Economic Monitor – Weekly Commentary
by Eugenio Alemán

A Difficult Job Becomes Even More Difficult!

March 17, 2023

Monetary policy, ever difficult to conduct, became even more difficult over the last week as one of the most difficult processes in banking came to fruition for one bank and brought down another bank in the process: a bank run on deposits.

The lessons the US government and the banking industry learned during the Great Depression helped create the Federal Deposit Insurance Corporation (1933), which instituted insurance on banking sector deposits. Insurance on deposits went from $2,500 back in 1933 to $250,000 today.

It seems that one of the biggest issues for SVB was that a large percentage of depositors were not covered by FDIC deposit insurance. That is, it seems that SVB took deposits mostly from businesses and then invested in longer term, in very safe, but low yielding government securities. As interest started to increase, it seems that customers started to shop around for higher interest rates on their deposits and the bank was unable to stop the bleeding. As customers took their money out, the bank had to sell some of those perfectly secure bonds on fire sale and lost a lot of money in the process, approximately $1.8 billion. When the bank tried to issue debt to re-capitalize for those losses, clients, businesses, and investors, instead of helping recapitalize the bank, went elsewhere, and pushed the bank into insolvency/bankruptcy.

While the FDIC and its deposit insurance facility were created to try to reduce and even try to avoid a banking run, the fact of the matter is that at some level, it is very difficult to completely prevent a run if trust in that bank is lost. The only alternative if this happens is that the central bank acts as “lender of last resort.”

Preventing Runs Against the Banking System Does Not Create Moral Hazard!

Being the “lender of last resort” is the role of the Fed and one of the ultimate reasons for the existence of a central bank. And the Fed fulfilled its role over the last weekend, by taking over SVB and stopping a banking run could have threatened other banks. Hopefully, what the Fed did will be enough.

Many are arguing that the Fed created “moral hazard” by saving the depositors at these two banks. Others are arguing that what the Fed did was tantamount to guaranteeing all the deposits of the banking system. We have even read that what the Fed did changed the nature of capitalism, or something of that nature. We respectfully disagree. Investors in those banks will lose their investment while employees and officers at the bank will lose their jobs.

It is clear the Fed understood that backstopping a run against these two banks and “guaranteeing” the deposits was the correct move. This guarantee does not mean that the Fed and the FDIC are, de facto, guaranteeing all the deposits of the system, as we have heard some saying.

That is, what the Fed and other regulators did does not contribute to moral hazard, as many are arguing. According to “Moral hazard is the risk that a party has not entered into a contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity. In addition, moral hazard also may mean a party has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.” It furthermore adds, “anytime a party in an agreement does not have to suffer the potential consequences of a risk, the likelihood of a moral hazard increases.”

However, what seems to be misunderstood is that parking your money at a bank, be it an individual or a business, is not a situation that could generate moral hazard. The US Federal Reserve (or any other central bank in any part of the world) needs individuals and firms to park their monies in the banking system so they can conduct monetary policy and have oversight of the financial system. If individuals and firms kept their monies in deposit boxes or under the mattresses, as it happens in many less developed/high inflation countries, it is impossible for the central bank to be successful at its role. That is, monetary policy to help the economy will be even more difficult.

Thus, even though the FDIC insures up to $250,000 for each account and social security number, it fundamentally does this in order to try to prevent runs, which before the establishment of the FDIC were more common than after the creation of the FDIC. Furthermore, the FDIC is funded by the insurance premiums it collects from member banks as well as its own investments in US Treasuries.

However, if runs happen despite deposit insurance, the only way to stop them is to have the Federal Reserve, the FDIC, and other regulators doing what they did over the weekend, which is guaranteeing the deposits of those institutions that suffered the runs. That should be enough to stop a further run against the system. That is, if these actions stop the run and stabilize the system, there will be no need to completely guarantee the deposits at any other financial institution.

The European Central Bank Sticks to Its Hiking Plan

Despite the uncertainty surrounding the strength of the financial sector, the European Central Bank (ECB) raised the three key interest rates by an additional 50bps this week, bringing the bank’s main rate to 3%. This is mostly because, in contrast with the US, inflation in Europe has been much stickier, with headline inflation still at 8.5% year-over-year in February. Additionally, Core inflation, which excludes volatile categories such as food, energy, alcohol and tobacco, increased in February from 5.3% to 5.6%. After announcing the rate hike, the President of the ECB Christine Lagarde stated that she is still determined in bringing inflation down to the 2% target, and markets are currently pricing in two more 25bps hikes at the May and June meetings.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.


Reading furnishes the mind only with materials of knowledge; it is thinking that makes what we read ours.

– John Locke