Why Bank Money Is “Disappearing” | Patrick Perret-Green

Episode Summary

Executive Summary: Patrick Parrott-Green argued that the US banking stress was foreseeable from worsening liquidity, rising loan-to-deposit ratios, and concentrated CRE exposure at smaller banks. He sees the crisis as ongoing, with tightening credit, rising delinquencies, falling money supply, and weak global growth—especially in China—pointing to lower yields, a stronger dollar, and more pressure on risk assets.

Main Topics: Early warning signs in small-bank liquidity (Priority: 5/5): Patrick explains that he tracked Fed H4/H8 data and saw reserves, deposits, and liquidity at smaller banks deteriorate through 2022, especially as loan-to-deposit ratios rose and commercial real estate exposure remained high. Banking turmoil, unrealized losses, and interest-rate risk (Priority: 5/5): He argues that SVB, First Republic, and peers were vulnerable because they held long-duration assets funded by short-term liabilities, with major unrealized losses and poor hedging. Interest-rate risk, not just credit risk, was the key failure mode. Credit tightening and future delinquency risk (Priority: 5/5): Even if the worst bank failures are behind us, he expects lending conditions to keep tightening as regional banks conserve capital, which will hit SMEs and broader growth. He also expects a delayed rise in delinquencies across consumer and commercial credit. Money supply contraction and QT (Priority: 5/5): Patrick emphasizes that money supply is falling for the first time since before WWII, driven partly by quantitative tightening and declining bank liabilities/deposits. He sees this as a major but underappreciated macro risk. Commercial real estate, private credit, and non-banks (Priority: 4/5): He highlights CRE distress, refinancing risk, and the role of non-bank lenders, CLOs, and private credit. He is skeptical that insurers or intermediaries like Blackstone can easily absorb troubled loans without further capital impairment. China and global disinflation (Priority: 4/5): He doubts China’s rebound will provide a meaningful global growth boost, citing property weakness, weak demand, high savings, and deflationary PPI. He thinks China is a leading indicator for global inflation lower over the next 9-12 months. Rates, dollar, and market outlook (Priority: 4/5): Patrick expects bond yields to move lower, possibly sub-3% in time, while a stronger dollar may emerge as foreign banks face dollar funding strain. He is cautious on equities and favors defensives.

Key Arguments: Small-bank liquidity deterioration in 2022 was visible in Fed balance-sheet data before the March 2023 banking stress. Regional banks are disproportionately exposed to commercial real estate: about 30% of banking assets but 70% of CRE loans. The banking problem was fundamentally about duration mismatch and interest-rate risk, not just traditional credit deterioration. First Republic and SVB were impaired by low-yield assets funded at rapidly rising liability costs; some were already in deficit before failure. Credit tightening will reduce business investment, especially for SMEs that rely on regional banks rather than capital markets. Consumer delinquencies are already rising, with subprime and credit-card stress back near or above 2019 levels. Money supply is contracting in a way that central banks do not adequately model or discuss, making macro conditions unusually uncertain. China’s slowdown and deflation mean it is unlikely to rescue global growth; instead it will transmit disinflation. The dollar may strengthen if foreign banks or overseas funding markets come under pressure, tightening global financial conditions further. The end-state for yields is lower rates, potentially below 3% in the shorter term and eventually around 1% to 2% as inflation falls.

Data Points: Small US banks’ share of banking assets: ~30% - Patrick said smaller US banks hold about 30% of banking assets. Small US banks’ share of CRE loans: ~70% - He said smaller banks account for about 70% of commercial real estate loans. Unrealized losses in US bank portfolios: over $600 billion - FDIC figure he cited for unrealized losses in AFS and HTM portfolios at end of Q4. Unrealized losses as share of banking capital: roughly 25% - He said these losses were about a quarter of the US banking system’s capital. Fed funds rate move: 0% to 5% - Used to illustrate rapid repricing of bank liabilities and funding costs. Student loan forbearance: 38 months - He referenced prolonged forbearance delaying some consumer stress. Excess savings: $500 billion - San Francisco Fed estimate he cited as remaining excess savings after a decline from roughly $2 trillion. Excess savings earlier level: ~$2 trillion - He contrasted the remaining excess savings with the much larger pandemic-era stock. Excess savings as share of GDP: ~6% of GDP - He linked the earlier savings buildup to supporting consumption. Merchant wholesaler inventory-sales ratio: highest since 2008 (excluding pandemic distortions) - He used this to argue inventories are still very elevated. Chinese PPI: -3.6% y/y - Used as evidence of Chinese deflation and global disinflation pressure. Foreign banks’ US deposits: $1.2 trillion - He cited the size of foreign banks’ deposit base in the US. Foreign banks’ uninsured/large term deposits: ~$760 billion (about 60%) - He noted that a majority of foreign-bank deposits are large, more flight-prone balances. Commercial bank money supply decline: first decline since before WWII; last time 1937 - He highlighted this as a major macro warning sign. ECB balance sheet reduction: €1.1 trillion - He said the ECB had reduced its balance sheet dramatically over a matter of months. ECB money growth / Eurozone money supply: -4% y/y - He said euro area money supply is contracting year over year. Shadow Fed funds rate: about -1% to ~7% - He cited San Francisco Fed estimates to show policy tightening beyond the headline funds rate. 30-year mortgage vs. long bond spread: about 300 bps - He said the mortgage rate spread over Treasuries is wider than at the GFC peak. US corporate/business debt: ~75% of GDP - He described business debt as near all-time highs. Citi instant deposit rate vs PNC: 0.1% vs 4.75% - Used to illustrate deposit competition and funding pressure. China retail/consumer reopening strength: stabilizing, but not a dynamic recovery - Qualitative datapoint derived from his discussion of low-budget spending and weak travel.

Pivotal Quotes: "something smells in the banking system" — Patrick Parrott-Green: His blunt summary of the ongoing banking and liquidity stress. "the problem is small banks have grown rapidly. It's very clear from the Fed's postmortem that while their assets exploded, their oversight didn't accordingly" — Patrick Parrott-Green: Explaining why smaller banks were vulnerable despite regulatory oversight. "the best way for it to look at it is it's like the oil in the engine of one's car" — Patrick Parrott-Green: A metaphor for liquidity: essential when present, catastrophic when it runs out.

Implications: Expect tighter bank credit, weaker investment, more credit stress, and continued pressure on commercial real estate and shadow credit. Macro conditions favor lower yields, a firmer dollar during stress, and caution on risk assets.