the acute phase of the deposit flight crisis has ended with the fdic’s seizure of first republic and sale to jpmorgan chase the events highlight how fed policy has aided the biggest institutions still expect commercial real estate to take center stage over deposit flight too big to fail banks win again on the eve of the fed’s next policy statement everyone in washington is talking more about “too big to fail” than monetary policy why in two words first republic that’s because jpmorgan chase the nation’s largest bank is acquiring the failed institution’s assets after months in which deposits have fled smaller regional banks for their larger brethren the takeover makes clear that the largest financial institutions have a great advantage right now and that’s in large part because of the fed by missing the boat on inflation in 2021 the fed was forced to raise rates aggressively throughout 2022 that’s ushered in significant deposit flight in 2023 hurting the smallest banks as deposits fled to moneymarket funds and larger banks concentrating risks in more highly regulated institutions certainly makes the fed’s job easier and many other countries have had more concentrated banking systems for a long while but from a political perspective it’s problematic something i’ll discuss below as for the rate decision expect another quarter percentagepoint hike on wednesday to a near 16year high this could be the last one because there is no consensus to go further but now the die is cast what comes next will be largely due to the tightening already instituted with a us government debt ceiling standoff as a potential catalyst for a recession that’s beneficial to the likes of jpmorgan chase but not for smaller banks the bond market or the us economy the first republic failure is the culmination of almost two months of turmoil that began with silicon valley bank’s rapid descent today i feel very much the way i did at the outset that the us banking system is healthier than it was in 2008 and that this is not an existential financial crisis like the one back then instead today’s bank stock losses notwithstanding the acute deposit flight issues that brought down svb and first republic are about to give way to more of a simmering balance sheet problem similar to the sl crisis of the 1980s and early 1990s first republic in particular is emblematic of that parallel that’s because we saw a first republic failure back then too when i first wrote about the similarities to the 1980s i used the failure of an oklahomabased bank called penn square as the poster child of the sl era’s problems that are going to crop up again but another first republic bank failed in 1987 that texasbased first republic got slammed hard by the slump in oil prices that occurred after the fed’s rate hikes and the double dip recession that followed its property loan book plummeted in value and it tried to finesse its way out via a merger with another troubled texas lender interfirst bank but eventually the fdic had to step in flogging the bank off to ncnb the precursor of today’s bank of america ncnb an acquisitive southern state superregional rebranded to nations bank and went national in a merger with bankamerica in 1998 to become the biggest bank in the united states since bankamerica’s name had more cachet the combined entity became bank of america the name used for bankamerica’s bank branch operation so first republic’s failure is literally history repeating itself but of course it’s one thing to have ncnb the 17th largest bank taking over a local texasbased first republic during an oil bust and savings  loan crisis to become the 10th largest bank it’s quite another to have jpmorgan chase the largest bank in the country take over the secondlargest bank failure ever in the country many saw ncnb as a white knight helping to fix a us banking system that was made too fragmented by interstate banking laws that helped to create bank failures by concentrating loan books in depressed regions of the country like texas and oklahoma it only became the bank of america behemoth a decade later jpmorgan chase is trying to play that same role today but it is already a massive bank an amalgam of at least four venerable massive financial institutions in different lines of work you’ve got the rockefeller’s bank chase which was already the nation’s biggest bank in 1955 when it merged with bank of manhattan that was merged together with chemical bank in 1995 making it again the largest bank in the country until bofa overtook it when it merged with ncnb and chemical itself was the result of a huge merger between chemical and manufacturer’s hanover in 1991 in 2000 all of ‘that’ merged into jp morgan a gigantic corporate lender with a big investment banking franchise and a storied history jpmorgan chase is like four separate banks  lender to corporations custody bank investment bank retail bank rolled into one and now it’s just gotten bigger via a deal which some think will earn the bank billions of dollars a year through first republic’s rich clientele and wealth management this will cause a lot of angst in the us simply because of the longstanding american penchant for federalism and suspicion of centralization those suspicions are what led to glasssteagall act of 1933 which divided commercial banks from their investment banks they go even further back causing rigid interstate banking regulations enforced by the national bank act of 1863 and mcfadden act of 1927 and while all of those rules have been relaxed beginning in the 1980s leading to the bofa and jpmorgan chase behemoths the suspicions remain for a country still upset today about bailouts of socalled too big to fail institutions a decade and a half ago that’s a political problem and specifically for the fed  being behind the curve has consequences the reality is that the fed by being behind the curve and forced to hike belatedly and therefore aggressively created the deposit flight problem we see today the precipitous rise in rates has also caught the entire financial services industry flatfooted heaping huge marktomarket losses onto their loan books and longterm bond security portfolios this is like what we saw in the 1980s when the fed belatedly tried to snuff out inflation sending interest rates to nosebleed levels that effort under thenfed chair volcker wrecked the whole business model of the savings  loan industry and precipitated a latin american debt crisis but if it weren’t for the blowback of the debt crisis onto us banks the fed might have gone further with that as context where does the fed go after this wednesday it knows it has already sown a round of financial instability that has caused the second and third largest bank failures in us history even though the acute crisis could be over i think the fed stops after its next move it pauses at a minimum to assess the situation since monetary policy acts with a clear lag and that lag is not just in terms of financial stability it also is in terms of the real economy apollo global management’s torsten slok noted monday that it takes on average 14 months from the fed’s first rate cut until we see the cyclical low in the unemployment rate with the fed having started it’s campaign i would say that makes the 34 rate in january the likely low ten months after the fed began hiking the reason the lag is compressed is because the fed was late making the policy catchup aggressive it’s like seeing the car with flashing red lights slowing into a potential traffic jam in front of you if you hit the brakes late you have to hit them harder exactly as the fed has done this morning torsten slok also had an interesting insight on how the deposit flight crisis has affected timed savings deposits in the us big banks are so flush with cash thanks to the fears about regional lenders they are offering lower rates on timed deposits while the smallest banks are being forced to offer more but it’s unlikely those marginally higher rates will offset the shift of cash into banks considered too big to fail that’s only going to make the us banking system more concentrated overall that’s bad for lending because the companies that rely on the banking system for loans are heavily dependent on the smaller banks since large companies can use capital markets for capital we should expect a credit crunch to grow this is why the us yield curve is steepening into a likely recession in a way more akin to the early 1980s than any of the recessions that came after take a look at the period around the 19801982 doubledip recession for example what you see is a market in disbelief at the fed’s determination to keep yields high as represented by the fact that 2year treasury yields were higher than 10year yields but look at the timing and the levels the us economy was three or four months into a recession in april 1980 when the fed funds rate started to recede that sent 10year yields nearly 2 ½ percentage points below 2year yields a quintessential signal the market was looking for deep cuts when the economy went into recession again in 1981 the fed stopped hiking sooner and so the curve didn’t invert as much but policy was so tight throughout that the curves only went back to normal and ‘uninverted’ well into recession by contrast in the next cycles the federal reserve started cutting before recession the curve normalized to upwardsloping before the recession too and when the curve did uninvert it steepened much more aggressively than in the 1980s that helped banks rebuild balance sheets and turbocharged lending to creditworthy borrowers if you look at the very end of the chart you see the present yield curve signal it shows the most inversion since the 1980s however with the curve already steepening before any recession what that tells me is that the market signals are closer to the 1980s than at any time since then but that things are not as bad as they were back then so unlike in the 1980s we have the chance of the curve uninverting before a recession hits if the fed actually started cutting rates too it would steepen even more that’s going to take the sting out of bank balance sheets all of those lowyielding loans and bonds on their balance sheets will be less underwater freeing banks up to make more loans but a recession is when the bill comes due on bad loans and as berkshire hathaway’s vice chair charlie munger said this past weekend commercial real estate is where the bodies are buried as the economy turns down and those loans sour particularly since occupancy rates haven’t normalized to prepandemic levels defaults will escalate resulting in a massive wave of credit writedowns and it’s only when the credit writedowns ebb away that we can claim all clear first republic’s death as a standalone institution thus not only demonstrates history is repeating itself it also likely marks the end of the acute deposit flight crisis and the beginning of a chronic writedown crisis i expect the pain to be more severe for regional banks because commercial real estate is an area they have been more active in and therefore jpmorgan chase’s acquisition of first republic is emblematic of a coming consolidation in the banking industry with too big to fail companies as the biggest winners if you look at realtime estimates of growth like the atlanta fed’s gdpnow figure the us is a ways off from recession the debt ceiling standoff could change that especially because there’s a greater chance now that the treasury could run out of funds in june traders are still eyeing august as the xday when the treasury has no room to maneuver and must default but treasury secretary yellen and the congressional budget office both flagged that things could come to a head as soon as early june credit spreads are starting to widen but they will widen further the closer we get to the xday that could mean more debt defaults increasing unemployment some analysts also think stocks could drop 15 without a deal soon combine this with the debt market tightening and increased risk of a credit crunch and you have a recession in the making maybe that will spur the fed into cuts just as markets have been crying out for don’t count on it though for now expect another hike and watch for what they say about the moves to come for recession watchers i’d watch commercial real estate as much as the real economy by the way when i think about the american suspicions of concentrated banking systems i look to the north at canada and across the pond to the uk and i have mixed feelings canada has the famous big five banks with its top three banks holding 60 of assets in the banking system versus less than 40 in the us that concentration helped canada get through the great depression without the massive bank failure waves in the us it still faces a test with the latest house price boom though by contrast in the uk which saw its banks succumb to a house price crash during the financial crisis a decade and a half ago the government only last year became a nonmajority owner of royal bank of scotland so a concentrated bank system is a doubleedged sword speaking of the uk and house prices i plan on writing about this next week in preparation for the next policy decision the mliv pulse survey is also in part about the uk and houses here’s the question i’d love you to answer in the survey which of the major economies will see the biggest decline in housing prices and standard of living this year which uk assets will perform the best and finally will king charles iii be the last monarch of the uk share your views in the latest mliv pulse survey quote of the week   some people think giving businesses more deposit insurance will help fix things they keep bigger bank balances than households   banks are still clamoring for cash to bolster their liquidity   here are several great accounts of the first republic takeover and problems at that institution politico ny times matt levine bloomberg big take   like me charlie munger thinks cre is a big big problem   corporate america is now focused on layoffs not growth also see here on ibm jobs and ai   interesting take on stagflation worries and investing