The Four Big Banks

Since the Great Financial Crisis, when regulators were forced to consolidate the banking industry to save the financial system, four large commercial banks emerged as key to holding the financial system together. Two of those large commercial banks, Bank of America and JPMorgan Chase, are drowning in cash from repeated government stimulus programs.

The commercial banking system is so overwhelmed with cash that the large commercial banks engage in zero-percent interest overnight loans with the Federal Reserve, referred to as Overnight Reverse Repurchase Agreements, where the Fed is loaning hundreds of billions of Treasury securities for cash in hopes to alleviate the pressure from all this cash on a nightly basis.

The financial system is facing the exact opposite problem it faced leading into the Great Financial Crisis. In the years leading up to the Great Financial Crisis, a global dollar shortage manifested itself in the banking system which exploded when variable-rate mortgage loans reset higher after the Fed engaged in a prolonged period of tightening financial conditions by raising the Federal Funds Rate.

Without enough money to pay on all the debts, consumers began skipping payments on their mortgages which fueled the largest financial crisis since the Great Depression. Today, we have a similar dollar shortage but due to the pandemic, the banking system is now drowning in a flood of customer cash since only twenty-five percent of stimulus checks are spent.

It seems rather impossible there could be another financial crisis since the banks are not only flooded with deposits, but the Fed has forced the banks to create trillions of dollars of excess reserves through its Quantitative Easing program. Yet, each night, commercial banks are borrowing over four hundred billion of Treasury securities from the Fed since they have too much money on deposit and a lack of pristine collateral to back it with.

The nightly Reverse Repurchase Agreements signal there is a lack of pristine collateral or Treasury securities for the banks to back their deposits with. The Treasury, led by former Fed-Chair Janet Yellen, has chosen not to issue more of the Treasury securities the banks want and instead let the Fed deal with the problem.

Upon closer examination, two of the banks are receiving most of the stimulus checks as deposits and are facing further regulatory penalties as a result of their burgeoning balance sheets. Citibank is not a large player in the retail banking space and has not received very much stimulus money. Wells Fargo is limited in how much it can grow its balance sheet since Yellen, during her tenure as the Fed Chair, applied an asset growth ban on Wells Fargo.

Most of the government stimulus is being deposited at Bank of America and JPMorgan Chase. As their balance sheets grow, the existing banking regulations punish them with additional surcharges and limitations.

To make matters worse, with money being concentrated within two banks, Bank of America and JPMorgan Chase are also the recipients of a large amount of Reserve Assets created by Quantitative Easing. The other two banks lack the balance sheet capacity to absorb all the bank reserves being created by the Fed each month which puts the burden on Bank of America and JPMorgan Chase.

One of the problems with Quantitative Easing is the bank reserves that are created by the Fed and in turn, are swapped with the large commercial banks who are creating bank reserves from customer cash, which are those Fed-created bank reserves, cannot leave the financial system. With Wells Fargo being unable to expand its balance sheet and Citibank not being a big player in the consumer space, money is trapped between Bank of America and JPMorgan Chase.

It seems rather odd there could be another financial crisis but with most of the money trapped between two banks, those who are short dollars may be unable to access them as government stimulus and assistance expires. While it seems impossible, it is entirely possible to have another financial crisis due to how Quantitative Easing traps money in the financial system.

It is unknown when the Fed will release Wells Fargo from its asset ban limitations but there will be growing pressure to do so. According to banking expert Zoltan Pozsar of Credit Suisse, Wells Fargo has the immediate balance sheet capacity to purchase up to $500 billion in Treasury securities to relieve pressure from Bank of America and JPMorgan Chase.

By freeing Wells Fargo from their asset ban, the Fed would immediately create a new buyer for Treasury securities which would put a massive amount of downward pressure on Treasury yields. So far the Fed has been quiet about Wells Fargo and the surge in overnight demand in reverse repurchase agreements.

With the next Federal Open Market Committee meeting in less than two weeks, all eyes will once again be on the Fed. As strange as it sounds, another financial crisis could be building in the financial system due to too much cash being able to get into the hands of those who need it and another global dollar shortage from the Fed’s last tightening cycle.