Warren Buffett's Warning for the Banking Crisis and 2023 Recession

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Charlie, last Saturday, Warren Buffett and Charlie Munger sat down for over six hours to answer an enormous range of questions from Berkshire Hathaway shareholders. But from listening to Buffett speak live, one topic that dominated the room was the current U.S. bank crisis, as well as what it's leading to in regard to the U.S. economy.

On the topic of Silicon Valley Bank, Buffett said there would have been catastrophic consequences if U.S. regulators had not insured all deposits, as the failure of this bank alone risked sparking bank runs across the U.S. If Silicon Valley Bank's deposits had not been fully covered, what do you think the economic consequences would have been to the nation? Well, I'd be just as simply say it would have been catastrophic, and that's why they were covered. Even though the FDIC limit is two hundred and fifty thousand dollars, that's the way the statute reads. But that is not the way the U.S. is going to behave, any more than they're going to let the debt ceiling cause the world to go into turmoil.

Buffett's comments followed the collapse of not just Silicon Valley Bank, but also Signature Bank, First Republic, Silvergate, and Credit Suisse internationally. Again, it sparked debate over just how much the Federal Reserve should assist above and beyond the pre-existing 250,000-dollar federal insurance on bank deposits. Earlier this year, the FDIC, the Treasury, and the Federal Reserve bypassed this limit by announcing a systemic risk exemption for both Silicon Valley Bank and Signature, announcing that all deposits would be covered.

It was an unprecedented move but has drawn criticism due to the increased risk of moral hazard at the banks. But others argue that this move from the government was absolutely necessary, as it reassures the country that their bank deposits will be safe, thus reducing the risk of further bank runs. This message to the American public is the main reason Buffett saw this move as inevitable and necessary.

I can't imagine anybody—the administration, the Congress, and the Federal Reserve, whatever it may have been, FDIC—I can't imagine anybody saying, "Uh, I'd like to be the one. I'm on television tomorrow and explain to the American public why we're keeping only 250,000 insured, and we're going to start around every bank in the country and disrupt the world financial system." So, I think it was inevitable.

But what's been interesting is that despite the U.S. Treasury and the Federal Reserve stepping up and taking drastic action to protect the banking system, the concern hasn't really abated. It's still making headlines, it's still being discussed, it's still got a lot of people on edge. So, with it now being May, I think a fair question to ask is: what is on the banking industry?

The situation in banking is very similar to what it's always been. Banking—that fear is contagious, always. Historically, sometimes the fear was justified and sometimes it wasn't. My dad lost his job in 1931 because of a bank run. It used to be that if you saw people lining up at a bank, the proper response was to get into the line. Without them knowing it at the time, this actually helped give the system a little bit of buffer time.

Having to physically wait in line for money to be distributed bought bankers time to try and calm the situation and potentially figure out a solution. But that was then, and it certainly isn't like that anymore. People think deposits are sticky anymore; they're just living in a different era. You know, you press a button. You don't have to get in a line and wait for days and have the teller counting out the money slowly in gold.

So, I think the line goes away. You can have a run in a few seconds, and that's exactly what we started to see happen at the banks that failed. Silicon Valley Bank had total deposits of 173 billion and saw over 40 billion dollars withdrawn in just one day. These days, bank runs can be shorter and sharper, and this actually increases the risk of a single bank run turning into a fast-moving panic-driven crisis.

And this is where the FDIC is so important—an insurance company funded by all the banks to ensure the first 250,000 dollars worth of citizens' deposits so that if bank run mentality starts sweeping through the system, it won't turn into a panic. People will know that in most cases, their money is perfectly safe. If you have people that are worried about whether the money is safe in the bank, an all-time would rise. You can't run an economy very well.

So the FDIC was very large; it's got changed over the years somewhat, but here we are in 2023, and we see the FDIC pay off for the 100 cents on the dollar to everybody or make it available on all demand deposits. Yet, you still have people very worried, and that just shouldn't happen. It shouldn't happen, but it has. The FDIC is working as per normal. The treasury and the Fed have stepped in and completely backed up the banks, but people around America are still feeling very worried about the stability of their financial system.

And stay with me after I thank our Berkshire trip sponsor, Seeking Alpha, because Buffett is very quick to call out exactly who he thinks is responsible for this mess. Hamish and Brandon's Berkshire Bonanza 2023 is brought to you by Seeking Alpha. Try Seeking Alpha for premium today to access Seeking Alpha's rating system, valuation breakdowns, 10 years of financial data, unlimited news, and analysis articles. Plus, have earnings call transcripts, investor presentations, SEC filings, and press releases all in one place.

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The messaging has been very poor. It's been poor by the politicians, who sometimes have an interest in having it poor. It's been poor by the agencies, and I'd say it's been poor by the press. I mean, you shouldn't have so many people that misunderstand the fact that although there may be a debt ceiling, it's going to get changed. Although there's a 250,000-dollar limit on FDIC, the FDIC and the U.S. government and the American public have no interest in having a bank fail and having deposits actually lost by people.

So, Buffett is quick to lay the blame on bad acting politicians as well as the media for essentially fear-mongering, which ultimately has blown the situation up into something that it really should never have been. But as Warren says, that's the world we live in. It means that a lighter match can turn into a conflagration, or it can be blown out. And, uh, who knows what will happen? We don't have any worry; we keep our money in cash and treasury bills at Berkshire because we keep 128 billion or whatever it was at the end of the quarter, and we want to be there if the banking system temporarily even gets stalled in some way. It shouldn't; I don't think it will, but I think it could.

But even though the media and fear-mongering politicians have escalated the panic around the banks in recent times, Buffett also takes the time to point out that this isn't the core issue that sparked the crisis in the first place. The fundamental cause of the issue, as it usually is with banking, is excessive risk-taking by management teams at a select few institutions. For example, in the case with Silicon Valley Bank, the initial worry stemmed from massive oversight of management to mitigate their interest rate risk. They bought a lot of government bonds at low interest rates with the intention of simply holding them to maturity.

But as interest rates rose, the value of those bonds fell, and when investors started withdrawing their money, this meant the bank needed to sell down those bonds and realize large losses, which only compounded the issue. Worry that the bank was losing money, more and more depositors then looked to withdraw, which ultimately collapsed the bank. At the end of the day, this could have easily been avoided by the bank's management team, but they took unnecessary risks to chase higher profits.

And the crazy thing is, in banking, usually there are no repercussions on the management team while the sky starts falling. I think that the understandings in bank regulation are so messed up, and so many people have an interest in having them messed up. The way it hasn't been addressed properly is a problem. Who knows where it leads, but you'll have to have a punishment for the people that do the wrong thing.

Hold the CEO or Carnival CEO gets—that's the bank in trouble. Both the CEO and the directors should suffer. The stockholders of the future shouldn't suffer; they didn't do anything, and it doesn't teach anybody any lessons. The lesson is that if you run a bank and you screw it up, you still live. You're still a rich guy, and the clubs don't drop you, and the target groups don't quit asking you for benefits, and the world goes on. That is not a good lesson to teach people who are holding the behavior of the economy in their hands.

So, I think there's some work to be done, but I don't think it's a difficult problem. It's just we've screwed up the answer, and we've screwed up the communication of it. I think a banker should be more like an engineer; he's more into avoiding trouble than he is getting rich. Yeah, they could do fine. They can do fine that way, and I think we had a big mistake when we go to the bank where everybody joins to get rich. Yeah, it's a contradiction in values.

And this is one factor that led Buffett to sell down the vast majority of his bank stocks in recent years. But beyond that, Buffett also described at the meeting that another key reason he decided to sell was that he simply doesn't believe banks' stock performance can be accurately predicted anymore. We've sold bank stocks in the last—well, we sold them first when the pandemic broke out, and then we sold some more in the last six months. We don't know where the shareholders of the big banks necessarily or the regional banks or anybody are heading in terms of owning banks.

Events will determine their future, and you've got politicians involved. You've got a whole lot of people who don't really understand how the system works, and I would say that there is something less than a perfect communication between various people and the American public. So the American public is probably as confused about banking as ever, and that has consequences. You don't know what has happened to the stickiness of deposits at all; they got changed by 2008. It's gotten changed by this. I mean, it changes everything.

And so we're very cautious in a situation like that about ownership. And I'm definitely going to sound like a broken record here, but this, of course, comes back to Buffett's rule number one of investing, which is don't lose money. If you can't predict with reasonably high probability where your business will be in 10 years' time, you can't really buy the stock; it becomes a gamble.

So, Buffett now thinks that, thanks to politicians, fear-mongering, and the cluelessness plus irrational behavior of the general public, that generally owning bank stocks is too dangerous. But overall, that is Warren Buffett's explanation of the banking crisis and his outlook for bank stocks.

I hope you enjoyed the video. Please leave a like on it if you did, and subscribe to see more videos. But with that said, I'll see you guys in the next one.