Some bank failure takeaways for feds worried about their own investments

Bank stocks might look like dicey propositions these days. There's nothing to focus investors' minds like the possibility of a run on the banks. It's not 2008 t...

Bank stocks might look like dicey propositions these days. There’s nothing to focus investors’ minds like the possibility of a run on the banks. It’s not 2008 though, and we probably won’t see the failure of hundreds of banks like we did back then. For more on the state of money and investments, big and small, the Federal Drive with Tom Temin  spoke with Certified Investment Planner Art Stein.

Interview transcript:

Tom Temin Art, actually, before we get to the whole banking question and what investors should be worried about right now, which seems to be about everything. I wanted to ask you, here we are with a quarter of the calendar 2023 behind us. Maybe review some of the returns in the TSP funds and the markets generally so far.

Art Stein Yeah, well, the returns have been very good so far this year and year to date, which means from the beginning of the year through yesterday, all the funds are up. The G fund’s up 0.8%, F fund’s up 2%. C fund a little less than 4%, S fund 2%, I fund 3%. And the L Income fund is up 1.5%. So it’s been a very good year. Now since this problem happened with the Silicon Valley Bank, which really was March 9th and 10th. Then we see that the stock funds are actually down. But taking that into account since the beginning of the year, the stock funds are still up and had a good quarter. So what’s an investor going to do? To begin with, they need to look at what do they actually have at risk? And of course, government employees and retirees have this great set of guarantees that no one else has, and they really don’t need to worry as much. I mean, if you’re a federal employee, it’s not like you work in the private sector, like we’ve been reading how even major companies like Amazon and Google, etc., have been laying off thousands of employees. Well, the government doesn’t work that way. And actually, if you have a bank run, there are a lot of government people that will be working much harder. Federal retirees, again, are in a much better situation. They have a federal annuity that’s guaranteed. That’s their pension. And FERS retirees also have Social Security, which is actually guaranteed. Both of those have cost of living adjustments. They’ve got their health insurance. So they should be in a much more secure situation. Now in terms of their actual investments, for the C and the S fund, which are the stock funds, how much do they own of the banks that have been affected so far? So of the banks that have been affected so far, The Silicon Valley Bank was in the S fund, as was First Republic, I guess, at the end of 2022. But I think that they were switched to the S&P 500 index, not by the TSP, but by the people that run these indexes. It’s not a TSP decision; they’re just using indexes and those investments are managed by BlackRock and some other companies. So there’s no immediate concern. Now if we had massive bank runs in the United States, that’s obviously going to kill the stock market and I’m not quite sure what it’s going to do to the bond market because there might be a flight to safety and bonds might look good to a lot of investors. But I don’t see that happening because, one, Silicon Valley bank was a really unusual situation. They clearly didn’t manage their investments very well and it didn’t match up with their liabilities. There are a few other problems, but even they could have survived if there hadn’t been what we call a bank run. And a bank run is when people just start pulling their money out of the bank, even though they may not have to. Silicon Valley Bank, such a large percentage of their deposits were not insured. And that’s not true of most other banks. I’ve read that as much as 90% of the value of the deposits in Silicon Valley Bank were not insured because they were over the FDIC limit; in a typical bank that’s closer to 20 or 30%.

Tom Temin We’re speaking with certified financial planner Art Stein. So the question is, getting back to say some of the TSP funds that might have had these in them as part of the index funds, if they are such a small percentage of these index funds, what’s the mechanism by which something occurring at Silicon Valley Bank and a couple of the others — European banks — affect the stock market so much?

Art Stein Well, because, one, they are part of the stock market. And clearly their stock values have gone down. So to the extent that those bank stocks are held by the C and the S fund, there’s one effect. But also, these type of bank failures are seen as bad for the economy. So people tend to sell stocks when they happen, and that affects the entire stock market.

Tom Temin And do you sense that there’s maybe a almost an underlying anxiety these days because people are looking at Social Security, seeing the Congress’s refusal to even consider anything substantive to try to extend the solvency of that fund, of Social Security. And the same thing is true of Medicare, really, for that matter, it’s also unsustainable. And if you look at the trends in health care spending by the federal government, and then you look at interest rates and then we hear all these warnings about how much of the federal budget will have to be devoted to paying the service on the national debt. And you add that all up, it’s almost like the couple of bank failures are the straw that’s breaking the camel’s back in a lot of people’s minds.

Art Stein I think it’s way too soon to talk about breaking the camel’s back. And remember, with Medicare and Social Security, the government can just print the money to pay the bills and everybody expects that. I expect that. I don’t think any senator or congressman is really going to let those programs go bankrupt. They’re not going to want to be around if they were part of voting against the money needed to continue those payments. I mean, there are just way too many people dependent upon that. But if the government is just printing more and more money to pay those and they haven’t made any other reforms, you expect that to be inflationary. And we’ve seen inflation go up a lot. And then the question you would want to ask is, well, if we expect inflation to remain high because of the deficits in the Social Security trust fund and the Medicare trust fund and things like that, how does that affect our investment strategy for long term and short term investors? And high inflation reduces the purchasing power of the bond funds, F and G. And long term, you would expect it to increase the value of stocks because companies can charge more. And historically, when inflation is hit, long term stock prices and dividends have adjusted.

Tom Temin Right. So you’ve got the situation then. I guess what I meant when I said the straw breaking the camel’s back, I meant from an investor flight or sell standpoint, not from the government going to collapse. But people see the trends and they see the size of the debt relative to GDP. And it’s going to be bigger than GDP in a short while. I think at some point that dawns on people that, yes, it can print money, but it’s not what we want the nation to be doing in perpetuity is printing money at the levels it has been for, say, the past five years.

Art Stein Tom, I think that individual investors, what they need to do is to have clear and appropriate investment goals, to have a suitable allocation between the stock and the bond funds and for their outside investments, between stock investments and bond investments. And then they just need to maintain perspective and a long term view and long term discipline. And that to me, as an investment manager, means when stock prices go way down, we buy more. And if bond prices go way down, we buy more bond funds. You want to be a little countercyclical. And historically, that would have given you a much higher rate of return. And for anybody trying to understand these things and then to invest accordingly, it’s very important to understand the difference between stocks and bonds and how that affects your investments. But if you really want to get into it, then you need to understand things that only really sophisticated bond traders do. I think that people should look at the historic returns. And really what that means historically is that stock funds over long periods of time outperformed the bond funds by a significant amount, and that difference was high enough to make putting up with some greater volatility of the stock funds worthwhile because they tended to have a much higher rate of return. Not every year, maybe not every five years, and in a few cases, not even every ten years. But the bond funds very unlikely to maintain purchasing power after we take into account taxes and inflation. So if you’re putting your long term money in something that’s losing purchasing power, that’s a problem.

Tom Temin So now is not the time to lose your nerve.

Art Stein Well, I don’t think it’s ever a time to lose your nerve, but I would say have an appropriate investment goal. If you’re retired and you need money in the short term from your investments, it should be invested in bank accounts and short term bond funds. For the money that you’re going to need in 10, 20 and 30 years, you need to have that heavily weighted towards the stock funds.

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