistently low inventory, mortgage rate fluctuations make their own seasonality. First-time home buyers who are on the edge of qualifying for a home loan may dip in and out of the market, depending on what’s happening with rates. It is almost certain the Federal Reserve will push back any interest-rate cuts to mid-2024 at the earliest. If mortgage rates follow, that could bring another surge of buyers later this year.

Mortgage rates have been impacting affordability and sale prices since they began rising rapidly two years ago. In 2022, sellers nationwide saw the highest sale premium when they listed their home in late March, right before rates barreled past 5% and continued climbing. 

Zillow’s research finds the best time to list can vary widely by metropolitan area. In 2023, it was as early as the second half of February in San Francisco, and as late as the first half of July in New York. Thirty of the top 35 largest metro areas saw for-sale listings command the highest sale prices between May and early July last year. 

Zillow also found a wide range in the sale price premiums associated with homes listed during those peak periods. At the hottest time of the year in San Jose, homes sold for 5.5% more, a $88,000 boost on a typical home. Meanwhile, homes in San Antonio sold for 1.9% more during that same time period.  

 

Metropolitan Area Best Time to List Price Premium Dollar Boost
United States First half of June 2.3% $7,700
New York, NY First half of July 2.4% $15,500
Los Angeles, CA First half of May 4.1% $39,300
Chicago, IL First half of June 2.8% $8,800
Dallas, TX First half of June 2.5% $9,200
Houston, TX Second half of April 2.0% $6,200
Washington, DC Second half of June 2.2% $12,700
Philadelphia, PA First half of July 2.4% $8,200
Miami, FL First half of June 2.3% $12,900
Atlanta, GA Second half of June 2.3% $8,700
Boston, MA Second half of May 3.5% $23,600
Phoenix, AZ First half of June 3.2% $14,700
San Francisco, CA Second half of February 4.2% $50,300
Riverside, CA First half of May 2.7% $15,600
Detroit, MI First half of July 3.3% $7,900
Seattle, WA First half of June 4.3% $31,500
Minneapolis, MN Second half of May 3.7% $13,400
San Diego, CA Second half of April 3.1% $29,600
Tampa, FL Second half of June 2.1% $8,000
Denver, CO Second half of May 2.9% $16,900
Baltimore, MD First half of July 2.2% $8,200
St. Louis, MO First half of June 2.9% $7,000
Orlando, FL First half of June 2.2% $8,700
Charlotte, NC Second half of May 3.0% $11,000
San Antonio, TX First half of June 1.9% $5,400
Portland, OR Second half of April 2.6% $14,300
Sacramento, CA First half of June 3.2% $17,900
Pittsburgh, PA Second half of June 2.3% $4,700
Cincinnati, OH Second half of April 2.7% $7,500
Austin, TX Second half of May 2.8% $12,600
Las Vegas, NV First half of June 3.4% $14,600
Kansas City, MO Second half of May 2.5% $7,300
Columbus, OH Second half of June 3.3% $10,400
Indianapolis, IN First half of July 3.0% $8,100
Cleveland, OH First half of July  3.4% $7,400
San Jose, CA First half of June 5.5% $88,400

 

The post Homes listed for sale in early June sell for $7,700 more appeared first on Zillow Research.

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February Employment Situation

By Paul Gomme and Peter Rupert The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000…

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By Paul Gomme and Peter Rupert

The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000 average over the previous 12 months. The payroll data for January and December were revised down by a total of 167,000. The private sector added 223,000 new jobs, the largest gain since May of last year.

Temporary help services employment continues a steep decline after a sharp post-pandemic rise.

Average hours of work increased from 34.2 to 34.3. The increase, along with the 223,000 private employment increase led to a hefty increase in total hours of 5.6% at an annualized rate, also the largest increase since May of last year.

The establishment report, once again, beat “expectations;” the WSJ survey of economists was 198,000. Other than the downward revisions, mentioned above, another bit of negative news was a smallish increase in wage growth, from $34.52 to $34.57.

The household survey shows that the labor force increased 150,000, a drop in employment of 184,000 and an increase in the number of unemployed persons of 334,000. The labor force participation rate held steady at 62.5, the employment to population ratio decreased from 60.2 to 60.1 and the unemployment rate increased from 3.66 to 3.86. Remember that the unemployment rate is the number of unemployed relative to the labor force (the number employed plus the number unemployed). Consequently, the unemployment rate can go up if the number of unemployed rises holding fixed the labor force, or if the labor force shrinks holding the number unemployed unchanged. An increase in the unemployment rate is not necessarily a bad thing: it may reflect a strong labor market drawing “marginally attached” individuals from outside the labor force. Indeed, there was a 96,000 decline in those workers.

Earlier in the week, the BLS announced JOLTS (Job Openings and Labor Turnover Survey) data for January. There isn’t much to report here as the job openings changed little at 8.9 million, the number of hires and total separations were little changed at 5.7 million and 5.3 million, respectively.

As has been the case for the last couple of years, the number of job openings remains higher than the number of unemployed persons.

Also earlier in the week the BLS announced that productivity increased 3.2% in the 4th quarter with output rising 3.5% and hours of work rising 0.3%.

The bottom line is that the labor market continues its surprisingly (to some) strong performance, once again proving stronger than many had expected. This strength makes it difficult to justify any interest rate cuts soon, particularly given the recent inflation spike.

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Mortgage rates fall as labor market normalizes

Jobless claims show an expanding economy. We will only be in a recession once jobless claims exceed 323,000 on a four-week moving average.

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Everyone was waiting to see if this week’s jobs report would send mortgage rates higher, which is what happened last month. Instead, the 10-year yield had a muted response after the headline number beat estimates, but we have negative job revisions from previous months. The Federal Reserve’s fear of wage growth spiraling out of control hasn’t materialized for over two years now and the unemployment rate ticked up to 3.9%. For now, we can say the labor market isn’t tight anymore, but it’s also not breaking.

The key labor data line in this expansion is the weekly jobless claims report. Jobless claims show an expanding economy that has not lost jobs yet. We will only be in a recession once jobless claims exceed 323,000 on a four-week moving average.

From the Fed: In the week ended March 2, initial claims for unemployment insurance benefits were flat, at 217,000. The four-week moving average declined slightly by 750, to 212,250


Below is an explanation of how we got here with the labor market, which all started during COVID-19.

1. I wrote the COVID-19 recovery model on April 7, 2020, and retired it on Dec. 9, 2020. By that time, the upfront recovery phase was done, and I needed to model out when we would get the jobs lost back.

2. Early in the labor market recovery, when we saw weaker job reports, I doubled and tripled down on my assertion that job openings would get to 10 million in this recovery. Job openings rose as high as to 12 million and are currently over 9 million. Even with the massive miss on a job report in May 2021, I didn’t waver.

Currently, the jobs openings, quit percentage and hires data are below pre-COVID-19 levels, which means the labor market isn’t as tight as it once was, and this is why the employment cost index has been slowing data to move along the quits percentage.  

2-US_Job_Quits_Rate-1-2

3. I wrote that we should get back all the jobs lost to COVID-19 by September of 2022. At the time this would be a speedy labor market recovery, and it happened on schedule, too

Total employment data

4. This is the key one for right now: If COVID-19 hadn’t happened, we would have between 157 million and 159 million jobs today, which would have been in line with the job growth rate in February 2020. Today, we are at 157,808,000. This is important because job growth should be cooling down now. We are more in line with where the labor market should be when averaging 140K-165K monthly. So for now, the fact that we aren’t trending between 140K-165K means we still have a bit more recovery kick left before we get down to those levels. 




From BLS: Total nonfarm payroll employment rose by 275,000 in February, and the unemployment rate increased to 3.9 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in health care, in government, in food services and drinking places, in social assistance, and in transportation and warehousing.

Here are the jobs that were created and lost in the previous month:

IMG_5092

In this jobs report, the unemployment rate for education levels looks like this:

  • Less than a high school diploma: 6.1%
  • High school graduate and no college: 4.2%
  • Some college or associate degree: 3.1%
  • Bachelor’s degree or higher: 2.2%
IMG_5093_320f22

Today’s report has continued the trend of the labor data beating my expectations, only because I am looking for the jobs data to slow down to a level of 140K-165K, which hasn’t happened yet. I wouldn’t categorize the labor market as being tight anymore because of the quits ratio and the hires data in the job openings report. This also shows itself in the employment cost index as well. These are key data lines for the Fed and the reason we are going to see three rate cuts this year.

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