In March 2023, the financial system experienced a significant shift that had a profound impact on the market. The Federal Reserve and the Treasury implemented a backdoor bailout of the banking system, a move that changed the dynamics of the industry. While some regional and smaller banks had failed previously in late February/early March 2023, the collapse of Silicon Valley Bank, Signature Bank, and First Republic Bank marked the largest bank failures in the history of the United States.
The reason behind these bank failures can be attributed to two main factors. Firstly, the banks were only offering a meager interest rate of 0.3% on deposits, while people could earn higher returns of 4% or even 5% in money market funds or short-term Treasuries. As a result, depositors began pulling their money out of the banks in large numbers. Secondly, the banks were burdened with significant unrealized losses on their longer-duration assets, such as mid to long-term treasuries and loans, due to inflation causing a collapse in the value of these bonds.
Strangely, investor confidence remained relatively stable despite these looming issues. These problems were known as early as November 2022, but investors chose to overlook them and had faith in regional banks until late February 2023. However, the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank triggered panic among investors, leading to a widespread dumping of regional bank shares. Consequently, the share prices of these banks plummeted by 10%, 20%, or even 50% within a single day. By early March 2023, the United States seemed on the brink of a full-scale banking crisis.
It was at this critical juncture that the Federal Reserve and the Treasury intervened to prevent a total collapse. Taking action, the Treasury, in conjunction with the Federal Deposit Insurance Corporation (FDIC), assured depositors that their money was safe by offering to backstop all deposits above the typical FDIC insurance limit of $250,000. Simultaneously, the Fed injected nearly $400 billion into the financial system within a span of three weeks. This massive liquidity infusion aimed to stabilize the market and restore confidence.
Additionally, the Fed initiated a backdoor bailout scheme, channeling close to $100 billion directly to the banks. The combination of these efforts had a significant impact on the stock market, marking a turning point in its trajectory. Stocks hit rock bottom during the regional banks’ crisis but experienced a decisive reversal thereafter.
A chart depicting the S&P 500’s performance since the beginning of the year illustrates this shift. Each candle on the chart represents a week of trading, with white candles signifying upward movement and black candles indicating downward movement. Following the regional banks’ issues in late February and early March 2023, there has been a steady upward trend, with the market closing up for 13 out of the last 19 weeks. Of the six down weeks, only two were significant, while the remaining four saw a strong rebound, with stocks recouping most of the initial losses by the end of the week.
The chart highlights the two substantial downward weeks with blue circles, which were notable events. The other four down weeks, marked by purple and red circles, either saw minor declines or witnessed market recoveries from the low points.
In simple terms, early March 2023 served as a pivotal moment for stocks as the market entered what can be described as “bubble mode.” Since then, stock prices have been soaring, with various companies experiencing substantial gains. For instance, Sirius XM Holdings doubled its share price within a week, and Carvana skyrocketed by 700%.
This turn of events underscores the significance of the Fed and Treasury’s intervention in averting a banking crisis and stabilizing the financial system. However, the sustained rise in stock prices amidst this “bubble mode” raises concerns for the future and the potential repercussions of an eventual burst.
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