Bank failures come in waves.

And the wave is often triggered by a widely held economic assumption that turns out to be bad.

By Pranshu Maheshwari, Mar 2023.

Before the Great Depression, the assumption was that stocks won't fall.

During the economic success of the roaring 1920s, several people bought stocks on borrowed money. When the stock market crashed in Oct 1929, most couldn't afford to pay back their loans.

They turned to withdraw money from their banks, triggering bank runs and a steep economic collapse. More than 9000 banks failed.

American Bank Failures since 1934

Source: FDIC.

The establishment of the FDIC in 1933, and other policy measures, slowed the pace of bank runs.

Before the S&L crisis, most assumed interest rates won't rise.

But in Oct 1979, the Federal Reserve began to sharply raise rates to combat inflation.

Savings and Loan institutions (S&Ls) took customer deposits on floating rates, and issued mortgages at fixed rates. When interest rates rose, their costs rose sharply, but revenues stayed the same. 2943 S&Ls failed starting in 1980.

Before the GFC, most assumed home prices would never fall.

Investors bought heavily into mortgage backed securities (MBS), particularly riskier sub-prime mortgages.

But it turned out that housing was oversupplied. Home prices began to fall in 2006, and MBS lost value. During the economic contagion, and the resulting Global Financial Crisis (2008), 465 banks failed.

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Is there another bad assumption today?

The recent failure of Silicon Valley Bank has raised fears of a new banking crisis. One way to look at SVB's failure is: SVB assumed that interest rates won't rise.

After the 2020 pandemic, venture capital and startups boomed. So SVB was flooded with new deposits. It had to do something with the money. So it invested them in safe US treasuries. Unfortunately, they invested in long-dated 30 year treasuries. Which are very sensitive to interest rate changes. So when the Fed began to raise rates in 2022, the treasuries declined heavily in value. The bank run might have been triggered by fear-mongering on Twitter, but it was certainly exacerbated by the reality that SVB's assets had lost value.

Similar fears are spreading about First Republic Bank. And investors are nervous about Credit Suisse too. It doesn't look like any of them made the same mistake as SVB.

But - it's not always clear until after the fact just how widespread the bad assumption was.