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Last month’s bank failures are reminiscent of the turmoil in the banking industry in 2007-2008.
In both cases, banks got caught with assets that had decreased in value. Then it was the newly created mortgage-backed securities that declined in value. This time, long-term government bonds in the banks’ portfolios fell in value. A decline in the value of a bank’s assets can make a bank insolvent, as its current liabilities exceed the current liquidation value of its devalued assets. Once bank depositors get wind of this, it is almost impossible to prevent a panic, where depositors frantically scramble to get their cash out of the bank.
Bank failures have been part of U.S. history since at least 1819. Congress created the Federal Reserve because of a severe banking panic in 1907. The Banking Act of 1933 created Federal Deposit Insurance Corp. to restore trust in the banking system after as many as a third of the banks failed. More extensive banking regulations were introduced after the 2008 crisis to decrease the chance of financial institutions failing.
In the 1960s and 1970s, Bohanon’s grandfather, the original C.E. Bohanon, was CEO of Phoenix Federal Savings and Loan in Muskogee, Oklahoma. After retiring in the 1980s, he predicted there would be a savings and loans crisis. S&Ls were financing too many long-term projects with short-term money. Grandpa Bohanon passed away in 1986, so he did not see his predictions come true in 1990. It is always the same story. The lender takes risks with deposits that don’t pay off.
C.E. cut his bones as a young banker in a bank collapse at a small-town state-chartered bank in the 1920s. The Haskell, Oklahoma, bank’s lending clients were cotton farmers. The bank collapsed when the price of cotton declined to 11 cents a pound in 1926. There was no deposit insurance, but Oklahoma state law required the bank directors to provide partial compensation to the bank’s time depositors. The 27-year-old Bohanon borrowed a substantial sum to make this payment, though he could have declared bankruptcy. Twenty years later, he finished repaying the debts shortly after World War II.
No wonder his judgment was considered quite old-fashioned and quaint pre-S&L crisis! But it was timeless and correct!
Similarly, the failure of SVB is almost exclusively driven by regulators and bank management ignoring what country bankers knew. That is, you can’t finance long-term investments with short-term money.•
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Bohanon and Horowitz are professors of economics at Ball State University. Send comments to ibjedit@ibj.com.
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