The Financial Riddler -- 3/27/2023

The less you know, the more you'll learn. The more you know, the greater your bragging rights. You can't lose.

Please excuse the delay in this Riddler’s posting. As my recent posts and podcasts indicate, I’ve been consumed/obsessed with our scary and worsening financial crisis.

Quick observation. Since you’re playing the Riddler, you like it. This means others you like likely will like it too. (Good tongue twister!) So, please do me a solid. Share Economics Matters, which includes my newsletter, podcasts, and the Riddler, with your beloved cousin 30x removed, your favorite ex spouse, your worst friend (good way to make up), your proctologist (surely anal about his finances), and every actual or prospective Presidential candidate you know (They could use some contact with reality.).

Riddle me this.

1. Our banking system has been lying about the value of its assets. It’s been marking long-term Treasury bonds, federally insured mortgages, and similar assets to book, not to market. This is called hold-to-maturity valuation. The exposure of this government-sanctioned deception is leading uninsured depositors to run for their money. This is what drove Silicon Valley Bank and Signature Bank to their unhappy graves.

   The next financial funeral? Surely First Republic, founded almost four decades ago. After that a long array of small and mid-sized banks will likely go belly up. This could culminate in a run on a systemically important bank. Which one might fail first? I’m thinking Citygroup, whose principal asset is Citybank. Citybank was founded years before Credit Swiss — way back in 1812. But City has a very large share of uninsured deposits and lots of assets marked to book. And, like Credit Swiss, City always seems to be in trouble. Anyway, enough background. Here’s my question:

   Marking all bank assets to market — pricing an apple at the value of an apple, not a lamp chop — lowers the value of all assets of all FDIC-insured commercial banks by

   a. $2 trillion

   b. $620 billion

   c. $572 billion

   d. $299 billion

   e.) $81 billion

And the answer is …

Last week I thought the value was $620 billion. But four top finance profs did their homework and showed it’s $2 trillion!

2. What fraction of our over 4,200 FDIC commercial banks are insolvent if we mark their assets to market? In other words, if we don’t let them pretend they have assets that are worth $2 trillion more than is actually the case?

   a. Roughly 5 percent?

   b. Roughly 15 percent?

   c. Roughly one third

   d. Over half

And the answer is …

The answer is over half! Let that sink in. Half of our nation’s insured banks are, as you read this, dead broke.

3. Let’s say you have more than $250,000 ($500,000 in the case of a joint account) in a small- to mid-sized FDIC-insured bank? Let’s say your checking account balance is $3 million. Then $2,750,000 is not insured. Yes, the government could, in the case of a run on your bank, insure all of your bank’s uninsured deposits. But Treasury Secretary Yellen has declined to ensure this insurance. Instead, she’s said that she’d take it one bank at a time. She also implied that she’d give the large, systemically important banks special consideration.

   Secretary Yellen is an absolutely terrific economist and public official. If she is concerned about insuring all deposits, she has a very good reason. Maybe she fears insuring all deposits won’t prevent a run in which case the FDI would quickly run out of money (It has essentially no reserves.). This would spark fears of high, if not hyper inflation because the Fed would have to print money to bail out the FDIC. Anyone with money in a bank, including insured depositors, would then want to pull their money out to buy, and freeze, lamb chops.

   Anyway, here’s the question. Are you going to leave your $3 million at risk or will you run on your bank, withdraw all $3 million and use the funds to purchase mutual funds that hold Treasuries?

   a. You run on your bank

   b. You stay loyal to your bank and risk at least $2,750,000

And the Answer Is …

Duh! You run and do so as fast as possible. Two dollars of every five dollars in checking account deposits is uninsured. Hence, the potential for a massive bank run that will destroy banking as we know it is real.

4. Since the collapse of SVB, how much money has been withdrawn and moved into equity-financed mutual funds holding Treasury bills and other securities.

   a. $22 billion

   b. $81 billion

   c. $117 billion

   d. $286 billion

And the Answer Is …

It’s $286 billion. In total some $550 billion has been pulled out of uninsured deposits and invested either in equity-financed mutual funds or in systemically large banks that have been “promised” special consideration if needed. The movement to equity based mutual funds is — my view — the beginning of the end of banking as we know it. The financial system is heading to Limited Purpose Banking (LPB) all on its lonesome.

Under LPB all financial corporations operate as mutual fund holding companies that issue only equity-financed mutual funds. To speed up the conversion, the government needs to institute a new agency — the Financial Services Authority — to verify and disclose, on a real time basis, all assets held by mutual funds. This is crucial for closed end funds. It will let them immediately start financing mortgages and small business loans and make their shares highly liquid in the secondary market.

5. BNY Mellon is our nation’s oldest bank. It was founded in 1784 by Alexander Hamilton. What is its share of uninsured deposits out of all deposits. And what is its marked-to-book assets as a share of its total deposits?

   a. 96.5 percent and 31.2 percent, respectively

   b. 77.0 percent and 64.6 percent, respectively

   c. 67.7 percent and 110.6 percent, respectively

   d. 91.2 percent and 40.1 percent, respectively

And the Answer Is …

It’s a. Answer b is Citygroup’s situation. Answer c is First Republic (Its figures may have gotten even worse of late.) Answer d is State Street Bank.

6. These questions have been very depressing. The answers surely have you calling your shrink. So, let me cheer you up with a little schadenfreude. Ten percent of 75 year-old Americans are depressed. In China, the depressed share for this age group is

   a. one fifth as large

   b. half as large

   c. twice as large

   d. three times as large

And the answer is …

The answer is three times as large. Indians and Mexicans are also far more depressed than Americans. Yes, there are measurement differences and Americans have more access to anti-depressants. Nonetheless, this finding is striking. It comes from a recent, very careful MIT study. The seven-person research team includes two economics Nobel Laureates.

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