Financial Planning – Successful Wealth Strategies

Why did this happen?

In its simplest form, banks gather deposits from clients (individuals and corporations), and they pay those clients a short-term interest rate. They then invest some of those deposits in fixed income securities, like US Treasuries or mortgage-backed securities. Depending on the duration of their fixed income portfolios, like many investors’ fixed income portfolios, some banks experienced substantial market declines during 2022. With a smaller fixed income portfolio, they have less money to repay their depositors, should they want to withdraw their money. If one depositor wants to withdraw their money, it’s not really a problem. But if enough depositors want to withdraw their money, you have a bank run. In the case of SVB, run risk was higher given the depositor concentration with Venture Capital–backed companies. The intersection of these risk can result in liquidity risk, which is at the core of the issue today.

How did the government act?

The government acted quickly to bolster confidence in the banking system. Key actions over the weekend included:

Protecting depositors – The Treasury pledged to fully protect all Silicon Valley Bank (SVB) and Signature Bank deposits. This will help minimize the impact on SVB’s technology-heavy client base, and it also should help reassure depositors of other banks as well.

Ensuring bank liquidity – Reminiscent of the alphabet soup of acts we saw during the global financial crisis (GFC), the Fed is creating a program to support other banks in a similar situation to SVB. The “Bank Term Funding Program” (BTFP) will offer loans to banks and treat all collateral at 100% of its face value. For example, if a Treasury bond was purchased for $100 and has declined in price to $90, the Fund will treat the bond’s value at $100 for collateral purposes. This temporarily eliminates the fixed income portfolio loss issue discussed earlier. The loans are good for one year, allowing banks to raise additional capital or seek financial partners. Importantly, the Fund is designed to be large enough to protect all uninsured deposits in the wider US banking system.

These actions focus on protecting depositors and the confidence of the banking system; these programs do not protect shareholders or debt holders.

What should I do?

This is not the global financial crisis. Banks are better capitalized, the government has learned a lot of hard lessons on how to handle bank failures, and the root causes of today’s issues are very different. All that being said, we expect some additional fallout from this episode, and we expect some continued market volatility as the ramifications of last week’s events are fully understood.

On the bright side, the Fed can now understand that its rate-hiking cycle has destabilized the financial system. Promoting financial stability is one of the Fed’s core functions, in addition to its dual mandate of price stability and full employment. As such, we expect the Fed to be more cautious in future rate hikes, potentially leading to a more stable rate environment.

In every economic cycle and every market cycle, there are risks, and there are opportunities. Last week reminded us that some risks can spiral out of control if they are not contained. Thankfully, quick action from the Fed, Treasury, and FDIC substantially reduced the risk of a financial crisis. But risks remain, and today’s risks are tomorrow’s opportunities. Perhaps that’s the nature of market cycles. Just as we encourage investors to stay invested through recessions and bear markets, we encourage investors to remain disciplined in their long-term investment plans.

Important Information

This is for informational purposes only, is not a solicitation, and should not be considered investment, legal or tax advice. The information in this report has been drawn from sources believed to be reliable, but its accuracy is not guaranteed, and is subject to change. Investors seeking more information should contact their financial advisor. Financial advisors may seek more information by contacting AssetMark at 800-664-5345.

Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results.Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss. Actual client results will vary based on investment selection, timing, market conditions, and tax situation. It is not possible to invest directly in an index. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Index performance assumes the reinvestment of dividends.

Investments in equities, bonds, options, and other securities, whether held individually or through mutual funds and exchange traded funds, can decline significantly in response to adverse market conditions, company-specific events, changes in exchange rates, and domestic, international, economic, and political developments.

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AssetMark, Inc.

1655 Grant Street10thFloorConcord, CA 94520-2445800-664-5345

What is The Debt Ceiling?

On January 19, the US government reached its legal $31.4 trillion (T) debt limit1. The debt ceiling is about paying the bill on purchases already made, just like paying your credit card bill. The difference, however, is when individuals reach their credit limit, they can no longer make new purchases on that credit card. In the case of Congress, when it reaches the debt ceiling or its credit limit, it can continue to spend. That is because Congress is not bound by the debt ceiling; instead, the Treasury department, which is responsible for the financing of or paying the government’s bills, is bound by the debt ceiling. In short, the debt ceiling is often confused as a vehicle to control future spending, which it is not. Instead, it’s simply the way to pay our past-due bills.

History of US debt

The US has carried debt since its inception. The US national debt has increased from $908B in 1980 to nearly $31T in 20222. Notable recent events triggering large spikes in the debt include the Afghanistan and Iraq Wars, the 2008 Great Recession, the 2017 Tax Cuts, and the COVID-19 pandemic.

The debt ceiling was put in place in 1917, allowing the government to issue bonds to finance participation in the First World War. Since WWII, the ceiling has been raised or suspended 102 times3. This has happened across both Republican and Democratic control of Congress, as the national debt has continued to rise as spending has exceeded revenues. Importantly, the US has never defaulted on its debt, thus retaining its stature within the global financial system.

While the US has never defaulted on its debts, it did have a close call in 2011, when Congress increased the ceiling just two days before the Treasury would run out of the means to pay bills owed. Days later, the rating agency Standard & Poor’s downgraded the US credit rating to AA+4 (from AAA), just like a knock on one’s credit score after missing to pay one’s bills.

The result of the downgrade on the US dollar and stock markets was swift but short-lived. The dollar sold off, and stocks (S&P 500 Index) fell 6% on the day of the announcement5. However, a year later, the S&P 500 gained 20%6. Within the bond market, we saw a strong rally in Treasuries, which led bonds higher. This rally in bonds, while counterintuitive, was likely caused by simultaneous fears of a European sovereign debt crisis, which led investors to still lean on the US Treasury market despite the downgrade.

How Much Debt is Too Much?

Undoubtedly, $31T in debt is a shockingly large number. Naturally, the question many investors have is how much debt is too much. Is there a tipping point at which it becomes a big problem for a country? The answer to that question requires understanding debt relative to the economy, as well as the interest cost on the debt.

While the debt has grown, so has the economy as measured by gross domestic product (GDP). US GDP has grown from $2.7T in 1980 to $26.1T in 2022, and the US remains the largest global economy7. Comparing a country’s debt to its GDP is considered a better indicator of a country’s fiscal situation than just the national debt number because it shows the burden of debt relative to the country’s total economic output and, therefore, its ability to repay it. The US debt-to-GDP ratio surpassed 100% in 2013 when both debt and GDP were approximately $16.7T, and it now stands at 124% as of 20228. For comparison, Japan’s debt-to-GDP ratio has been over 200% since 20139. Clearly, countries don’t strive to have a greater than 100% debt-to-GDP ratio. However, if the economy can continue to grow, its large debt alone doesn’t mean imminent doom.

Second, looking at the interest we pay on debt today shows that despite rising interest rates, the interest cost remains below the mid-1980s and 1990s when the total debt was smaller than today10. In other words, the US can still afford to pay its debts even though interest rates and the amount of debt have risen.

What’s Next?

Now that the debt ceiling limit has been reached, the Treasury will run down its cash balance and use “extraordinary measures” to keep paying the bills. It is estimated that the Treasury has enough funds to keep the US from defaulting until June 202311, but there is a lot of uncertainty around that date.

Congress is in charge of suspending or raising the debt limit, and a full-throttle drama will likely ensue as political parties demand concessions as they try to negotiate a deal. If Congress does not suspend or raise the debt ceiling before it reaches a critical point, it would raise the risk of a hit to the economy, similar to 2011, as well as the risk of default. That said, given the 102 times since WWII when policymakers have reached a consensus, we hope history is a guidepost that we will avoid a worst-case scenario of default, and any potential damage could be short-lived.

1 https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debt-limit

2 https://fiscaldata.treasury.gov/datasets/historical-debt-outstanding/historical-debt-outstanding

3 https://privatebank.jpmorgan.com/gl/en/insights/investing/tmt/debt-ceiling-drama-what-you-need-to-know

4 https://www.atlantafed.org/cenfis/publications/notesfromthevault/1108

5 FactSet

6 FactSet

7 https://fred.stlouisfed.org/series/GDP

8 https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/

9 https://www.fitchratings.com/research/sovereigns/japan-debt-trajectory-at-risk-as-possibility-of-tightening-rises-18-01-2023

10 https://fred.stlouisfed.org/series/FYOIGDA188S

11 https://privatebank.jpmorgan.com/gl/en/insights/investing/tmt/debt-ceiling-drama-what-you-need-to-know

Important Information

AssetMark, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission.

AssetMark, Inc.

1655 Grant Street10thFloorConcord, CA 94520-2445800-664-5345

Category: Financial Planning

Banking Crisis Averted, But Risks Remain

Dooming Debt or Déjà Vu?