By J. Keith Buchanan, CFA, Senior Portfolio Manager
Last month, SpaceX launched the most powerful rocket to date from a launchpad in South Padre Island, Texas. This marked the first test flight of the Starship spacecraft atop the Super Heavy rocket booster. About two minutes and 24 miles above ground, the vehicle exploded in midair before the separation of the ship and the booster.
In a tweet following the explosion, SpaceX acknowledged that Starship experienced “a rapid unscheduled disassembly.” The ship exploded, to state it more succinctly, but a “rapid unscheduled disassembly” just sounds better.
In a previous Spotlight, we talked about the mini-crisis in the banking sector which triggered the rapid unscheduled disassembly of Silicon Valley Bank, Signature Bank, and First Republic Bank. We did not have any direct equity exposure to those names, but we have been investigating these bank failures and exploring the ripple effects, if any, to other banks and sectors.
What was different from past banking failures is that this was a crisis of confidence, not asset quality. In previous crises, there are a group of assets to which one can point as the genesis of the turmoil. Those assets typically have some form of counterparty risk that impedes the market from pricing said asset. However, the assets on the balance sheet of Silicon Valley Bank were U.S. Treasuries backed by the full faith and credit of the United States of America.
The crisis of confidence occurred among depositors transpired as the quintessential prisoner’s dilemma game theory. Game theory is the analysis of how parties behave given different scenarios and interplay. In the classic prisoner’s dilemma, there are two players suspected of committing a crime together, and they are separated upon interview. If neither player confesses to the crime, they both go to jail for one year. If one confesses and the other doesn’t, the confessor walks free and the silent player goes to jail for ten years. If they both confess, they both go to jail for three years.
The prisoner’s dilemma boils down to the paradox of being faced with a situation where selfish and/or uncooperative actions ensure worse outcomes. That’s exactly where depositors stood over the past almost three months. If depositors in First Republic, Signature, and Silicon Valley Bank had not withdrawn their deposits, those banks would still be standing and risk to the institution and its investors would have remained normal. However, if their fellow depositors withdrew their money, pain would be inflicted on the remaining depositors as they would lose their uninsured deposits.
Banks are fairly unique in this regard. Their capital base is the genesis of their profitability. A portion of their capital base is funded by the general public and can be retrieved at any moment. Therefore, that portion of their capital base, and at least a portion of their profitability, is inherently flighty and influenced by herd behavior.
Unlike any banking crisis of the past, the dilemma extends further into today’s banking system as mobile technology and social media enhance the paradox facing players, or in this instance, depositors. Now, stocks are selling off as social media spreads fears of contagion consequently forcing depositors into a prisoner’s dilemma. Even though intraday stock trading has no direct causal relationship with the availability of deposits it still is affecting depositors’ decisions. We saw this clearly with PacWest Bank as they acknowledged that the First Republic closure caused ripple effects which triggered a selloff in their stock. That week, PacWest suffered a 9.5% decline in deposits.
Once again, rumors and stock price declines placed depositors in a prisoner’s dilemma. Then depositors withdraw deposits which causes more selling and share price pressure. This unfortunate sequence becomes the vicious cycle which feeds on itself.
Perhaps, the rapid unscheduled disassembly was not of the foundation and underpinnings of the regional bank system. The explosion seen and heard was just that of confidence in the system.
For more news, information, and analysis, visit the ETF Strategist Channel.
GLOBALT is an SEC Registered Investment Adviser since 1991 and, effective July 10, 2013, remains a Registered Investment Adviser through a separately identifiable division of Synovus Trust N.A., a nationally chartered trust company. This information has been prepared for educational purposes only, as general information and should not be considered a solicitation for the purchase or sale of any security. This does not constitute legal or professional advice and is not tailored to the investment needs of any specific investor. Registration of an investment adviser does not imply any certain level of skill or training. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information may be required to make informed investment decisions, based on your individual investment objectives and suitability specifications. Investors should seek tailored advice and should understand that statements regarding future prospects of the financial market may not be realized, as past performance does not guarantee and/or is not indicative of future results. Content may not be reproduced, distributed, or transmitted in whole or in part by any means without written permission from GLOBALT. Regarding permission, as well as to receive a copy of GLOBALT’s Form ADV Part 2 and Part 3, contact GLOBALT’s Chief Compliance Officer, 3400 Overton Park Drive, Suite 200, Atlanta GA 30339. You can obtain more information about GLOBALT Investments and its advisers via the Internet at adviserinfo.sec.gov, sponsored by the U.S. Securities and Exchange Commission. The opinions and some comments contained herein reflect the judgment of the author, as of the date noted. Investment products and services provided are offered through Synovus Securities, Inc. (SSI), a registered Broker-Dealer, member FINRA/SIPC and SEC Registered Investment Adviser, Synovus Trust Company, N.A. (STC), Creative Financial Group, a division of SSI. Trust services for Synovus are provided by STC. Regarding the products and services provided by GLOBALT: NOT A DEPOSIT. NOT FDIC INSURED. NOT GUARANTEED BY THE BANK. MAY LOSE VALUE. NOT INSURED BY ANY FEDERAL AGENCY
