The cost of deposits and the next Fed chair

Supply and demand
You all know what the banking business model is. You take in money and use it as collateral to lend out more money. The way to turn a profit doing this, of course, is to borrow low and lend high. So, the key is to be able to pay as little as possible for the money you bring in. When it works it's a beautiful thing.

Lately, the cost of deposits has been falling. Most of the big banks are earning so much they are spending multiple billions on stock buybacks, which come after counting all their profits. But that trend may have run its course, Polo Rocha writes today.

The inflationary effects of the war in Iran very well could hamper the Fed's ability to cut rates again. That would put some upward pressure on the costs and competition for deposits among banks, forcing bankers to raise the interest on deposits in a bid to get new customers and keep the ones they have. That cuts into margins. Several bankers hinted during earrings calls that this new competition may be starting up. 

Making it all about rates is a double-edged sword, of course. If you make your pursuit of customers all about rates, then the customers are likely to do the same thing. Which means they'll be more apt to leave you over rates (another reason why banks are so against the idea of crypto firms offering anything that resembles interest on deposits.) The real trick is to offer a range of services that make your offering sticky to entice customers to stay no matter what rates are doing.

The silver lining is that there is still strong demand for loans, so banks have more pricing power on that side of the equation. And, of course, none of this is existential. It's not a question of profits or no profits. It's a question of how big are the profits.

And, of course, where rates go from here depends a lot on the next Fed chair.

Is Fed chair a, like, hard job?
I'd think that in a vacuum, the job of Fed chair is pretty easy. If the economy's running hot, raise rates. If the economy's slow, lower rates. You shouldn't need a PhD in economics to figure that one out, right?

Of course, it is not nearly that easy, and for the past few decades it seems like every Fed chair has faced at least one crisis. Paul Volcker got the job in 1979 when inflation was wrecking the economy. Alan Greenspan faced Black Monday just months after he took the job in 1987. Ben Bernanke got a honeymoon period when he came in the seat in 2008, but then was met with the worst economic crisis in 80 years. Janet Yellen I guess you could argue didn't face any unexpected crisis, but was still cleaning up the wreckage of the Panic of 2008. Jerome Powell got a global pandemic. 

The job is actually very hard. 

Which brings us to the next Fed chair. No matter who it is, there are several … things, let's call them, that could put a lot of pressure on the next Fed chair, no matter who it is. The U.S. is currently embroiled in a war with Iran that has put a chokehold on the oil market, with the danger that it would do real harm to the economy. An AI spending bubble that could either blow up and take the stock market with it, or lead to widespread layoffs as companies replace people with bots, which would do real harm to the economy. A rapidly growing, lightly regulated asset class in the private-credit market that has some of the hallmarks of past bubbles, which could do real harm to the economy. That doesn't even include a president who pointedly attacked the last Fed chair because he didn't move interest rates to Trump's liking. Or the federal debt crossing the $40 trillion mark later this year.

Then, what if the person who gets the job of Fed chair isn't even an economist? Kevin Warsh does not have an economics degree anywhere on his CV. Warsh has a law degree and made a fortune on Wall Street, but is not a trained economist. This is a problem, Kenneth Thomas of K.H. Thomas Associates argues in a BankThink essay. "The economics Ph.D. matters because a Fed chair overseeing 400 Ph.D. economists needs to speak their language, challenge their models and interrogate their assumptions," he writes. "Instead, those economists will soon be led by a noneconomist who's spent the last 15 years saying they don't know what they were doing."

And that's just the general day-to-day stuff. That's being Fed chair in a vacuum. That's not even thinking about a crisis. Let's hope Warsh is up to the challenge.