Dalrymple column: Recent bank failures a result of classic no-no, borrowing short and lending long
“There is no remembrance of former things, nor will there be remembrance of later things yet to be among those who come after.” — Ecclesiastes 1:11.
There’s nothing new about the causes of the recent mega-bank failures. Case in point: the implosion of San Francisco’s First Republic Bank, which is the second largest bank failure in the nation’s history, just behind Washington Mutual (WAMU) during the Great Meltdown of 2008.
One of the root causes of First Republic’s takeover by the regulators was borrowing short and lending long, meaning that they made home loans to billionaires at below market rates, and fixed the rate for as long as 10 years with an eye to getting the borrower’s deposit and other banking business. It worked, as it always does, for a while, until short-term rates, and the bank’s cost of borrowing goes up. Then the yield on the low-interest loan is lower than the lender is paying to fund the loan, and the lender is losing money.
The savings and loan industry did this from the mid-1840s. Finally, about 130 years later, it was realized that the entire business was either insolvent or on the verge of being so. To correct this, the Garn-St. Germain Act was passed by Congress in 1982, with the ironically risible title of, “An Act to Revitalize the Housing Industry by Strengthening the Financial Stability of Home Mortgage Lending Institutions and Ensuring the Availability of Home Mortgage Loans.” (Whew!) I’m sure you’re not surprised to learn it did just the opposite. The law gave a bushel basket of new powers to S&Ls without mandating additional capital (net worth) as a buffer against loss. And it gave that lending ability to operations untrained in its application.
In every endeavor or business there are core guiding principles that are essential to the success of the activity or business model. For example:
Investing: Buy low; sell high.
Landscaping: Green side up.
Skydiving: Do not exit aircraft after takeoff without parachute.
And, in banking: Do not borrow short and lend long.
So why do lenders do the same thing over and over and expect different results? Well, yes, they’re probably insane, but it’s a valid question and the answer is elusive. Leading up to the Financial Crisis in 2008, very bright people decided it was a good idea to make mortgage loans to borrowers who demonstrably could not afford the debt service. Why?
Possibly it’s “hubris,” from the Greek “hybris,” meaning “wanton … arrogance resulting from excessive pride.” (Webster’s Collegiate Dictionary). For example, if you’re really, really smart, you come to think you’re smarter than everybody else, and soon you figure maybe natural laws might not apply to you. In any event a lot of MBAs crossed the border into La La Land at the turn of this century motivated by, possibly, a dash of hubris and a lot of greed.
So far, with the failure of Silicon Valley Bank, Signature Bank and now First Republic, the major causes of their bankruptcy were as old as banking. Besides borrowing short and lending long, they took in so-called hot deposits that were uninsured and would leave quickly at the first sign of trouble, resulting in bank runs that turned into sprints, thanks to smart phones and social media. And, in the instance of SVB and Signature, they made loans to questionable borrowers. Startups with negative cash flows at SVB; crypto related enterprises at Signture.
We’ll close with a comment that might give credence to the hubris theory. At the time of SVB’s failure, news sources reported that Greg Becker, CEO of SVB, headquartered in Santa Clara, California, often ran the institution from his home in Hawaii.
Marie Antoinette, when told that the people were rioting because they had no bread, was reported to have said, “Well, let them eat cake.” She never said it, but it’s become an iconic phrase to describe the clueless insensitivity of the 1 percent.
I guess “clueless” is the proper word in these circumstances.
C’mon Greg, have you no shame?
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His email is email@example.com
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