Irrational exuberance and First Republic

The story of the banking woes of First Republic is so American that one is not surprised. American capitalism it seems thrives on ‘irrational exuberance’ – the phrase used by former Fed Reserve chairman and Ayn Rand acolyte 27 years ago. Bankers, especially central bank governors fear irrational exuberance and it is easy to see why. First Republic chased rich clients – the polite term is high net-worth individuals or HNIs – and turned them into depositors and it was how the bank grew. At the same time it gave these rich clients mortgage loans at almost throw away rates. It was an untenable banking proposition at the best of times, and it no doubt broke down when the Fed Reserve raised rates aggressively to fight raging inflation. First Republic was literally caught on the wrong foot. The bank’s annual report says that it did not lend only to the rich folk at throwaway interest rates, but it had also extended loans to schools and non-profit organisations account for 22 per cent of the bank loans, but that its main thrust has been big loans at low interest rates. And even Meta’s Marc Zuckerberg made use of it when he got a 30-year mortgage of $5.95 million for a Palo Alto home at an interest rate starting at 1.05 per cent, according to a 2012 Bloomberg report, says a Reuters report. The owners of First Republic still follow their stilted banking philosophy despite the rising tide of troubles.

An interesting fact of the emerging banking crisis, which threatens to hit the American financial system is that the Silicon Valley Bank (SVB), Signature Bank, and now First Republic are all west coast banking ventures, and they appear to be greenhorns compared to the aged and storied banks of New York and the east coast. The west coast banks are either burning their fingers or learning from experience, of course at the cost of the stability of the American economy. America and the world pay a heavy price for the capitalist antics of the Americans. In a manner of speaking, America is a successful capitalist economy because it dares to fail, and it is this that leads to the spectacular success of the few maverick entrepreneurs who survive and thrive.

Patricia A. McCoy, a former US Treasury official, and a professor Boston College Law School summed up the First Republic crisis in a concise manner: “Wealthy customers were drawn to First Republic in part because they could get large mortgages at rock-bottom interest rates.” And as is evident, that is not exactly a good way of doing banking. The story of Credit Suisse showed that it is the same folly that led to the collapse of the 166-year-olf Swiss bank. So you cannot blame just the Americans for the problems rising on the financial front of global economy.

What is the remedy for the follies of bankers, who never seem to learn from past mistakes. One way out could have been stricter surveillance from the governments or independent banking regulators. Though this is not a fool-proof remedy, it can help to a certain extent. The other is to drill it into the heads of bankers that it is not a great idea to break the rule book of prudence to create a sense of excitement and a sense of intoxication of scoring short-term victories. And frame rules that will push the rule-breakers into the abyss.

There are no rescue packages and salvaging operations. There is of course the fear of the spread of contagion of a failed bank and how it could trigger a domino effect, bringing down all in the vicinity as it were. The big ones cannot be allowed to fail because they are too big. And the small ones cannot be allowed to fail because they spread the contagion of panic. It should be a straightforward framework: Rule-breakers must pay.