It’s A Big Club, And Regional Banks Ain’t In It
You may have seen the hilarious comedy routine in which George Carlin tells his audience that the country is run by a “big club” and “you ain’t in it. You and I ain’t in it…” For all of the Regional Banks in the country, it’s as if Mr. Carlin was speaking to them. In the latest financial reports from the Big Four Banks, it is apparent that there is a big club that the Regionals aren’t part of.
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Our story begins sometime in late 2020 or early 2021. It’s right in the middle of the Covid-19 Pandemic, and Washington is finalizing the plans for a “Stimulus Program,” which will come to the financial aid of American citizens and businesses. The objective is to provide a rescue for people to make ends meet during the economic lockdowns sweeping the county. The Government will send out checks allowing citizens to pay their bills and prevent a total shutdown of the economy.
Stimulus was an extraordinary measure needed in those distressing times. Both the President and Congress were ready to put the plan into action. While across town at the Federal Reserve, Jerome Powell and the rest of the Federal Reserve were trying to deal with a growing issue of their own. For Powell’s entire term as Chairman, one of his major issues was to finance the nation’s growing Debt.
Financing the Debt meant that the Federal Reserve must devise a way to sell more and more Treasury Securities, those Bills, Notes, and Bonds which make up the country’s borrowing. In 2007 the Treasury Market stood at a mere $5 trillion. By the time Powell assumed the Chairmanship of the Fed, the Treasuries market had ballooned to over $18 Trillion. And now, with this new Stimulus Program, it threatened to expand by another $5 or $6 Trillion at least.
As it turns out, Powell and his compatriots devised an ingenious plan. A plan that would help the Fed sell those bonds and notes and simultaneously help the banks with their capital requirements. In 2021–22 interest rates were essentially nil. The Fed had lowered their Fed Funds rate as low as possible without going negative like Japan and Europe. So, while Powell could not increase the Bank’s income, he could make it easy for them to eliminate any worries about their capital requirements. If the Banks would buy Treasuries, they could be used, at 100%, for reserve capital. The Fed would recognize those Treasuries, at full value, for the Bank’s reserve.
It was a win-win, the banks solidified their regulatory requirements, and the Fed sold more bonds. What could be better?
The plan worked well until inflation hit, then it all fell apart. Then the Fed was dragged kicking and screaming to raise interest rates. At first, the Fed tried to ignore the problem. It’s just “transitory,” they said. But reluctantly, the Fed was eventually forced to raise rates. And once they began down this new track, they became rabid, raising rates faster and higher than we’ve seen in a generation.
However, the higher the Fed takes interest rates, the lower the market value of those bonds they encouraged the Banks to purchase back in 2021–22. Bonds that once provided 100% of Regulatory Capital now only provided 80% or even 70%. For some banks, this was enough to close them down. Witness Sovereign Bank and Silicon Valley Bank.
However, our story continues. One group of Banks avoids this entire issue; they are the big four: JP Morgan Chase, Citigroup, Wells Fargo, and Bank Of America. Over the past few trading days, all four Banks have reported sparkling earnings. Earnings were driven by the Bank’s ability to avoid significant losses in its Treasuries portfolio.
It’s no accident that these Big Four Banks are also members of an exclusive club called “Primary Dealers.” In 1960 the Dealers were set up to aid the Federal Reserve in distributing US Treasuries. Currently, there are 24 Primary Dealers, each with a coveted position at the table with the Federal Reserve. Every issue, from the smallest to the largest, goes through this group first.
Not only are they the first in line for every new issue and thus entitled to an automatic “markup,” but they are also privy to a priceless amount of information. Information that no one else has access to. Does the Fed have significant financing due in the next couple of days? That’s proprietary information. Only the Fed and these Primary Dealers have access to that.
Wall Street has come to accept this as just a standard business practice. It is a procedure that is rarely challenged today. Although in years past, several “gadflies” questioned this “insider trading.”
So with that background, I invite you to consider this. These four Primary Dealer Banks, JP Morgan Chase, Citigroup, Wells Fargo, and Bank of America, reported earnings unaffected by the worst Treasury Bond Market in 30 years. A time when rising interest rates depressed the principal value of all bonds.
As any bond investor will attest, that is a remarkable accomplishment. An accomplishment that we’re not likely to see repeated by any other financial institutions.
So how are the other, smaller banks doing? According to CNN, all the other banks in the country are not faring so well. American Banks, except for the big four, are sitting on a collective loss of $620 billion in their Treasuries. It is a remarkable dichotomy between those four Primary Dealer Banks and all the rest.
Perhaps Carlin was right: “It’s a great big club, and you ain’t in it…”
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