ANALYSIS: Does Banking Crisis Increase Urgency for Biden to Negotiate on Debt Ceiling?

ANALYSIS: Does Banking Crisis Increase Urgency for Biden to Negotiate on Debt Ceiling?
A sign in front of a First Republic Bank office in Oakland, Calif., on March 16, 2023. Justin Sullivan/Getty Images
Lawrence Wilson
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A third U.S. bank failure in two months was not tied to the political standoff over the debt ceiling and is unlikely to impact negotiations on raising the nation’s statutory borrowing limit, but that could change, experts say.

First Republic Bank was taken over by bank regulators on May 1, becoming the second-largest bank failure in U.S. history. Although JPMorgan Chase agreed to purchase nearly all of First Republic’s assets, the failure of the San Francisco-based institution will cost the Federal Deposit Insurance Corporation (FDIC) about $13 billion from its deposit insurance fund.

Despite the unusual circumstance of two financial crises occurring at the same time—a series of bank failures and a political standoff over the nation’s debt ceiling—experts say the situations are not related and are unlikely to impact each other.

“First Republic Bank entering receivership over the weekend, and the subsequent purchase of the bank by JPMorgan is separate and distinct from the challenges that [President Joe] Biden is facing in negotiating options as it relates to the debt ceiling,” Mike Davis, founding partner at Olive Tree Ridge private equity firm, told The Epoch Times.

“Respecting the debt ceiling dispute, this is actually a separate issue, and it is much more of a political dispute than a true economic one,” said Robert Kravchuk, a fellow at the National Academy of Public Administration.

But that could change. Increasing public anxiety about the prospect of a default by the U.S. Treasury, combined with anti-inflation measures by the Federal Reserve Board, could drive interest rates to levels not seen in years.

A sign outside the headquarters of JPMorgan Chase & Co., in New York, on Sept. 19, 2013. (Mike Segar/Reuters)
A sign outside the headquarters of JPMorgan Chase & Co., in New York, on Sept. 19, 2013. Mike Segar/Reuters
If that were to happen, banks that have based their business model on the historically low interest rates enjoyed for the past decade would face an increased risk of failure.

Mismanagement, Rising Interest

“First Republic failure was mismanagement,” Ari Rastegar, CEO of Rastegar Property Company, told The Epoch Times.

“This is about a bank grossly underappreciating interest rates hiking as quickly as they did,” Rastegar said. “Their management was focused almost exclusively around increasing deposits and not properly hedging,” meaning not mitigating against the risk of rate increases such as occurred over the past year.

In an attempt to reverse the rate of inflation, the Federal Reserve Board hiked its prime rate nine times in 12 months beginning in March 2002. The rate rose from 0 to 4.75 percent, reaching its highest level since 2006.

During the intervening years, First Republic was able to thrive by attracting large investors, whose money was held on deposit at very low interest rates offering a source of cheap capital.

When rates rose suddenly, these banks were forced to raise the rates paid to depositors while the loans they had made to borrowers were based on the previous, lower, rates.

“The Fed had to raise rates hard and fast to slow inflation, but that exposed the interest rate risk it created [by keeping rates low for so long]. Many banks are now in a position where their assets are worth less than the banks paid for them,” EJ Antoni, a research fellow at the Center for Data Analysis, told The Epoch Times.

As depositors began to move their funds to institutions paying higher interest, First Republic lost about $100 billion, nearly half of its deposits, according to data from the bank’s first-quarter earnings report.

In March, Silicon Valley Bank and Signature Bank failed amid similar circumstances.

“People sometimes forget they’re in a capitalistic society, and this is the survival of the fittest, not survival of the unfittest,” Rastegar said. “They didn’t do it right. They’re gone.”

No Taxpayer Money

Biden praised the work of bank regulators in orchestrating the sale of First Republic Bank during a White House event on May 1.

“These actions are going to make sure that the banking system is safe and sound,” Biden said. “Critically, taxpayers are not the ones that are on hook.”

President Joe Biden speaks in the Rose Garden at the White House on May 1, 2023. (Madalina Vasiliu/The Epoch Times)
President Joe Biden speaks in the Rose Garden at the White House on May 1, 2023. Madalina Vasiliu/The Epoch Times

Many Americans have a hard time believing that government intervention in the banking crisis does not come out of the taxpayer’s pocket, but it’s true, according to Kravchuk.

“Given popular animosity toward banks, Republicans may press for a deal that limits or prohibits use of ‘taxpayer money’ to ‘bail out’ banks. But there is no clear economic connection between them,” Kravchuk told The Epoch Times.

Funds held by the Federal Reserve are not taxpayer funds, Kravchuck said. This money is created by the Federal Reserve, which has the sole authority to do so. Taxpayer money is held by the U.S. Treasury.

So while many people dislike it when the government steps in to bail out failing banks, it does not do so using tax money.

JPMorgan Chase CEO Jamie Dimon sounded an optimistic note about the banking crisis after his company acquired First Republic.

“This is getting near the end of it, and hopefully this helps stabilize everything,” Dimon told journalists on May 1, according to Bloomberg. “The American banking system is extraordinarily sound.”

A Perfect Storm

While the debt limit standoff did not create the banking crisis, there is a scenario in which the debt impasse could make it worse for banks, economists said.

“The bank crisis may impact the ongoing debt ceiling dispute through either misunderstanding or fear,” Kravchuk said.

Peter C. Earle, an economist at the American Institute for Economic Research, agreed.

“Every headline in which the obstinance of the two sides is confirmed drives U.S. Treasury yields up,“ Earle said. ”That increases the likelihood that the kind of duration gap that felled Silicon Valley Bank, Signature Bank, and mortally wounded First Republic could spread, ensnaring other financial institutions.”

JPMorgan Chase CEO Jamie Dimon testifies before the House Financial Services Committee on Capitol Hill on April 10, 2019. (Mandel Ngan/AFP via Getty Images)
JPMorgan Chase CEO Jamie Dimon testifies before the House Financial Services Committee on Capitol Hill on April 10, 2019. Mandel Ngan/AFP via Getty Images

The effect of rising uncertainty in the markets, plus another interest rate hike by the Federal Reserve Board, could make it very hard for some mid-sized banks, according to Rastegar.

“I think the issue that we’re seeing with First Republic and Silicon Valley is systemic throughout many middle market banks,” he said.

“What’s being projected is that [Federal Reserve] Chairman [Jerome] Powell is going to hike rates by another 25 basis points. And I think without having the debt ceiling issue figured out, it’s kind of hard to understand everything that’s happening with inflation,” Rastegar said.

The failure of First Republic has led to calls for more regulation by some in Washington, rather than debt negotiations.

The president said tighter regulation of regional banks is necessary, and some lawmakers joined that chorus.

“The failure of First Republic Bank shows how deregulation has made the too big to fail problem even worse,” Sen. Elizabeth Warren (D-Mass.) wrote on Twitter. “Congress needs to make major reforms to fix a broken banking system.”

“As one of the few members of Congress to vote against bailing out Wall Street Banks in 2008, I’m glad to see that taxpayers won’t be asked to foot the bill for First Republic Bank’s failure,” Sen. Jon Tester (D-Mont.) said in a statement. “I’ll do everything in my power to hold bank executives accountable for engaging in risky behavior, and I’ll take on anyone in Washington to ensure federal regulators do their jobs.”

The Associated Press contributed to this story.
Lawrence Wilson
Lawrence Wilson
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Lawrence Wilson covers politics for The Epoch Times.
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