Introduction:
Bank failures are distressing events with far-reaching implications for the economy. The failures of Silicon Valley Bank, Signature Bank, First Republic Bank, and Silvergate Bank this year have been labeled as some of the largest bank failures in U.S. history. While they may bring to mind the global financial crisis of 2008, it is crucial to recognize that the bank failures witnessed in 2023 exhibit unique characteristics that set them apart from the crisis over a decade ago. Two specific reasons contribute to these distinctions. First, the analysis does not adjust the two episodes for inflation. Second, the failures in 2008 were not limited to banks alone, as many large firms faced trouble during that time and required bailouts.
Are we comparing apples to apples?
In 2023, the FDIC has taken over three banks with a total of $506 billion in assets. First Republic Bank had $229 billion, Silicon Valley Bank had $167 billion, and Signature Bank had $110 billion. By comparison, during the 2008 financial crisis, the FDIC took over 25 banks with a total of $373 billion in assets, including Washington Mutual, which accounted for $327 billion in assets alone. However, these figures have not been adjusted for inflation. When comparing these two scenarios, should we only focus on banks and exclude other institutions?
If we examine the first major collapse of 2008, it was the investment bank Bear Stearns that, although not insured by the FDIC, functioned similarly to a bank by making loans, transacting securities, and participating in auctions related to treasuries. Bear Stearns was not allowed to fail in a literal sense and was acquired by JPMorgan Chase. To facilitate this transaction, the Fed took control of Bear Stearns's assets worth $29 billion. This situation is very similar to the sharing of losses of First Republic Bank by the FDIC. A quarter before its failure, Bear Stearns's balance sheet showed approximately $395.4 billion in assets. Adjusting for inflation, this would amount to $571 billion, which is more than the combined total of the 2023 bank failures. (Source: Wall Street Journal)
Another example of failure in 2008 was Lehman Brothers, another investment bank that was allowed to fail. The size of their balance sheet's assets in 2008 was $639 billion when they filed for bankruptcy. After adjusting for inflation, this would amount to $886 billion today.
The following day, AIG, an insurer and not a bank, was bailed out due to its impending failure, with its asset size totaling $1.05 trillion. After inflation adjustment, this would be equivalent to $1.46 trillion in today's dollars. The Federal Reserve Bank of New York took control of 79.9% of the assets' ownership, and AIG was nationalized. This also led the federal government to place Fannie Mae and Freddie Mac, each with around $900 billion in assets, into conservatorship. It is important to note that neither Fannie Mae nor Freddie Mac were banks. Shortly thereafter, Washington Mutual, a conventional bank, experienced failure.
Another significant rescue was that of Citigroup when the FDIC, along with the Treasury, guaranteed Citigroup's loan portfolio of $306 billion. At that point, Citigroup's total asset size on its books was $2.05 trillion, which would amount to $2.8 trillion today when adjusted for inflation.
One of the laws introduced in October 2008 was the Troubled Asset Relief Program (TARP), which was seen as the savior for bailouts.
If we sum up all the failures and bailouts in 2008 described above, including the conservatorship of Freddie and Fannie, the total amount would be $4.5 trillion at that time. Adjusted for inflation, that would amount to $8.7 trillion today. Comparing the bank failures of 2023, the total amount would represent only around 5% of the 2008 figure.
Since then, significant developments have taken place in the banking regulatory space and overall market dynamics. It is essential to elucidate the distinctions between the 2008 and 2023 failures through these parameters as well. By examining these aspects, it becomes evident that the bank failures in 2023 differ significantly from the financial crisis of 2008.
Regulatory Reforms and Oversight:
The regulatory framework governing banks has undergone substantial changes since the 2008 financial crisis. Authorities worldwide have implemented comprehensive reforms to strengthen oversight and resilience in the banking sector. Notably, the Basel III framework, introduced in response to the crisis, has mandated higher capital requirements, enhanced risk management, and improved liquidity standards. These measures have significantly improved the stability of banks, ensuring that failures are less likely to trigger systemic risks and contagion effects.
Source: Bank for International Settlements (BIS). (2021). Basel III: Finalizing post-crisis reforms. Retrieved from: [https://www.bis.org/bcbs/publ/d424.htm]
Underlying Causes and Risk Factors:
As discussed above, the underlying causes and risk factors associated with bank failures in 2023 are distinct from those of the 2008 financial crisis. In 2008, the crisis originated from the collapse of the subprime mortgage market, excessive risk-taking, and complex financial derivatives. Conversely, the bank failures in 2023 can be attributed to factors such as inadequate risk assessment, poor management decisions, or exposure to industries undergoing significant disruptions, such as technological advancements or geopolitical factors. These failures are more idiosyncratic in nature, affecting specific institutions rather than posing a threat to the entire financial system.
Source: Reinhart, C. M., & Rogoff, K. S. (2014). This Time is Different: Eight Centuries of Financial Folly. Princeton University Press.
Market Contagion and Systemic Risks:
One crucial distinction between the bank failures in 2023 and the financial crisis of 2008 lies in the level of market contagion and systemic risks. The 2008 crisis witnessed the rapid transmission of problems from one institution to another, extending beyond banks and ultimately threatening the stability of the global financial system. In contrast, the bank failures in 2023 have been relatively contained, with limited spillover effects on other financial entities or the broader economy.
