In the ever-shifting landscape of global finance, the American banking system finds itself quietly sinking into a new whirlpool of crisis—a second wave of bank runs has quietly begunOn the surface, the acute crises that plagued U.Sbanks appear to have subsided for the momentHowever, a more covert and long-lasting chronic crisis is simmering underneath, defined primarily by a structural shift of bank deposits towards money market funds.

Despite lacking the insurance protection of the Federal Deposit Insurance Corporation (FDIC), money market funds present a compelling appeal through their distinctive investment strategiesThey primarily invest in ultra-short-term government debt instruments, favoring bonds issued by government agencies and treasury instruments with maturities of six months or lessThe brilliance of this investment array lies in its ability to deftly sidestep default risks while shields holders from the devaluation shocks instigated by aggressive interest rate hikes from the Federal Reserve, due to their minimal investment duration

Moreover, money market funds promise alluring returns of over 4%, starkly contrasting with the meager interest rates of 0.4% to 0.5% offered by traditional bank deposits.

In this intense competition against money market funds, both large and small banks find themselves in awkward positions, struggling to keep paceLarger banks, suffering from excess savings, have seen their net interest margins shrink to nearly negligible levels, leaving them unable to raise deposit interest rates to compete effectively with money market fundsMeanwhile, mid-sized and small banks are trapped in a life-or-death struggle, contending not only with the larger banks over limited deposits but also against the allure of high-return offers from money market funds, putting them in a dual-front battle that is exceedingly tough.

The intensity of this trend is closely linked to recent bankruptcies in institutions like Silicon Valley Bank (SVB) and Signature Bank

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The fall of these banks acted as a series of heavy blows awakening dormant depositors, initiating a so-called “Great Awakening of Depositors.” Previously, despite the existing interest rate spreads, customers largely remained complacent, reluctant to shift their savingsThe harsh reality of bank failures jolted many awake, prompting a reevaluation of deposit safety and profitabilityUpon discovering the significant returns offered by money market funds, a structural migration of deposits seemed inevitable and propelled by strong momentum.

Since the onset of the U.Sbanking crisis in early March of the previous year, money market funds have witnessed a massive inflow of funds, drawing in over $340 billion within an alarmingly short span, pushing their total assets beyond the $5.2 trillion mark and setting a new historical precedentNaturally, this phenomenon has captured the attention of U.S

Treasury Secretary Janet YellenIn meetings, she highlighted the structural vulnerabilities inherent within money market funds and issued stern warningsShe acknowledged that the systemic risks posed by money market funds and shadow banking entities such as open-ended funds, relating to bank runs and low-priced forced asset sales, have not been fundamentally mitigated or adequately resolved.

Examining the flow of funds further, one can uncover a significant “black hole”—the overnight reverse repurchase agreement (RRP) facility established by the Federal Reserve for money market funds and non-bank institutionsThis facility offers a high return of 4.8%, luring funds in at an impressive rate, citing stability and security that often outstrips many short-term U.STreasury bonds; after all, funds are held in central bank accounts, ensuring a top-level security rank

This creates a concerning potential crisis where funds injected into the money market fund ultimately find themselves absorbed into the overnight reverse repurchase system, effectively siphoning liquidity away from the banking system.

Reflecting upon the Federal Reserve's balance sheet, we find both reserve accounts and overnight reverse repos entrenchedWhen funds from the money market funds flow towards the overnight repo system, the reserves within the banking sector's accounts are drawn in, slipping into this “black hole.” Upon entry, these funds vanish without a trace from the banking ecosystem, no longer engaging in lending activities, simply resting to earn substantial interest while losing all liquidityFurthermore, as the Federal Reserve continues its rate hike trajectory, the appeal of overnight reverse repos only grows strongerEven if the Fed were to lower interest rates in response to an economic downturn, the yields on short-term treasuries may well undercut those of the reverse repos, maintaining the “black hole's” entropic nature.

Consequently, an outflow of deposits from small banks continues unabated towards money market funds, a significant portion of which ultimately becomes ensnared within the overnight repo “black hole,” translating to a continual depletion of bank reserves, predominantly at the expense of small and mid-sized banks

Coupled with the Fed's ongoing balance sheet reduction measures, this situation only exacerbates the plight of smaller banks, pushing the entire banking infrastructure towards greater instability.

This second wave of bank runs can be likened to a silent yet lethal chronic disease, steadily eroding the foundations of the American banking systemThe crisis of institutions like Silicon Valley Bank resembles a punctured artery; although shocking, it may still be stemmed through emergency measures from the Federal ReserveOn the other hand, the gradual and chronic depletion of deposits affecting thousands of small to mid-sized banks resembles sinister capillary bleeding—imperceptible yet relentless—a scenario in which even the best intentions from the Fed may render them powerless against the issue's stealthy progression.

In grappling with this crisis, it appears the Federal Reserve is stuck in a dilemma: if it persists with its anti-inflation policies, implementing continual rate hikes and balance sheet reduction, the banking sector may bear unsustainable strain, potentially triggering more bank collapses