MICHAEL BURRY’S ONE BANK CHART SAYS IT ALL

Michael Burry is famous for being one of the earliest investors to recognize the subprime crisis in 2008.

Burry was characterized in the Michael Lewis book, The Big Short. In 2005 he was one of the first to recognize how bad mortgage loans were.

Burry’s tenacious inquiry and ability to navigate the financial backwaters make him a must listen to.  When Burry starts tweeting about a crisis, it is worth paying attention.

What is Burry saying about the current mess we find ourselves in?

He seems remarkably hopeful.

Source: Twitter

While Burry hardly ever does interviews, he does use Twitter. Though he deletes his tweets regularly, others have taken it on themselves to screen capture his tweets before he removes them.

In the last week, Burry has tweeted that he doesn’t think the current crisis will take down the system.

While not yet calling the “all clear”, he believes the Federal Reserve took important actions last week and that the crisis should eventually resolve.

Maybe most important, Burry has given us a roadmap of what to focus on as this all plays out.

TAKING A STAND

On Monday, shortly after Silicon Valley Bank (SIVB – NASDAQ) and Signature Bank (SBNY – NASDAQ) were taken over by the FDIC, Burry made his thoughts known by saying he expected the crisis could “resolve very quickly”.

Two days later, he expanded on that thought. He described the path forward by referencing the 1907 Panic:

Source: Twitter

WHAT WAS THE OCTOBER 1907 PANIC?

The 1907 panic that Burry referenced is an example of a classic bank run.

The essence of any bank run is a loss of trust. A loss of confidence.

Banks are, at all times, playing a confidence game.  If the public has confidence in the institution, everything is fine. But if confidence is lost, the bank has no leg to stand on.

In 1907 it was the fault of bank directors who were up to financial shenanigans (in particular, a corner of the copper company United Copper) that lit the fuse.

When the corner failed, the banks and brokers involved failed.

But it didn’t stop there.

The bank directors involved in the corner were ousted from their director positions at other banks. While this may have seemed prudent, it had the opposite effect.  The public began to question those institutions as well!

Back then, deposits began to flee from one very large bank called the Knickerbocker Trust company.

When those fleeing deposits were suspended, the rout was on. Depositors of other banks fled on the worry their bank might eventually do the same!

It is not impossible that the whole system might have gone down, had it not been for J.P Morgan.

The man that is, not the bank.

Morgan stepped in, along with his bank of the same name, and cajoled other bankers to do the same. They pledged loans to the banks under fire and stopped the run dead in its track.

Morgan was such an imposing, larger than life figure that his intervention restored the confidence that had been lost. As Edwin Lefevre, a financial writer at the time, put it:

There was not needed a financial genius, an adroit banker, a great capitalist! What the occasion called for was a man — a human being who could command the respect and the confidence of the public that had grown distrustful, so that it might heed wise counsel; a man also whose bidding all bankers and financiers and captains of industry would do; in brief, that rarest of creatures, a man who could rise above self-interest.

ESCALATION VERSUS AFTER SHOCKS

Comparing 1907 to today is a good one – especially now, a week later.

On Thursday a consortium of banks got together and agreed to deposit $30 billion into First Republic Bank (FRC – NASDAQ).

This is almost eerily reminiscent of what Morgan did a hundred plus years before (again JP Morgan (JPM – NYSE), this time the bank, was a leader in the consortium!).

The question that all investors are asking themselves now is – is it enough?

For shareholders of First Republic, the answer might be no. The bank announced Friday that they were looking to raise capital. BIG dilution seems inevitable.

But for the banking system as a whole?  Well, let’s go back to Burry’s tweet.

You will note that Burry did not say that J.P Morgan stepped in and everything recovered immediately. It took 3 weeks for the Panic of 1907 to resolve.

What we are seeing this weekend – with First Republic and the black hole that is Credit Suisse (CS – NYSE) – are not necessarily signs of spreading contagion. They are more likely aftershocks.

Every earthquake comes with a series of tremors after the big event. Each tremor is less than the BIG ONE, and less then the one before.

Eventually the tremors diminish to the point that they are not even noticeable.

First Republic, which seems unlikely to go into receivership by the FDIC, feels more like an aftershock than another domino.

In a Thursday night press release First Republic said that “daily deposit outflows have slowed considerably” this week. This from the bank at the center of it all.

There has also been plenty of buying among smaller regional bank executives. These insiders are looking at stock prices that have dropped by 20-40% in some cases while their businesses have likely changed very little. Not a sign they are worried about their own deposits.

CONTAGION?

But I suspect that even Burry does not know for sure how this will end. The essence of a bank run is lack of confidence and confidence is fickle. It can change quickly.

With that in mind, Burry gave us one more nugget. A chart to let us know what to look for. A road map of sorts:

Source: Twitter

What this chart is showing are the two elements that are putting banks at risk.

1. Concentrated depositors
2. Unrealized losses

It is no surprise that Silicon Valley Bank was the first to go. See how far out they are in the above chart–up and to the right? That’s not a good thing in this chart. They were a HUGE, HUGE outlier in both respects.

Signature Bank had the cardinal sin of a VERY concentrated deposit base. They also had a crypto business which was more prone to capital flight and less likely to be looked favorably on by regulators.

First Republic was next in line (again no surprise).  But as you can see First Republic is not anywhere near as shaky as the first two.

Once you get past First Republic there is a wide swath of large regional and money-center banks with very similar risk profiles.

WHEN DO WE CALL HOUSTON?

If these banks start to shake – Comerica (CMA -NYSE), Wells Fargo (WF – NYSE) and the like – well then Houston, we do have a problem.

Right now, that seems unlikely. There is no where near as much risk with these banks as the one’s that have failed so far.

Still, it is a time to be vigilant. However unlikely, the one worry is a big one: so many banks are in the same boat.

Most of the time confidence in the banking system can be restored by banks simply selling a few assets and showing they are money good on redemptions. They can nip the problem in the bud.

But today if banks did have to sell assets, they wouldn’t necessarily be able to meet all their obligations.

The Wall Street Journal pointed out this weekend that 187 banks are in a similar position to Silicon Valley Bank.

Christopher Whalen, a very excellent independent banking analyst that runs a service called The Institutional Risk Analyst, pointed out that Bank of America (BAC – NYSE) and JP Morgan are in a not too different boat.

If you include all their mark to market losses – meaning both losses on loans and securities (with Silicon Valley Bank the focus was just on their securities portfolio) – both banks are technically in a negative capital position.

In other words, if they really did have to liquidate in a flash, they would be insolvent.

As are many others.

TECHNICALLY IS NOT REALITY

Yet Burry is not telling his Twitter fans that the next 2008 is upon on. Why?

Again, confidence.

The chance that deposits will flee either of these banks, or any of the other smaller regional banks that are next in line on above chart, seems remotely small at this point.

There is no evidence of deposits flight spreading. Anecdotal reports have been clear: the vast majority of banks are not experiencing deposit outflows.

The Federal Reserve and FDIC moves last weekend restored confidence. Remember that the bank next on the chopping block, First Republic, actually said it saw outflows slow as the week went on.

The crisis is not snowballing. It seems to be abating.

The thing to keep an eye on is what might trigger an escalation.

I don’t have the slightest clue of what that might be.  A recession leading to loan losses? An uptick in inflation and concurrent rise in rates? Other underbellies of the financial system that we probably did not even know exists blowing up?

But I do know are a couple of things:

1. The system is more vulnerable than usual.
2. If the problem did escalate, it would be escalating to the herd.

The underlying problem remains. Nearly all banks have significant unrealized losses on their balance sheet. Many are in a position where if those losses were forced to be realized, they would be underwater.

Which would be a problem.

But only if confidence is lost.