Billionaire investing royalty is scared about more bank failures: 'We are running out of time to fix this problem'

Shares of PacWest Bancorp, for example, tumbled more than 30% after the lender announced that it is exploring “strategic options” for its business, including a potential sale. And there were also broad declines in the sector in response to the Fed’s announcement earlier in the day that it would be hiking interest rates to their highest level since 2007, even in the face of recent banking instability highlighted by the failure of First Republic just last week. It’s a decision that has left even the most seasoned of investors feeling nervous and predicting further regional bank drama. 

Jeffrey Gundlach, the billionaire cofounder and CEO of DoubleLine Capital, told CNBC Wednesday that he’s definitely “turning more bearish” after the Fed decided to raise rates despite regional banks’ latest issues.

“It just seems to me that deposits are going to keep drifting out,” he warned. “Leaving rates this high is going to continue this stress. I believe with a very high degree of probability there’s going to be further regional bank failures.”

And Gundlach is far from alone in his concerns about the health and prospects of regional banks amid rising rates. “The regional banking system is at risk,” Bill Ackman, founder and CEO of Pershing Square Capital Management, tweeted Wednesday. “We are running out of time to fix this problem.”

On Thursday, we got a taste of what the billionaires were talking about as contagion fears reignited in the financial sector, leading the SPDR S&P Regional Banking ETF, which tracks U.S. regional bank stocks, to fall nearly 7% by midday. The fund is now down over 40% since March 1.

The latest selloff was sparked by PacWest Bancorp’s potential sale announcement Wednesday. Shares of the California-based lender, which has been under pressure since the failure of its peers Silicon Valley Bank and Signature Bank in March, dropped as much as 60% in early trading Thursday and were halted for volatility multiple times. Tennessee-based First Horizon also sank nearly 40% after terminating its merger agreement with the regional TD Bank, and Phoenix-based Western Alliance Bancorp plummeted as much as 60% before paring some of its losses amid rumors, which it denies, of a potential sale.

Ackman noted that these regional banks are struggling to cope with rising interest rates that have “impaired assets,” and at the same time they’re facing increased competition for deposits from Treasuries and even Apple’s new savings account.

To boost investor confidence in the ailing banks, the billionaire believes all depositors, both insured and uninsured, should be backstopped by the FDIC. “The [FDIC’s] failure to update and expand its insurance regime has hammered more nails in the coffin,” he wrote, arguing First Republic wouldn’t have failed if its depositors were protected. 

“Banking is a confidence game,” he added. “At this rate, no regional bank can survive bad news or bad data.”

Treasury Secretary Janet Yellen told the Senate Appropriations Committee in March that she will not consider “blanket insurance” for banks, but in a speech to the American Bankers Association later that month she noted that if smaller institutions face depositor runs and “pose the risk of contagion,” she would step in and backstop depositors.

Nelson Peltz, cofounder and CEO of Trian Fund Management, also argued this week that more regional banks are likely to fail unless the FDIC and Treasury backstop both insured and uninsured depositors. That’s the only thing that will “stop the deposit outflow from the small regional and community banks,” he told the Financial Times in an interview published Thursday, adding: “I don’t think we want all of the funds just going to major banks.”

JPMorgan Chase was able to scoop up the assets of First Republic, including $173 billion of loans, $30 billion of securities, and $92 billion of deposits, after its collapse last week in a move analysts have lauded as a dream scenario for the megabank’s shareholders. But Peltz warned, as Fortune has previously reported, that regional banks in the U.S. are critical to the health of the economy.

“We’re one of the few countries that has a large infrastructure of small regional and community banks,” he said. “They have filled the needs of small businesses for well over a hundred years—I believe we can’t afford to let them go.” 

“I believe regional banks are the backbone of many companies and real estate across the U.S.,” he added, arguing that backstopping deposits “is the way to give them continued influence and strength.”