Mar 20, 2023
Bank Crisis Survivors Remember How Fast the Dominoes Can Fall
(Bloomberg) -- Steve Chiavarone doesn’t want to scare anyone, but what he remembers most from the last banking crisis was how sure most people were that it wouldn’t happen.
At his New York office in early 2008, Wall Street’s best and brightest — “strategist after strategist after strategist after strategist,” recalls Chiavarone, now senior portfolio manager at Federated Hermes — paraded through to say that even if a recession hit, it’d be shallow and short.
That’s not, of course, how things played out. A few months later, “you’d go to your office every day and something that you never thought would happen would happen,” he said.
All sorts of crises have been predicted by financial Cassandras in the aftermath of 2008. In reality, they’re exceedingly rare in markets. And yet, with three US banks down, a fourth teetering and the government-brokered acquisition of a fifth — and much larger — institution in Europe, the comparisons to that episode have become a little harder to ignore.
Not that this episode will match the magnitude of that one. While odds of a recession are way up, authorities are better equipped today to deal with stress in the financial system, and the largest banks are stronger than they were then.
Reasons for Wariness
But for the current class of investing professionals who seem largely unperturbed by recent events — desensitized perhaps by the years of false warnings — there are important messages to be gleaned from the first-hand accounts of veterans, like Chiavarone, of that crisis. His biggest: Things can unfold in ways that seemed inconceivable just weeks earlier. “It’s one of the reasons I’ve been as cautious as I have,” he said.
And given the pace at which events are unfolding, and how there are new potential problem areas that didn’t exist back then — high inflation, for instance, and the boom in the opaque world of private credit — telling the difference between investor courage and complacency has become a more urgent matter.
“The equity market has largely treated the recent events as a surgical strike on a specific cohort of stocks,” Goldman Sachs Group Inc.’s head of hedge fund coverage Tony Pasquariello wrote in a trading note Thursday. “I find that a bit remarkable.”
On Sunday, UBS Group AG agreed to buy Credit Suisse Group AG for $3.2 billion in a government-brokered deal aimed at containing a crisis of confidence. The Swiss National Bank has agreed to offer a liquidity line of 100 billion francs ($108 billion) to UBS as part of the deal, while the government is granting a 9 billion-franc guarantee for potential losses from assets UBS is taking over.
In markets, bets on crisis that have been busting bears for years are in scant evidence today. The Nasdaq 100 just had its best week since November, credit spreads are about a third of their level in 2008 and the dollar is falling. And while Treasury volatility is the highest since 2008, crushing quants and other big managers, it wasn’t enough to keep hedge funds from snapping up single stocks last week at the fastest pace since January 2021, according to a trading note from Morgan Stanley.
That’s all consistent with a belief stress in finance will be contained. Unnervingly, it’s not totally inconsistent with the outlook that prevailed before 2008’s storm, which ended up knocking American stocks down by more than half. One of the signature properties of bank stress is the speed with which dominoes fall when faith breaks, said Adam Crisafulli, the founder of Vital Knowledge in New York.
Built on Confidence
“You want banks to be as boring, as stodgy as possible,” said Crisafulli, who was working at Bear Stearns when it had to be bailed out by JPMorgan Chase & Co. in 2008. “The entire business model is predicated on confidence. So even if you are very, very comfortable with the financials, if the market has lost confidence in a financial institution, it’s very difficult for a financial institution to rebut or refute that loss of confidence.”
Francesco Filia, chief investment officer at Fasanara Capital in London, was working in cross-asset derivatives at Merrill Lynch when it was sold in a bailout months after the Bear Stearns collapse. When the 2008 catastrophe broke out, he says, its full dimension was hard to see.
“From the inside, you don’t capture the full scale of the crisis,” Filia said. “You’re always too far from the decision power. We were looking at our own CDS widening and wondering what might have happened, but not knowing what was being discussed in terms of rescue packages.”
A difference between 2008 and now is inflation, which threatens to complicate the Federal Reserve’s response should things mushroom. While bond traders wasted little time pricing out future interest rate hikes in the aftermath of Silicon Valley Bank’s collapse, consumer costs continue to rise at more than twice the pace central banks have targeted. For investors, there’s a no-win aspect to it all — either inflation remains high or is finally arrested by a recession spurred by stressed-out banks reining in credit.
“There’s never just one issue,” said Steve Sosnick, chief strategist at Interactive Brokers, who was helping co-manage Timber Hill’s $3 billion to $4 billion market-making book in 2008. Back then, “every time you thought it was going to get better, it didn’t. Every time you think it’s all done, something else is hiding out. It was inevitable that hiking rates now would break something, just as it was inevitable then that hiking rates and cracking down on crappy mortgages would break something.”
Even though there are big differences between now and then, among them more experienced governments, 2008 was so traumatizing that you can’t blame people who lived through it for worrying history will repeat, said Quincy Krosby, LPL Financial’s chief global strategist.
“Granted it’s not the same and the backdrop is different, but the one lesson that stays with you is that there will be pockets of calm — but you are leery of weaknesses in the system,” said Krosby, who was an investment strategist at an insurance company in 2008. “When there is a problem in the system the tentacles tend to be far and wide.”
Kris Sidial is a professional short, running tail-risk strategies for hedge fund Ambrus Group, so it’s no surprise he’s pessimistic. He plans to hold on to bearish bank options that he has already ridden to a 40-fold profit over the last month.
“When the Credit Suisse thing popped up, it was a sign that there’s another body,” he said in a telephone interview Saturday. “It’s very binary. There’s really no in-between situation here where this drags out,” he said. “This is either going to get fixed — there’s going to be government intervention and this gets fixed — or it’s going to be a nightmare.”
Sidial said he’s already worrying about finding prime brokers who won’t collapse in unison should contagion spread. “Forget US equity markets, the whole world is connected to the banking system. If that hits, everything’s going with it. You can destroy tech, you can destroy everything else, but banking is the one thing where if that goes down, there’s massive repercussions.”
At the same time, upheaval often leads to opportunity in the market, says Paul Nolte, a senior wealth manager at Murphy & Sylvest Wealth Management, who was an adviser at a boutique investment firm in 2008.
“We’ve seen this play out more than a few times. When the Fed panics, that’s usually a pretty good time for investors to start nibbling in the financial markets. This past week was a perfect example,” he said. His firm has been adding to its position in Comerica Inc., a regional bank, and adding exposure to broad benchmarks like the S&P 500 and Nasdaq Composite.
Rich Steinberg, chief market strategist at Colony Group, survived 2008 even after Lehman Brothers went bankrupt on his birthday, which left him “under my desk sucking my thumb.” His wife walked in with a job application for a bakery noting: “You’re up early, you could always go and like make bread before you come into the office.” The application is still on his desk.
There’s a lesson in his survival. “Don’t confuse a great brand with not having risk. The second thing is don’t panic in great franchises.” Also: “Try not to outsmart the market when you really see names under a lot of pricing pressure. The psychodynamics in these really turbulent times can really bring valuations and or pricing swings way greater than you think.”
These days, “I walk down the hall to the other portfolio managers and I’m just looking for validation,” Steinberg said. “I’m pretty panicked about having even a 5% exposure to the financials. What do you think? And everybody collectively said just hold tight. Like, don’t make the mistake of blowing out.”
In 2008, banks were more leveraged while regulators had much less experience dealing with systemic stress, said Arthur Tetyevsky, a financials strategist at Seaport Global Holdings who worked in a similar role but at HSBC Holdings Plc during the financial crisis. At the same time, because the market is now dominated by passive funds, it’s not as easy to get out of big positions.
“The most important lesson that was learned back then is that a problem requires a quick response. You know, backing of the regulators, backing up of supervisors,” he said. “I’m seeing a response rate that’s much, much quicker today compared to 2008.”
How inflation affects that response remains a wild card. “You had a very benign inflationary environment back in 2008,” said Crisafulli of Vital Knowledge. “And that essentially meant that central banks were only limited by their imagination. That’s now obviously not the case.”
--With assistance from Emily Graffeo, Lu Wang and Denitsa Tsekova.
(Adds Krosby memories of 2008)
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