"When you see one cockroach, it means there are more": this is how the recent banking problems in the US are explained

Barcelona"If you see one cockroach, there are probably more." With these words, Jamie Dimon, the long-serving CEO of the US banking giant JP Morgan Chase, referred to the bankruptcy of two automotive companies last month, which caused losses at several US banks, including his own. A few weeks later, other regional institutions announced heavy losses due to loans defaulted on by several corporate clients, which sent their stock prices plummeting and raised questions in the press about the health of the US financial system.

The two companies that went bankrupt—almost simultaneously—last month were the automotive parts manufacturer First Brands and Tricolor, a company specializing in providing credit. subprime (to low-income clients and, therefore, at high risk of default) for car purchases. JP Morgan Chase admitted to losing $170 million from the bankruptcy of First Brands alone, a small figure for a multinational with assets valued at $4 trillion and annual revenues of $170 billion, but which nevertheless set off alarm bells among investors and forced Dimon himself to intervene.

Days later, another smaller investment bank, Jefferies, saw its stock price fall 9% when it announced a $750 million exposure (money lent or invested) in First Brands. The stock market declines continued days later due to problems at two regional banks, Zions – from Utah – and Western Alliance – from Arizona – which suffered a drop in their share prices. In the case of Zions, it announced $50 million in losses on two loans, one industrial and one commercial, and will take legal action to recover them. As for Western Alliance, it sued a real estate investment fund to which it had granted a $100 million loan, which it has not yet recovered. The same fund is facing legal disputes for non-payment with three other regional banks that are collectively claiming $270 million.

All of this had a major impact on investor confidence in the robustness of the US financial sector and caused sharp declines in the stock prices of banks, both small and large, in the US and around the world.

High fragmentation

However, the episodes described involve small losses or problems affecting small US entities. Why, then, has the sense of doubt about the financial sector's stability spread? "The US banking sector is very different from the European one," explains Emili Vizuete, an economics professor at the University of Barcelona specializing in the financial sector. The main difference is that, while in Europe the financial industry is dominated by large banks that "do everything," in the US it is "highly segmented," he adds.

In other words, a European bank has divisions that handle all types of businesses. This isn't always the case in the United States, where most institutions specialize in a specific type of business, such as mortgages, consumer credit, student loans, etc. Furthermore, they are heavily regionalized, similar to how savings banks were in Spain before the 2008 financial and real estate crisis.

On paper, this fragmentation has the advantage that if a particular sector experiences problems, it doesn't affect the entire banking industry. That is, if there are problems with consumer spending, at least initially, banks specializing in consumer credit will suffer, but not the rest. The downside is that these are smaller entities with all their eggs in one basket, so if their sector has problems, they can't save themselves by having businesses in other sectors.

To this element, we must add the fears surrounding the so-called shadow bankingShadow banking, and in particular the so-called Non-Depository Financial Institutions (NDFIs, or non-deposit financial institutions), companies that provide specialized loans (often to other companies) but lack a banking license and customer deposits or accounts. In other words, there are companies providing credit without being formally banks, and therefore operating outside of banking regulations and regulators, such as the Federal Reserve (the US central bank).

The size of NDFIs is a concern for investors, especially because it is not as closely monitored by authorities who, since 2008, have significantly increased regulation of credit to US banks to prevent another collapse of the sector like the one that nearly brought down the global economy seventeen years ago. The other question is the level of exposure of the overall financial sector, both in specialized regional banks and in NDFIs.

Situation contained, for the moment

The main source of anxiety is that all these small entities and shadow banks largely finance themselves by turning to "the normal banking system," Vizuete points out, either because conventional banks grant them credit or invest in them. And if not, they find financing through investment funds, which, in turn, have large US banks as shareholders. In other words, if small banks or NDFIs start to suffer because clients aren't repaying their loans, their losses won't just remain confined to their sectors, but will jeopardize, at least in part, the solvency of the country's largest institutions. Another concern is whether the large banks have become too lax again in lending money to these institutions and, at the same time, whether these institutions are also lending to clients (businesses and individuals) who are too risky. "Panic is normal," Vizuete adds, but he also sends a message of calm: the situation the US financial sector has experienced in recent weeks is "not even close" to the magnitude of the crisis of the subprimes of 2008. The exposure is limited, for the moment, to about 1.4 billion dollars, a low figure for the US banking sector as a whole. "It is not a danger right now," concludes the UB professor.

However, with the US economy stalled by political and international uncertainty since Donald Trump's return to the presidency, rising unemployment, and growing fears of a technology bubble surrounding artificial intelligence and cryptocurrencies, Dimon's words were all that was needed to further instill fear in investors. "2010 and there are signs that there may be an excess of credit."