Who’s Afraid of the Big Bad Banks?

Who’s Afraid of the Big Bad Banks?

Bryan Taylor, Chief Economist, Global Financial Data


               The recent seizure of both Silicon Valley Bank and Signature Bank by the FDIC as well as the takeover of Credit Suisse by UBS has put the market on edge.  Fear that the financial contagion could spread to other regional banks or to Europe has driven the price of many banks down in price by over 30%.  Although regional banks have recovered, there is fear that more banks may fail.  Although the Fed raised interest rates by a quarter point, the Fed has also offered to pump money into banks by valuing their bonds at face value rather than their market value when they are used as collateral.

               Some investors are concerned about the stability of the banking system and fear that other banks will collapse soon; however, concerns about the stability of banks and the financial system may slow the increase in interest rates in the future.  The yield on both 2-year and the 10-year US government bonds has declined since SVB and Signature Bank were taken over by the FDIC.

               Are these concerns legitimate? Absolutely. 

Many of the financial crises and bear markets in the past were driven or exacerbated by bank failures. Financial failures have played a role in almost every major bear market in the past. This article briefly goes over the history of bank failures to show how they have affected financial markets in the past.

The Panics of the 1800s

               The Panic of 1825 occurred in Britain and led to the failure of 70 banks, many of which were small, country banks. The panic nearly took down the Bank of England itself.  The Banque de France provided an infusion of gold reserves to the Bank of England to help keep it afloat.  The boom in the 1820s was driven by investments in the newly independent Latin American countries and from capital freed up by the conclusion of the Napoleonic Wars.  However, some money flowed into fictitious investments, such as the non-existent country of Poyais (see “The Fraud of the Prince of Poyais on the London Stock Exchange”) as well as South American mining companies that collapsed when the mines did not produce as anticipated.  The Panic of 1825 was the first major stock market decline to follow the end of the Napoleonic Wars, but it was the first of several panics that occurred in the 1800s. The decline from the Panic of 1825 in London is illustrated in Figure 1.

Figure 1.  GFD UK-100 Price Index from 1815 to 1835

               The Panic of 1837 was in part caused by the non-renewal of the charter of the Second Bank of the United States. There was a run on banks in New York City on May 10, 1837 and the banks ran out of gold and silver and suspended specie payments.  Nearly half of all banks failed, and the recession continued for the next four years. Many individual states, such as Michigan and Mississippi, defaulted on their bonds.  The economy started to recover in 1838, but when England and the Netherlands raised interest rates, the economy started its decline once again.  When the American market hit bottom in 1843, the United States ended its longest bear market in history which had begun in 1792.

Figure 2. GFD US-100 Price Index from 1830 to 1845

               The Panic of 1857 was the first worldwide economic crisis that spread from the United States to Europe (see “The Ohio Life Insurance and Trust Co. and the Panic of 1857”).  The price of railroad stocks peaked in July 1857.  On August 24, 1857, the Ohio Life Insurance and Trust Co. announced that its New York branch had suspended payments.  The company declared bankruptcy and depositors became concerned about the safety of their money at other banks. The SS Central America was bringing gold to New York to replenish the banks’ supplies, but it sank on September 12, 1857 and all of its gold along with 425 passengers sank to the bottom of the ocean.  The price of railroads and grains continued to fall and the economy fell into a recession.  Three banks in England, the Borough Bank of Liverpool, Western Bank of Scotland and city of Glasgow Bank failed.  The panic spread to Germany and Scandinavia.  It wasn’t until the start of the Civil War that the economy started to recover.  The collapse of the Ohio Life Insurance and Trust Co. can be seen at the end of Figure 3.