What the bankers are actually worried about

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Bankers rule at the annual Milken Institute Global Conference in Beverly Hills, Calif.

So there’s tension in the air as this year’s confab of financiers and business leaders starts on the same day that First Republic Bank fails in a government-backed takeover by JPMorgan Chase.

Just a bit of unpleasant housekeeping, many of the attendees at this year’s conference say.

“No one likes to see a bank fail, but that said, it’s good to see the last remaining source of uncertainty resolved today,” Citibank CEO Jane Fraser told a packed ballroom during the conference’s kickoff session. “We should all feel pleased about that.”

Fraser said the US financial system is “very solid.”

First Republic’s demise follows the failure of two other banks, Silicon Valley and Signature, in March. Is a crisis spreading? Nope. In an interview with Yahoo Finance, Marc Rowan, CEO of Apollo Group (Yahoo Finance’s parent company) said, “the three banks that have failed … totally predictable mark-to-market losses on treasuries, well known structure of the deposit base.” Well-run banks don’t have such problems, he insists.

So everything is fine? Sorry, no.

Americans don’t need to worry about a cascading series of bank failures, but the three failed banks are already setting off a series of repercussions likely to include a sharp cutback in lending that that will slow growth, maybe to a halt.

“The implications are going to be pretty profound,” David Hunt, CEO of asset manager PGIM, said on the kickoff panel. “There’s going to be a real ratcheting up of regulation in the banking system. That will further hinder the supply of credit going into the economy. We are going to see a real slowing of aggregate demand.”

Behind the scenes, more money is flowing out of traditional banks and into other institutions that comprise the “shadow banking” system: private-equity firms, hedge funds, non-traditional lenders and so on. The big, well-known firms aren’t showing unusual signs of stress.

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But there’s a lot of scuttlebutt about mid-market firms that could get squeezed by rising rates and falling asset values, just as those three regional banks did. Shadow banks are less regulated than banks that take customer deposits and offer FDIC insurance. So if there’s some kind of crisis, the odds of a government bailout are low. Watch this space.

There’s always a political specter haunting the Milken attendees. This year it’s the debt-ceiling standoff between Republicans who want to slash spending in order to raise the federal borrowing limit, and Democrats who say raise the limit and talk about spending cuts separately.

“We don’t pick up the phone and tell the politicians what to do,” Fraser said. “But we do lay out the consequences. This time feels different. It’s more worrying.”

There’s a loose consensus that markets have not priced in the disruption that might be coming as debt-ceiling bargaining goes down to the wire this summer.

“The markets love to believe politicians will be rational,” Hunt said. “But what if that’s not true this time? The market doesn’t handle these kinds of situations well.” At PGIM, he says, “we’re working on that more than some of the recession scenarios.”

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Inflation is on everybody’s mind, as it has been for the last 18 months. Sure, it’s coming down, and the Fed may soon enact its last interest rate hike for a while. But some important global trends could keep inflation higher than Americans are used to: deglobalization, reshoring, protectionism, industrial policy.

“A lot of deflationary forces are basically behind us,” Karen Karniol-Tambour, co-chief investment officer of Bridgewater Associates, said. “Everything that was made in the cheapest possible place is now moving the other way. That means we’re producing stuff that’s more expensive. Decarbonzation is great, but in the medium term it’s not saving any money. A world of higher inflation means higher risk premiums, higher real rates. Most investors have very little inflation protection.”

Bank failures. Yeah. But there’s plenty of other stuff to worry about as well.

Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman

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