When I heard that First Republic Bank was taken over by the FDIC yesterday and sold to JP Morgan Chase, I immediately thought of my clients. I wrote the email below (now a blog for you!) to give you my take on what happened, share what I think is in store, and give you an idea of what you can do to be prepared. (If you're not interested in the full story and just want to know what you need to know, scroll down to "What does this all mean for me?")
What's going on with the banks??? 😱
Yesterday we saw the third bank (First Republic Bank, with $229 billion in deposits) to fail this year. For perspective, the last big bank failure was Washington Mutual in 2008, which had $307 billion in assets at the time. ($386 billion if you adjust for inflation) A whole bunch of smaller banks failed between 2008-2010, prompting the government to sign the Dodd-Frank Act into effect in 2010.
One of the goals of this legislation was to force banks they deemed "too big to fail" to follow protective measures to prevent the 2008 financial crisis from happening again. Under this act, banks with $50 billion or more in assets were subject to more strenuous capital and liquidity requirements. This limited their business operations and profitability, so the banks pushed back. They succeeded in convincing the government to make some large changes in 2018, one of which was raising this threshold to $250 billion.
Of the three banks that failed this year, all three were between $50 - $250 billion. In other words, these failures likely wouldn't have occurred had these rollbacks not been made to the Dodd-Frank act.
It's also fair, in part, to blame the Fed for waiting too long to raise rates, then raising them too quickly. This combination of higher interest rates, less liquid holdings, and investor panic culminated in investors pulling out more funds than the banks could pay out, therefore leading to their demise.
I don't have a crystal ball, but there are likely other over-leveraged banks out there. You can see how your local financial institutions are ranked here. Most of the primary financial institutions in our area have a 5 star rating, thank goodness.
You can be sure that there will be conversations happening around what "too big to fail" looks like at the government level, and efforts will be made to keep banks from getting that big. We'll likely see regulatory reform for banks once again, and may also see an increase in FDIC coverage limits, reducing the temptation to pull out large sums that land over the $250,000 limit. (Some speculate that higher FDIC coverage may have kept some wealthy investors from withdrawing large sums from First Republic Bank)
What can we learn?
Big picture, this is a painful reminder that protections like Dodd-Frank, similar to insurance policies, are in place for the worst case scenario. Just because that worst case scenario hasn't happened yet, or doesn't seem like it's going to, doesn't mean you should drop that insurance. (Friendly reminder to make sure you have adequate life insurance, homeowners or renters insurance, and a willl! Also if you got long-term care insurance, don't drop it without talking to am advisor)
What does this all mean for me?
- Any funds that you may need in the short term should be keptliquid. Your emergency savings isn't intended to keep up with inflation, it's intended to be there if you need it. Don't invest it in the market.
- As far as your long-term investments, stick to your strategy, and don't be tempted to freak out and go into cash. (Unless you have a crystal ball telling you the perfect time to buy back in, in which case, can I please borrow it? 😅)
- Avoid unnecessary debt as much as possible. It can be tempting to over leverage when your income is great, but don't fall for it. You'll sleep better at night if you limit your debt as muc as possible.
- Stay diversified, and don't assume that an investment (of any kind!) will do well again because it's done well in the past. Especially if you're counting on it doing well in the short-term.
I hope this helps you understand what's going on! Please let me know if I can help ease your mind by answering any questions. 💕
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.