Bank Crisis 2.0 with Ram Ahluwalia

Transcript

bankless Nation we have an episode today talking about the bank crisis season two David I feel like we're about to do all of this all over again the content that we put together back in March when the first Banks uh started failing well there was a brief Hiatus a pause and now last week they resumed the second largest bank failure since 2008 just happened last week but the failure of First Republic Bank uh we talked about this on the roll-up David and we described it as a we have a Snowman on the right here all these bank failures that have just happened so uh who do we have on what are we going to talk about what uh what is the season two characterized by so far uh we're

bringing on now returning guest Ram alawalia who helped us navigate banking crisis season one uh and it was a supremely useful episode to understand well everyone was giving very emotional very hot takes Rome was able to make a us very feel very grounded uh and so uh that was season one uh turns out that there's season two uh and it's very different when a bunch of banks collapse inside of one local time frame uh but now that was in March and now we're in May and now banks are collapsing again uh so how has this changed the game is the big question that we should ask but first before we get into the episode one and talk to our friends and sponsors over at Swell so swell is a

decentralized staking as a service protocol you guys know and love these non-custodial the way we like it uh and so as well as brand new into the staking as a service system so if you are interested in getting on the ground floor of a brand new Dao in the LSD space swelt might be for you there is a link in the show notes to get started they are doing their Voyage tours decentralization and they would like you aboard their ship Link in the show notes absolutely and it is also staking season while the banks are failing the ethereum community is a staking now now is the time to start staking and we've gotten live with uh withdrawals recently so um I'm starting to get more excited about staking as well um all right David so we had First Republic Bank fail last

week I think the big question on my mind going to this episode with ROM is is this a harbinger of things to come like you know you know when you always feel like the last Domino the fall has fallen and yet still there's another Domino right so yeah what happens after this uh it's it's things are feeling kind of shaky and yet last week one of the commentary I I have which I'm going to ask for mom is like it felt like no one was talking about this or it wasn't quite the hoopla we saw with with Silicon Valley as the market just gotten used to oh bank failures big failures are just what we do now that's just the how we live in 2023 we just our banks just fail I can't be how it is but that's what we're going to ask ROM about

anything else in your mind as we get into this episode yeah uh it is important to note that the nature of traffic just moves slower uh back when we were having our D5 pool 2 summer of of 600 apys things in in that era in that Paradigm move really fast so things move slower when things are just at the you know single digit yields which means the question that I have is like how long of a phase in the market should this be has some bank failures in March now it's May is this 2023 uh there is a conversation of commercial real estate and credit risk there uh which is the conversation to be had in traffic and so there's another thing to pay attention to and really just overall the Paradigm of the too big to fail Banks

and what that means for our financial markets uh well these are the things this is what we're getting into we are going to be right back with a bank failure season two the new crisis is upon us it seems we're trying to make sense of this with ROM but before we do we want to thank the sponsors that made this episode possible including our number one recommended exchange for 2023 which is you know it Kraken go set up an account Kraken Pro has easily become the best crypto trading platform in the industry the place I use to check the charts and the crypto prices even when I'm not looking to place a trade on Kraken Pro you'll have access to Advanced charting tools real-time Market data and lightning fast trade execution all inside there's spiffy new modular interface kraken's new customizable modular layout lets you tailor your

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beta tester and buyer is airdropping their wallet token for simply just using the wallet you can sign up at ambuyer.com and while you're there sign up for the web app wall experience as well so thank you ambeyer for pushing the frontier of smart contract Wallets on ethereum us in a very confusing first season but episode one of season two of the banking crisis has just dropped where the second largest United States bank failure ever since 2008 has just happened so we are

here to ask ROM how many episodes will season two have so ROM I will ask that first question to you how many episodes are we going to have of this second phase of the bank of Crisis first off thank you for having me I I hope that this is a two-season cereal and it ends with the whimper not a bang unfortunately I don't think that's the case I think there's a a another one or two uh Seasons ahead of us especially as we get into some of the content around the commercial real estate okay so this is the era that we are going into this is not just a blip on the story of the United States finances this is uh so we're at the we are at the beginning of the story is what we are

saying yes exactly we're seeing the uh an unfolding and it was precipitated by the most rapid pace so rate increases since 1981 and you know similar patterns at work but nothing's quite the same similar to kind of the issues around the SNL crisis and uh we're going through the interest rate part of the storm the repricing as you know of these uh Securities which were held to maturity and that the next part of the storm will be around the credit risk namely in the commercial real estate but yeah so you have um thank you by the way for putting together a bunch of slides so for the podcast listeners this is also a YouTube video for the YouTube people that are watching live what's up

thank you for being here uh gonna be a graphics heavy uh podcast episode so ROM thank you for coming uh prep for for all the slides that we're gonna run through uh but first uh we've done a ton of banking presses content before so we've kind of gotten the gist uh long term held hold to maturity assets uh got whiplashed around by very rapid interest rate increases all of the regional banks in order to have any sort of profitability had to go really far out on the the time frame and then the value of those bonds just got absolutely nuked when the Federal Reserve jacked up interest rates and now all the regional banks are underwater and there's a flight to safety up to the to too big to fail Banks that's uh We've covered that part of that story pretty damn well but

the the new story is what we would like to like what is new now that we are in season two of banking crisis uh and what is the new elements of of this whole phase of the market so I'm wondering if we could kind of start with that bazel level of understanding as we go into your slides and as we uh unpack the story a little bit further what are the new elements of the story here it's an it's an excellent summary so I think there are a few new elements one is the issues we saw with the earlier set of bank failures around the Securities portfolio and the mark to Market issues you described there but there's another Saga that's going to unfold around the loan portfolio so a good example of us First Republic Bank First Republic was originating these mortgages at a two and a half percent

interest rate and of course those loans are not worth as much as they were in a low rate environment so the repricing of the loan book is uh what we are navigating through and another uh part of the story which has yet to unfold we're starting to see Tremors around it is in the commercial real estate market so we're seeing some more volatility from banks that are exposed to commercial real estate but we haven't yet seen a bank go through receivership that had a lot of exposure to Commercial Real Estate so ROM I I just want to um get a recap because it sort of happened and I was somewhat paying attention but not fully

of what happened last week which is First Republic Bank um failed I believe that was early last week and this is on top of in our season one uh there was Signature Bank and there was Silicon Valley Bank and there's silvergate bank that all kind of failed in in season one now we have season two which is kind of kicking off with a got a new character Arc here uh it's a brief character died off you know the first few minutes of the Season here which is first for public Bank did First Republic Bank die fail for different reasons than the season one cast of characters like Silicon Valley signature it seems like what you might be saying is that had to do a bit with kind of like treasuries and bonds maybe First Republic is a little bit different but

but help us understand that so there are some shared comorbidities and the common factor to all was negative equity now how they got to negative equity was a bit different so what do they have in common First Republic Bank and the other Banks one is a high percentage of uninsured deposits that's one the second thing they had is a high level of unrealized losses in the whole to maturity portfolio for Silicon Valley Bank that was in the mortgage-back Securities portfolio for First Republic Bank that was in the jumbo mortgage portfolio then the third issue that they both experienced due to these preceding issues because people look at the financial statements they

say hey this bank has negative equity is a bank run in the case of First Republic Bank there was a call it like a panic of 1905 style private bailout you know that was a bailout where the big Banks got together including JPMorgan and others and made a 30 billion dollar deposit infusion to First Republic um and uh you know Force Republic announced their earnings they took no questions and answers on the Q a component of the earnings call that's rare I don't know that I've ever seen that before and their stock price dropped and they were put into receivership they were acquired by JP Morgan and as a part of

those deal terms the FDIC is providing some ring fence on the losses as well as financing to JP Morgan one difference I also noticed Rama did I mentioned this in the intro to to David was that um maybe not in the kind of the financial commit community in the communities you track maybe it was a bigger deal but I didn't hear the politicians kind of uh castigating a certain group or or a blaming kind of like Silicon Valley Tech Bros or like crypto people for this and I was almost wondering if there's sort of a social thing going on which is like oh this time around the politicians kind of want to keep this one quiet we don't want to draw too much attention to it and I don't know if that's just my perception or what do you think is different socially this time around in season two

really interesting question like I think there are two factors one is First Republic probably banks these politicians First Republic was and is now our JP Morgan you know a world-class wealth management franchise you know when I was at Merrill Lynch I was actually part of the deal team that played a role in acquiring First Republic pre-crisis we bought it for a bunch of money then we sold it for half the price in the 2000 a crisis Community needed the liquidity then General Atlantic bought it by the way General Atlantic was also the one leading the Silicon Valley Bank rescue that 500 million can come back to later you'll see the familiar cast of characters small world right so First Republic goes public their stock goes up like 30X over like 10 years up until it doesn't because these

mortgages they did not sell those mortgages when rates were low they could have securitized them now to your point specifically look some of this is like understanding The Narrative at first it's easy to see easy to say like Tech forward Silicon Valley crypto Banks they're blowing up they don't know what they're doing it's fast money now First Republic comes a little bit closer to home and the other you know a factor is banks are a confidence gain in the same way money is a confidence game all banks are doing duration mismatch banks are borrowing short and lending long and it's important to have public confidence in the banking sector

for all the reasons we've discussed before so yeah it's uh they're trying to supervise and regulate and do the right interventions and not alarm the public at the same time um ROM uh you've got a great set of slides that we'd love to run through so if we could uh get those up and running sure and as we do just the high level mapping of what we're about to go into just the agenda what are we gonna what are we gonna talk about today if you could just um preview the content so here here's some of the topics you know what are the core morbidities of bank failure um how do we get here I think a lot of that's been discussed how are the banks and Regulators responding what's the next chapter in this Saga for

the banks around commercial real estate risk and also critically go to fix the banks what's the right long-term View and this is content I have not seen put out there and I believe there's a very important role for crypto to directly address the issues in the banking system and make a difference to ordinary Americans so excited to get to that as well let's do it why don't we start with um comorbidities and for people who aren't um I love the word code I love it too it is so awesome for us then David okay so a comorbidity is when you when someone dies for a particular reason you look at all the diseases that they had the

underlying symptoms that they had and you start to like associate all of the underlying reasons all underlying uh diseases that somebody has for their death and so if somebody uh there's a frequent comorbidity between atherosclerosis and Alzheimer's and so we look at the common denominator between why someone died and you like map out all the associated diseases to come up with the prognosis how'd I do wrong it's great look I'm not a doctor either so I'm taking notes as well we'll credit to Dr Danish on Twitter uh took the inspiration from there yeah it's basically like so if uh you know someone passes away someone dies and you know I could look at the co-morbidities uh related to that disease group and I'm like oh well there's high cholesterol

there's high blood pressure here there's you know uh high levels of obesity there's a few other comorbidities that are associated with this disease State and this death and I'm looking at those two so we're looking at elements that are associated with kind of unhealthy and unhealthy presentation that's what we're looking at for for the banks right so what ways are these Banks all unhealthy uh together as a pattern that's right so these are the the morbidities that are shared in common uh so if you have a high percentage of uninsured commercial deposits then that means you've got a corporate Treasurer or a CFO who is at the trigger ready to push a wire out if they feel their bank

is at risk so that money isn't sticky it's it's fast money the second is rapid deposit growth why does that matter because from the two trillion dollars in QE what these Banks did and there were beneficiaries that marginal liquidity they turned around and bought these Securities which we've talked about those Securities were underwater with the fastest pace of rate increases since 81 and that created comorbidity number three the significant unrealized losses in the whole to maturity portfolio in some cases the unrealized losses are so much that it pushed the bank into negative equity like Silicon Valley Bank and First Republic Bank and these banks are also publicly traded that creates a negative feedback loop

because these statements are out there you can look at the financials and you can identify what's happening when the stock price declines what happens then comorbidity number one kicks in that Treasurer looks at it and says gee I don't want to lose my job because I did not did not protect my corporate you know Treasury Ron let me make sure I understand this so the first is high percentage of uninsured commercial deposits so uninsured commercial deposits some examples of that would be what sure so the FDIC protects depositors up to 250 000 right so anything above the 250k then that's correct and the other key Point here is commercial so commercial meaning like a business deposit so Silicon Valley Bank service commercial client Silicon Valley Bank service

commercial crypto clients First Republic Bank also had issues with a high exposure to commercial clientele as well the reason that matters because that's more plone more prone to flight you know retail money mom and pop and Joe six pack they're not reading the Wall Street Journal American Banker or Twitter right that they're busy living life that's right okay so all all these failures had that in common they all had the co-morbidity in common and uh rapid deposit growth this was just what over what time range the last 10 years or so just really over the last over the last three years yeah since the semis right because easy come easy yes exactly so the stem is two trillion dollars and of

course QE which raises the deposits at the banks so now if you're a bank and you've got deposits you're paying out an interest on those deposits unless you're JP Morgan so how do you fund the payout of the deposits you turn around and you buy Securities and you make loans so the security purchase the first thing you do because it's liquid you just go to the upper Market push a button it takes time to make loans find loans underwrite loans and so what you can see on this chart here is you know who is naked who grew rapidly on the deposit growth uh turnaround bought these Securities and therefore because those Securities have declined in value there is a write down

on their Equity that unrealized hold to maturity portfolio became realized because they were exposed to bank runs okay I see the rapid deposit growth run the halter maturity portfolio with unrealized losses run by that comorbidity with us again right so here's how that works so imagine your Silicon Valley bank now they took in record deposits due to a record year for Venture fundraising right poor codes are depositing 50 to 100 billion dollars in new deposits at Silicon Valley Bank so what did Silicon Valley Bank do they they turned around and they bought these mortgage-backed securities they bought longer duration treasuries

during a low rate environment and rates went up now banks are permitted to classify assets such as these Securities into their whole to maturity portfolio and you can only do that if you intend to hold to maturity do not have an intention to sell those assets uh and of course the rates went up so there were unrealized losses into that into that whole maturity portfolio meaning the mortgages and securities weren't worth what they had purchased them for I should add that this hap this is not an uncommon theme in Banks it happens right so hold to maturity accounting has

been out there for decades the issue is when the bank is forced to sell those Securities which they never intended to do and why are they forced to sell them they're forced to sell them because they have a bank run people want liquidity people want cash first the bank starts prioritizing okay meet the wire transfer with cash then meet the wire transfer Demand with selling what are called available for sale Securities or their trading portfolio and then they crack the emergency glass at The Last Resort they sell whole maturity Securities uh and then they crystallize those losses I got it selling unripened Securities

right yeah um so this is this is the foundation of the context of of season one and also First Republic right and so we're still just kind of reviewing stuff that's already happened correct correct that's right okay so just so I understand so far the story is a high percentage of uninsured commercial deposits right so this is money that's flooding in above the 250k so we got that check check with all of these failures so far rapid deposit growth particularly since coveted stimulus numbers went up really fast in terms of deposit so check check check significant hold to maturity portfolio that just means they bought a whole bunch of like uh treasuries and more back Securities that are now underwater in this environment and

they're faced with a situation where they have to um sell them because everybody's withdrawing okay so now how about number four comorbidi negative equities what does that mean so negative equity is what is the result of when you sell Securities in your whole maturity portfolio at a loss you sell those underworlds number four so now you cannot pretend and say hey it's on our HTM portfolio we're gonna hold to maturity it's true if you hold the maturity those bonds are good but in that in the current period they're marked below value and you're forced to sell those Securities you incur a loss by the way one thing I should point out the high percentage of uninsured commercial deposits that existed pre-covered that is a business model issue so First Republic Silicon

Valley Bank silvergate always had a high level of uninsured commercial deposits but these other these other comorbidities start to present themselves so there is management responsibility around all of this and some banks did handle this better than others we should come back to silvergate later on I believe okay and then the last one I'm gonna make an attempt to make a guess the last of the fifth comorbidity here is publicly traded so in all of these bank failure cases they were all publicly traded and this is basically so investors can see what's actually going on on the balance sheet and they look at that fear yeah we're just like oh this doesn't look good and so because it's completely public it's not happening in the private space where you know we

don't have to disclose all of this information tapping the public space and that precipitates some sort of Crisis as well so all of these cases have been publicly traded bank companies and stocks that's right so that that sets up the vicious feedback loop stock price declines on some fear corporate Treasurer looks at the stock price declining they make a decision to wire funds out to another bank then the next quarterly report the bank deposits have declined and stock price declines further that causes other corporate Treasures to do a bank run and that is a common factor here so this actually produces some sort of defense for banks that are not publicly traded how many banks are publicly

traded good questions excuse me the ratio of publicly traded to non-publicly traded Banks is probably the better question most banks are not publicly traded there's four thousand Banks across the United States and the vast majority of them are small Community Banks there are a couple dozen Regional Banks those Regional banks are publicly traded then of course you have the the systematically important Banks which are publicly traded the big the these are all in a certain class of Bank too would you characterize thesis like mid-sized they're not quite the the small small but I mean silvergates a community bank so I think it's a small thing it was a small small Bank you know a couple billion dollars in assets uh svb signature and First Republic I would put

as in the regional category yes there are smaller there are other regionals that are much bigger than them but yeah they're in the regional category okay ROM how does this progress from here so so first off a few things to notice like on this slide here you can see that when the tide goes out you can see who's most exposed so there's a rhyme and a reason to which banks are experiencing these risks it's not a random phenomenon why that matters is we're trying to understand is is this systemic right or is it a tempest and a teapot today it's I would my thesis it's Tempest in a teapot okay that's good news right it's good news that's good

news contain contains chaos I don't want to be the guy that says theres could pay to be quoted forever we'll be we'll get to cre later because this is not yet a cre story give it give us special real estate commercials right so that story has yet to unfold okay and so we'll come back to that but so far there's a rhyme and a reason and a pattern to which banks are having issues and you can see the red ones are gone put in receivership the orange boxes have had stock price pressure the last one or two weeks okay and those core morbidities are also present

in that case but it creates some comfort in that there's a finite set of banks have these issues by the way this scatter plot isn't exhaustive it's not complete there are other Banks here not shown and sometimes the worst of the banks are not even on these charts because I can kind of create a self-fulfilling prophecy so um so you know we saw this chart in the prior bankless podcast it's really interesting so remember when we spoke last time Silicon Valley Bank had blown up Signature Bank had blown up but now you have pressure on these other Banks so this this chart was quite prophetic uh and you know you can do this analysis to identify where the soft points in the banking system are using public data

from the call report system all that all the banks including private banks are required to disclose their financials quarterly with a lag which is too slow to the FDA signal those financials are public so you're not feeling so well if you're Zion Wall PA CW I don't I don't know what these actual Banks uh are what these uh ticker symbols represent but that's a collection that are kind of circled with the same comorbidity right that's right that's right and it's a it's a kind of Market where if there's a one false move then you get stock price decline and you get this volatility this is really interesting this this slide here shows up morbidity number four publicly traded this is an excerpt from a Merrill Lynch report on Western

Alliance Bank so they looked at the earnings and they said Western Alliance had good earnings and good fundamentals and their stock price jumped on the news and they had some pressure prior to their quarterly earnings release however the Maryland pulled the rating they said we don't have a view on the stock we're not giving you any guidance anymore and ignore any other research we've shared on this because we don't know what's going to happen next and this is the highlight it said quote Western Alliance and the broader Regional banking group are caught in a negative feedback loop driven by Steep sell-off and stock prices feeding into deposit attrition fears and it's no longer treating the Fundamentals by the way every day every other day Western Alliance stock price

goes up then down up then down it's kind of similar to what First Republic had gone through although they're different institutions different considerations you know around them and events happen right so you know credit ratings agencies will say hey we're downgrading this stock those events also can create pressure on the stock right so you you use the Tempest in a teapot analogy and and that that Tempest is the all the fundamentals that have weakened have created fears and I have created a bank run which have started to spiral out of control I am not used to the idea of a bank run being contained by a teapot

and so that is a new thing to understand that a teapot I know I'm brutalizing this metaphor here but like it's actually doing a good job of containing a bank run so what what are those walls that are keeping this thing from being totally crazy it's a great question and the walls aren't perfect I'll tell you what the strategy of The Regulators is so the core issue is twofold one is you have banks that have these underwater loans and securities on their balance sheet and it's tagged us whole to maturity so if only they can hold to maturity the banks are good so The Regulators say all right we're going to do two things now to prevent these Bank runs action number one is provide liquidity

to the banks and that's the bank term funding program that's the FED discount window that's the FED home loan Banks so if you bank or gain a bank run and you've got illiquid assets then pledge those E-liquid assets to the bank term funding program the FED discount window and then you're gonna get liquidity to honor your depositors JPMorgan offered a credit facilities or even private credit facilities because the Federal Reserve only accepts high quality collateral mortgages and treasuries First Republic makes jumbo mortgages which federal reserve does not accept except right so strategy number one is liquefy that Banks provide credit facilities to the banks strategy number two is protect uninsured depositives

so the FDIC cannot ensure all uninsured depositors as a deposit cap two hundred thousand dollars and what could stop all Bank runs in their tracks is the FDIC will it have to be Congress would say hey all deposits are insured then no Bank runs wouldn't happen Banks could hold to maturity Congress isn't going to do that anytime soon and so what the fdsc is doing is they're invoking these systemic risk exception even though it's a 10 a teapot it's kind of funny right so the FDIC is saying hey every bank that has failed and puts into receivership they've insured every single depositor

and they're trying to signal to the public that your money is safe with the banks that you can have confidence in the banking system but they can't come around they can't come out and say every future bank failure we're gonna go do this we're going to protect all uninsured depositors and that's why secretary Yellen kind of squirms and you know under Congressional scrutiny because just because she she doesn't have the authority to to make that call that's correct but that is the Playbook so functionally you're getting unlimited Deposit Insurance that's the pattern and practice of the fdsc today every Bank they've protected every single depositor my prediction is any bank failure from here no deposit will lose any money but legally they cannot say that they

don't have the authority to say that there's moral hazard questions as well right but that's what the Market's assuming right now ROM is that we're just all assuming that hey like the bank failures in the past they've protected depositors above 250k so they're just going to carry that forward and whether that's actual law or not kind of the the market is assuming wink from Yellen that that's going to continue and all depositors are protecting are protected thus um stopping the bank running his tracks I believe that's right with two considerations one is if a bank has a negative equity then markets punish and they focus on the institution and you get this

negative feedback loop the second thing is no Bank can withstand a bank run not even JP Morgan because all banks are doing duration mismatch right so here's a stylized example of a bank on the left hand side This Is A bank's balance sheet their assets include loans those are like jumbo mortgages commercial real estate loans could be loans to startups like in the case of Silicon Valley Bank those loans are all liquid and they change in price based on interest rate and credit risk so those on the right hand side you have these deposits which are liquid they can go at any time and when those deposits run the bank cannot sell the assets on the left-hand side of the balance sheets illiquid so there are two things that

markets are focused on markets are saying hey if a bank has a negative equity then they're focused on it the second thing is if if markets detect a possibility of a bank run even if they have positive equity like in the case of silvergate we saw on that core Mobility chart they have positive equity they'll go after it also because they can force the bank to transition from positive Equity to negative equity by trying to sell loans at inopportune times or forcing the default because they cannot generate liquidity the the words that you're using ROM have put um this idea of the the Marcus if the markets detect and uh it's one thing I've learned in the last like 18 months

of watching uh yields in crypto and then also turn into yields in the banking sector the markets and yield as well is like this all-knowing mycelial network between all the financial institutions and when you say like the markets detect it's like the eye of Sauron is like running around this mycelial network and it's like oh hey how's your Equity doing oh is that negative equity and then everyone piles on and then it's and then it takes down that bank and then it moves on to the next one that seems like a very powerful force I I agree I love the mycelium analogy by the way uh it's it's exactly right so the these ifs are on the panopticon is trying to identify the next failure and this interesting thing where there are several banks have

issues but the markets are trying to congeal on which one's next right and then they grab and then markets will focus and gravitate towards that bank and that bank story comes to the fore so there is like some non-linearities around by the way here's another thing now markets aren't perfect and markets aren't you know 100 efficient so in the case of uh Silicon Valley Bank there's a slide here I have this November there was a Wall Street Journal article which showed that the bank had negative equity if you took all the losses in the health maturity portfolio and you recognize those losses you say it's a negative equity so it had been out there for months it was known these

are known issues uh and here it is but the market didn't care until recently exactly so the market chooses when it cares or doesn't care right right and the Zeitgeist is now oh it's bank failures we literally use the term as bank failure season and so the mar the market is probably why we use those words like oh Bank bank failures back on the menu and now the market starts to get really jittery around particular Banks but I bet you it turns into an even worse feedback root Loop when like short sellers start licking their chops and start to play into this fear and it turns into just like a cultural Zeitgeist set up by the underlying weakening foundations wheat very weakened foundations by the Whiplash interest rates that the Federal

Reserve gave us all throughout 2020. that's right the Whiplash interest rates as well as the social media and the speed of information and movement right so right Silicon Valley Bank had negative one billion dollars of cash because all the wire transfer is going out of it over a two-day period by the way like just to put in perspective like you know there are alternative histories that could have been folded here uh so this is svb you can see on the slide here they had negative equity on November 11th it was in the Wall Street Journal and then on March 8th what happened on March 8th Silver Gate announced that they were liquidating and they were not put in receivership they honored every single withdrawal by the way on the date of that announcement they were still considered

adequately capitalized they had positive Equity okay guess what guess which bank was raising money on that exact same date that was Silicon Valley Bank so silvergate announces are liquidating that hits the Bloomberg feed meanwhile Goldman Sachs is building this order book to do a capital raise for Silicon Valley Bank which would have saved the bank or at least allow them to get through to the other side and do another raise in a future day so all those orders are with the drawn and svb has a botched Equity raise so SUV blows up two days later Signature Bank blows up so to your point confidence is fragile and you know there could have been

alternative histories and their interactions with with with the stock market I want to get back to um the the Tempest in the teapot example because it's clear that um you know regulators and and uh the the powers that be are trying to um stem this problem and prevent this from this contagion from spreading and the analogy to me as we talked about comorbidities and this sort of thing is like there's a herd there's a herd of banks some of the banks are sickly right and there's all of these predators to David's analogy kind of the mycelium the Predator who's looking for the sickly bank and it's gonna you know attack the sick ones and call the herd that way but so far the temps in the teapot analogy is basically like it's been the sick

ones they're really sick ones unhealthy ones that have been called and so long as that's the case and it's very predictable like we can look at the herd and we're looking at on the screen the rational herd yeah we can pinpoint oh here's another one that's sick here's another one it's you know uh yeah sure you know some sort of poor creature with like a broken uh arm or something like this and you could see it and you could see the Predators start to encircle it and you know tackle it feels like a nature Channel or something but as long as that happens in an orderly fashion that is the market that evolutionary process like calling the herd and taking care of things and in the cycle of life and all these things so not a problem right or or is it a problem wrong it's a

good it's a good summary I don't know that that'll play out in the future a good example is like silvergate liquidated even though they have positive Equity because they had a bank run and any Bank is at risk of a bankrupt no Bank can survive a bank run so in other words the concern from like a public perspective is if good Banks die we don't want that to happen if bad Banks die weak Banks and the herd then there's Market discipline there's accountability there are moral hazard concerns if good Banks start getting shot like Old Yeller in the back uh because of uh you know I guess we have three metaphors that work the mushroom metaphor the the prey and like our lovely you know golden retriever but

if you if you if good Banks start to go down because of fear then you start to go from Tempest in a teapot to systemic risk and those are the concerns and it could it you know with with commercial real estate those are risks like you know I was at I was at Merrill Lynch in in during the financial crisis of 2008 Maryland she had positive Equity you know Banks borrow from each other overnight they have overnight funding short it's like a deposit borrowing from other bank overnight funding you can withdraw it in time Merrill Lynch uh was down to One Bank funding partner which is Bank of America and had we no ability to roll over our funding we would have blown up

right so the point is if you don't get access to liquidity because people lose confidence in you as a bank then you can die even if you're positive net Equity even if you're like a good bank okay um ROM earlier this morning uh Jim Cramer tweeted out commercial real estate isn't going to destabilize the system so a well overplayed joke in this space uh because Jim Cramer tweeted it is going to happen which happens to be the second part in your slides which actually lets you know that Jim Cramer was actually onto something so I want to turn this conversation to the commercial real estate sector and the fragility there but first we must talk about some of these fantastic sponsors that make

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the most trusted team in D5 download the uniswap wallet today on iOS there is a link in the show notes now we are back from that c minus transition into our sponsors but good thing we got some a plus content from ROM here ROM uh there's a new player in season two a new players entered the game uh commercial real estate why is this new player on the scene and what do they have to say sure so commercial real estate is the primary business of lending that that banks are engaged in especially the regional Banks and there was a lot of commercial real estate in the low interest rate environment you had developers that were borrowing at lower variable floating rates rates went up uh and they're going to have trouble

refinancing but the other factor is the work from home movement so you have double-digit vacancy like 50 to 60 percent in downtown L.A also New York City and other major Metro markets and that matters because there's the risk of less income generation on those properties which creates a higher likelihood of commercial real estate debt defaulting the commercial real estate Market's substantial there's two trillion dollars in commercial real estate debt that has to be refinanced over the next four years 450 billion dollars coming due this year and the regional banks have the most exposure to commercial real estate the mega Banks

don't really do commercial real estate so ROM whenever somebody talks about there being uh problems with real estate uh credit and real estate loans I go back to 2008. is that the right place to go for this or how is this similar versus different and again we haven't gotten to this phase yet you're just predicting this is this could be the next source of contagion and bank failure it's the next source of uh comorbidity risk here but like how is this similar different to 2008 because you were you were in the trenches then I'm sure you remember it well yeah there's similarities and and differences and there's a slide here that describes that but one difference is that this is commercial real estate not single-family

residential real estate you can see the differences here on the slides uh the other is that 2008 was driven by securitization of these no doc no income uh mortgages which were then securitized again with the CDO squareds and it was led by the biggest investment Banks and the largest banks in the land so it was absolutely systemic it was also credit risk driven now here are the commonalities commercial real estate is a credit risk issue uh there will be write Downs on the bank balance sheets thus far what we've seen are HTM losses from the repricing of mortgages and securities from rates having gone up we will see credit risk losses on bank balance sheets because uh some of them

got over levered the the vacancy issues are not going to be refinanced their debt so overall ROM do you like um do you like the position we're in now better than to that then we were in in 2008 are we are we stronger is it comparable this is a much better position than 2008 in 2008 the banking system legitimately was on the rocks it was a you know the the scenario could have been like a Great Depression I remember the Great Depression started with bank runs uh and you know liquidity and access to deposits make the world go around right if if Mom and papa are thinking about do they have access to their funds in their local bank account then you're in a

really bad state of the world because then bankruptcies and defaults happen from good borrowers that otherwise wouldn't have happened right so this is a very this is a it's not a 2008 because the big systematically important banks are not at risk is there pain to come yes and that pain to come we can identify where that pain is going to be it'll be concentrated in the Regional Bank sector especially those banks that were aggressive in commercial real estate office right so even commercial real estate not all commercial real estate is created equal uh elderly care facilities are going to be fine right medical is going to be fine industrial use cases are all right it's it's office is one

and then behind that I'd say you know multi-family there's like big apartment buildings okay Rob I got another uh metaphor to add to the mix here so uh we're talking about the Tempest in the teapot this is not 2008 so the teapot is still intact but we have this new player called commercial real estate risk and so if we're using the idea of this like mycelial Network this is like disease culling the herd of weak Banks this disease is getting is evolving is getting an upgrade kind of like how covid like adapted and and we had new strains new strain just dropped it is particularly targeting banks with high commercial real estate and so the walls are still intact because it's still just

banks that are focused on Commercial Real Estate and so there's a new sector of banks that are now now susceptible to this disease which is the contagion of uh Bank Run the bank run contagion is now going after the next weakest Banks which are the commercial real estate risk but beyond that walls of the teapot are still contained around the Tempest which is why we're still calling this not 2008. how's that how's that yeah that's an that's an excellent summary as well you know this next challenge yeah the tools that The Regulators have aren't going to be as effective and the reason why is the Federal Reserve and the bank term funding program they do not Finance commercial real estate

so you cannot create liquidity on that so these walls have cracks in them yes okay I get I get the whole not 2008 part but I'm still getting the fear that's the ending of season two Cliffhanger now we open up season three here but yes no so uh you know this is going to be a three-year process because those maturities they take time to develop and that the bank has to refinance them or not um you know as I mentioned you can identify the banks that have the most exposure uh those Banks know which banks they are and The Regulators are focused

on this now The Regulators don't have the real-time data into the loan docs and to the exposures of at a granular level um you know I think blockchain could fix that uh but yeah this is this is you know it's gonna it's not again it's not a 2008 it's not putting uh the US economy at risk of a major uh significantly negative outcome but you know you are seeing declines in commercial real estate lending right so look at this chart commercial real estate loan growth is close to zero percent now this is in the aftermath of svb so the the loan officers at these banks have tightened lending they're preserving liquidity they're refinancing their best borrowers that's why there's

not much low growth and also bank loan growth has come to a standstill as well so the banks particularly the regional banks are starting to go into a crouch in a Crouch position so Ron there's two takes I want to run Bayern and part of these are you know narratives that are running around crypto circles right the first is an Arthur Hayes take which is basically this is the nationalization of the banking system is is his high level take and he could kind of you know get into this but like the idea of uh a big Bank the too big to fail Banks consume all of the smaller Banks I mean JP Morgan just acquired First Republic they have all of the Assets Now these banks are basically like quasi-entities of the state they're not very private they're almost like

public right and so I would love your reaction to that and then I want to run by the the uh Balaji type scenario of you know much much more dire where he predicts okay yeah sure Ron maybe commercial uh real estate is kind of next Domino to fall but that's a series like you have to forecast this to the series of dominoes that that I am which is like yeah then it's another thing that is another thing that is another thing and it eventually leads to kind of uh US dollar Fiat blow up debasement uh catastrophe you know buy crypto now hurry before it's too late like that whole end game scenario too so first give react to maybe the Arthur Hayes take is this are we witnessing the nationalization of the

banking sector well I'll say first off you know Arthur's correct that banks are quasi-public institutions there's a a partnership between Banks and centralized authorities like the Federal Reserve uh Banks cannot really exist without a lender of Last Resort number one and number two Deposit Insurance that's the nature of fractional Reserve banking the only way we as a species have figured out how to make fractional Reserve banking work is you have a centralized Authority The Authority that can liquefy the banks uh and stop Bank runs through Deposit Insurance so that's the so they're quasi-public institutions absolutely true and that's why we highly regulate them another key factor is you know banks on average have 10 turns of

Leverage they're more leverage than hedge funds and their Leverage is coming from these deposits and those deposits are insured by the federal government and notice that the thickness of the deposit bar relative to the equity bar who's got more at risk the the central Authority rather than the equity holders this is why if you're at JPMorgan there are hundreds of regulators focused on JPMorgan they could be on site going through the books uh and they have broad powers to regulate Banks so in that sense I agree with his perspective that these are quasi-public institutions they absolutely are these deposits wouldn't be there without Deposit Insurance but you know I I don't

see nationalization on the horizon uh this is going to be a private Market I do see more shotgun marriages I do see big Banks buying small Banks which is not in the public interest so not quite it's uh maybe there's a spectrum spectrum of how nationalized the banking system are and you see the outcome as moving a bit closer towards more nationalized but still a public private uh type of relationship maybe there's just a bigger set of banks there's fewer Banks uh more regularly that's what you see more regularly more regulation will happen when I when I heard the term nationalized Banks I hear is there a bank owned by the government that furnishes deposits directly to the economy and creates loans for the

economy that doesn't I see that I do not expect will happen I hope that will never happen that would be like worse than cdbcs by the way agreed okay so how about the uh Balaji take which is basically you know he came out last week he he talked about sort of his 90-day prediction being short you know not quite right in the short run but the long run I'm still I've got like 70 probability that this will happen in in years uh what's your take on that um could this contagion could this be just you know another Domino to fall are we going to get a season three season four season five season and then we have kind of the the Final End Game episode where like the US banking system has

fully failed and we have a full reset right just at the end of uh uh yes exactly there's there's a lot there let me unpack that a few different branches of the tree wind can go down and it depends on the actors at the Federal Reserve and Congress in particular so first off the Federal Reserve is keeping interest rates High because inflation is high if the Federal Reserve keeps interest rates at an elevated level then you're going to feel a continued stress on the banking sector because more deposits will continue to move towards money market funds and that's a slow drain on the right-hand side of the bank balance sheet the liquidity leaves a system the banks were forced to sell loans at a bit of a loss uh if the Federal Reserve lowers interest

rates to reflate the bank balance sheets that's going to be inflationary uh if the Federal Reserve continues uh down if Federal Reserve pivots and moves down that path that's what you'll see now I don't expect like a hyperinflationary scenario I would expect elevated inflation so my thesis is you see inflation higher for longer but there are few scenarios that this can play out you know for example the rise of artificial intelligence is very deflationary and I expect it to happen in the next one or two years but at some point you know that's a powerful deflationary force which you all are tracking too if there's a significant uptick in unemployment then we might get bailed out by AI

so ROM your your base case prediction here is not that we see a full Cascade uh complete collapse uh hyperinflation type scenario but that we we have this elevated pressure release valve in the form of high inflation higher than power anybody in the FED is maybe wants or is willing to admit but that will be that will be the way we we um release the pressure of uh this colossal level of of debt that the entire structure is under but it happens gradually slowly over over months and years and not kind of all at once collapsed it's elevated inflation the last time we saw unemployment report at 3.4 percent which we saw last Friday was in 1969. now 1969 was the harbinger of elevated inflation

in the 70s you had record low unemployment by the way you also had the deployment of the Great Society programs which are extraordinary stimulus programs and in the world today of course we just exited extraordinary 2.1 trillion of the Copa deck so I think it's a very similar pattern but of course there are differences we have the onset of AI which is the deflationary force we don't have an OPEC commodity crisis uh you know we have more National Domestic produced energy uh a lot is going to turn on what does Jay Powell do does he blink and lower rates which is what markets expect him to do or does he hold the course and become a Paul

volcker and cause a recession so we have to assess and reassess I think better than saying like what's going to happen a year from two years from now it's good to have those views and scenarios but there are decision points and guide posts along the way that we can measure one of those is what will Fed policy look like a second will be what will Congress do will Congress have any fiscal stimulus or not uh I don't believe they will I don't think there's any appetite for more stimulus so and the other thing to take a good look at is the excess savings on consumer's balance sheet so recall that 2.1 trillion stimulus you can see it on

the bank balance sheets it's burned off to about 500 billion dollars in excess savings now that's one of the reasons why you have elevated inflation until that thing Burns off I think you're still going to have elevated inflation and you're still going to have you know a record low unemployment I expect that'll burn off you know in the sometime the next you know four to six months Ron what do you think Powell does do you think he blinks I don't I don't think he wants to Blink he wants to stay the course there are two things will cause them to shift course one is a financial Market dislocation something serious breaks breaks the treasury market breaks the repo Market breaks it's not this it's not what we've seen it's not these Bank values that's not enough no this is not

enough this is not this is not enough the FED believes that they can execute a two-pronged strategy they believe they can liquefy the banks by providing credit facilities to the banks that need liquidity and at the same time raise rates so here's another metaphor for you we are moving down a fast car and some of us a lot of us actually consumers and corporates have termed out our debt we took out a 30-year fixed rate mortgage and a two and a half percent interest rate because rates were low for a long time so we're not sensitive to Rising rates and a lot of corporates are the same too they're borrowing at very low rates and they termed out their debt I mean they have to pay back their debt for a long time but there are other sectors of the economy that are not like

that developers in the commercial real estate the housing market uh rate sensitive cyclical parts of the economy including financials uh and that so now owl is slamming on the brakes we've got our seat belts on and that other sector of the economy that has those debt exposures they're going to go flying through the window that's what we're starting to see in flow the cre um and it's a tough position right because because the it's harder for the FED to slow down the economy because we all got our seat belts we turned out our debt they've got to slam the banks brakes even harder to create the effect that they want um okay I see the predicament that we're in

the it it does the way that I've been talking about it on the weekly roll-up and others is that um it's like strategic toppling uh so the FED is just letting people hit the windshield and then they're just picking up their guts and then putting them back together and they're like yo you're fine uh but like allowing allowing the chaos to happen um wrong at the very beginning you talked about how there are some ways out that you have uh which has an interesting crypto element to it which I'm curious as to how anything crypto can produce to actually save something like uh the banks but can you can you walk us through how to fix the banks sure no thank you for this I think this needs an important attention now crypto needs a positive narrative to go on

offense and show how we can create real world impact that benefits ordinary Americans and strengthens the safety and Silence of the banking system that's in everyone's interest so on the left hand side here you can see how The Regulators are handling this and their approach to this on the right hand side these are the real long-term fixes that no one's talking about and we need to talk about one is enable private Capital to add Capital to the banking system we saw this announcement apple is launching a savings account well guess what that's actually a Goldman Sachs savings account that billion dollars in deposits that record deposits that's going to Goldman Sachs not apple apple also announced in the same week that

they're buying back 90 billion dollars worth of their stock guess what that is more than the losses to the FDIC Reserve fund times four Apple was sitting on a war chest here so is Amazon so is Google so are private Equity company soar entrepreneurs so is venture capital and there's an opportunity to take this old aged fragile banking system built on Legacy technology and Revitalize it with outside Capital with competition and with a digital first approach built on the blockchain I'll come back to the blockchain in a moment but one thing to point out is that it's illegal for a non-bank to own a

bank doesn't make any sense it's an old 1956 rule uh that matter in a different time and place and these rules aren't Norms internationally and the losses and the issues you have in the cre bank balance sheets they are a drop in the bucket relative to the capital that is available in private market so I'll pause there before we get to blockchain but yeah so basically you're saying that the tech sector ruthlessly competitive also extremely well capitalized what if we took those properties and put it into the Aged and failing banking sector yes basically what you're saying right yes and and more to that JP Morgan is petrified of

the idea of Apple entering the banking system I would be absolutely Apple has 150 million credit cards on file more than any Bank including Jacob I speak with this from knowledge as being a guy that grew up in Banks Capital markets I would go to DC I was part of these trade groups policy Association like like the the big banks are mortified of big Tech because if capital and consumers like their technology right because they're good I use the Apple card it's great right and I've got a Google Wi-Fi device here like it's omnipresent with me it's a channel right if a bank right if JP Morgan wants to acquire me they got to send a direct mail solicitation hope I open up a credit card here we already

saw the the phenomenon social media and Tech fail other Banks right so you can just extrapolate as to what happens when somebody like Jeff Bezos or Tim Cook or I don't know Elon Musk he'd already made PayPal uh yes yes and like they have enough customers they could even create their own networks create competition for a Visa or Mastercard which is causing Merchants to pay two to three percent out uh on their margins and these are low margins for Mom and Pop retailers so but guys this does this doesn't necessarily comfort me okay so we might succeed in the end goal of like ripping out the the failing fax machines that is our existing uh banking system but then

we're left with something that is kind of like China where big bank and big Tech have sort of merged together and unless that's built on decentralized crypto bankless technology you just like uh here's the new boss same as the old boss and you've just uh yeah but this new boss isn't failing though so that's important it's I guess but I don't know like uh yeah Comfort me on that so I could move towards something that is not um um that is just just a bigger thing that could fail right big Tech already is too big to fail that's an issue right it's a it's a bargain It's a grand bargain with the Devil the the technology companies have tons of capital but actually I'm publishing an

op-ed in American Banker it's gonna hit this week and I speak to your point Ryan and one of the points I make is that you have to enable entrepreneurs and Venture Capital to enter the category as well because uh you need more competition you need more novel ways to approach this and I also suggest that what these big tech companies can do is serve as a source of strength meaning like play a role as like a backstop and enable private Market you know competition so look at Anchorage Anchorage was the last de novo application that was approved by the OCC now that happened through a quirk of History because uh Brian Brooks Legend was the acting head of the OCC so we

could approve that application guess what it's not going to happen again but Anchorage is this interesting kind of web 2.5 Bank where they can interact with a blockchain and at the same time meet the high standards of safety and soundness and compliance that the federal Regulators require so you know we used to have 15 000 Banks like just 25 years ago now we're down to four thousand uh and we're gonna see less and it's getting too big to fail uh and my priority number one is strengthen the banking system ad competition ad Capital uh and you know these are necessary evils and trade-offs that we have to make but I agree with your point like we should we

should enable and encourage competition the banking system so definitely in favor of um reducing the barriers to entry to to compete against the big Banks um what what what's your take then on how crypto fits in how does blockchain fit in here it's such a critical role right so tokenization this is the key idea and I had a threat from consensus talking about this putting real world assets on chain well what does that do it gives you transparency and it gives you standardization so these banks have two trillion dollars in commercial real estate debt they got to refinance with the next four years and they don't have enough Capital to do that they also need to sell off their cre debt to other buyers and right now they're selling it to other Banks and

the entire banking system is going through a six percent deposit drawdown the system as a deposit drawdown they don't have enough ability to refinance these loans so if you can put these loans on chain then you can broaden the market for Capital to include non-bank actors there's so many other benefits around this you get transparency right you're not guessing at does this Bank have good loans or not good loans right now the Market's trying to search like we talked about the eye of Sauron which bank has a good clean balance sheet we can't see which loans are performing we can't see which banks have what loan exposures in what jurisdictions now there's a good question on whether that

should be made available to the public but certainly the regulator should see that and even the bank management team should see that the bank management teams are using Legacy technology decade Zone technology through this oligopoly of what are called bancorps software and they're protected from competition they've got the data put that data on the blockchain create liquidity create transparency create standardization Google is spending tens of billions of dollars buying treasuries they could pick up these CRA loans at a discount improve their yield you could put those assets on chain imagine if you had stable coins backed by real world assets that were on chain an on-chain credit asset manager so I think that is a a compelling opportunity

for for crypto this is just get this utility out of here I I would like to return to my coins maybe then crypto could talk about something other than uh meme coins too maybe we have some real world uh use to offer the world I think that's your broader point isn't it wrong I I agree and look it's these themes are at work and they're happening right so at consensus and this is public knowledge of Wellington one of the largest asset managers globally has a project called Spruce they're working with uh avax and ethereum and a couple other blockchains to test putting loans on chains so with sock gen uh and so are other Banks as well so you know I think we ought to encourage that

it's a good policy Focus enable private Capital to enter the market enable non-banks to invest and have majority control positions in Banks not even Berkshire Hathaway can do that and encourage technology transformation for the banks very cool beautiful Ron this has been a cool future yeah it is it's one that I would get behind and support uh ROM thank you so much for for guiding Us in in season two uh it's a big TBD at the end of this uh this season I think we'll have to see what's in store for season three and Beyond but at the end of this we get to maybe a way that crypto can help fix the banks which is pretty cool and thank you for spending some time with us today and explaining that to the bankless nation my pleasure thank you

for having me of course tell us uh tell us what you do at Lumi death so I'm the founder of Illumina we're a private wealth advisory we focus on alternative assets and digital assets We Believe crypto and blockchain have a promising future if you look at the last two years 60 40 portfolio hasn't worked all-term Investments um create diversity and our value prop is really two buckets we provide service to high net worth individuals trust estate planning cognizant of crypto and Investment Management Services we're fiduciary we're substitute duty of care we don't have conflicts uh and we believe in the promise of you know transformational technology I can definitely say from our experience

with with ROM as part of the bankless community and in these episodes is uh this is someone who knows both the old Trad Phi world and and the New Frontier of crypto and D5 so um certainly somebody to know and I'm glad you're working in the space so closely wrong thank you Ryan uh we'll end it here risks and disclaimers of course none of this has been Financial advice crypto is risky so is the banking system uh you could definitely lose what you put in but we are headed west this is the frontier it's not for everyone but we're glad you're with us on the bank list Journey thanks a lot