There’s plenty of discussion about how the economy looks right now. This past week and over the weekend, three banks have failed. On Wednesday, Silvergate Capital (NYSE:SI) kicked off the party, signaling the bank would be winding down operations. This was followed by the subsequent collapse of SVB Financial’s (NASDAQ:SIVB) Silicon Valley Bank and Signature Bank (NASDAQ:SBNY) on the weekend, leading bank stocks much lower in today’s session.
The fact that most bank stocks are trading lower today shouldn’t be a surprise. When three banks fail in the span of less than a week, investors have the right to be concerned. Indeed, smaller banks are feeling the pain to a much greater degree than their larger counterparts. That’s because many experts expect deposits to flow to the safest areas of the economy.
To quell a bank run on more small and medium-sized banks, the Federal Deposit Insurance Corporation (FDIC) announced plans to back depositors from SVB. However, concerns about the ultimate ramifications of these collapses will remain.
Now, there’s a growing concern we could be due for another severe recession if a financial crisis takes hold. Let’s dive into these concerns and whether a potential depression could be possible.
Could the Decline in Bank Stocks Lead to a Depression?
To be clear, we’ve only had one depression over the past century, from 1929 to 1939. Since then, the economy has seen several severe downturns, called recessions. But we’ve never gotten close to the bread lines and unemployment seen following the roaring 20s (of the last century).
A depression is generally defined as a severe and prolonged economic downturn. Many view a depression as a more extreme version of a recession, which lasts three or more years.
Currently, the economy is still growing, at least according to Q4 figures. Thus, it’s unlikely we’re in a complete economic recession. However, parts of the economy, such as housing, have already been noted to be feeling recession-like headwinds likely.
That said, the potential for a complete financial crisis could spur what many dread: A potentially deep recession or worse. While regulators work on restoring calm and order to the financial system, depositors are taking the safe route right now. Thus, I think the most likely scenario we’ll see play out is that the largest banks in the U.S. get even larger (and even less likely to fail). If that’s the case, a depression remains an improbable outcome.
We’ll see. Anything can happen. If anything, we’ve all seen what happens when the Federal Reserve comes in and saves the day, as it did during the short pandemic-driven recession.
For now, investors appear to have reason to remain highly cautious. In a few weeks, we’ll likely find out whether this caution was warranted or if many of these small and medium-sized banks were worth buying on this rather incredible plunge today.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.