Stock markets are jumping back up today. It seems that financial investors think the monetary authorities and banking supervisors have got the banking crisis under control. That could be wishful thinking.
The banking crisis of 2023 is not over yet. The Californian ‘tech’ bank Silicon Valley (SVB) that went bust last week has been taken over by the US banking authorities; and so has the cryptocurrency bank Signature. First Republic Bank, used by local companies and rich New Yorkers, has got liquidity funding from a batch of big banks, but it is still tottering on the brink, as depositors flee.
And over in Europe, one of the largest and oldest banks Credit Suisse has been eliminated after 167 years. In a shotgun marriage, its rival Swiss bank UBS has taken over CS for just $3.2bn, a fraction of its book value. The Swiss authorities forced this through to ensure that CS shareholders would keep most of their equity investment, but bond holders of CS have been wiped out to the tune of $17bn – an unprecedented step. The Swiss National Bank is also providing $100bn in liquidity funding to cover deposit withdrawals as a sweetener to UBS, while thousands of low-grade banking workers are to lose their jobs. The government insisted this was the only solution – otherwise CS would have to be nationalized and we can’t have that! Thus, the strong (UBS) has swallowed up the weak (CS).
Some say that all this has been done without a bailout that would use public money and credit. But that is baloney. The liquidity funding by the Swiss authorities is huge and the US Fed has set up a Bank Term Funding Program which enables banks facing depositor withdrawals to borrow for one year using as collateral their government or mortgage bonds that they hold, at ‘par’ (namely the price they paid for them), not what they are worth in the bond market today. So the government is taking on the risk of default. Also the US authorities have guaranteed all the deposits in banks, not just up to the previous threshold of $250,000. So the better-off will not lose their money as the government will cover any bank collapse using public money.
Already this is a large crisis, fast being comparable to the 2008 meltdown and it’s taking place not in the speculative ‘investment’ banks as in 2008 but in standard depositor banks.
There are many other US banks out there facing the same problems of ‘liquidity’ i.e. not able to meet depositor withdrawals if there is a run on their bank. A recent Federal Deposit Insurance Corporation report shows that SVB is not alone in having huge ‘unrealised losses’ on its books (the difference between the price of the bond bought and the price in the market now). Indeed, 10% of banks have larger unrecognised losses than those at SVB. Nor was SVB the worst capitalised bank (equity), with 10% of banks having lower capitalisation than SVB. The total unrealised losses sitting on the books of all banks is currently $620bn, or 2.7% of US GDP. That’s a huge potential hit to the banks and the economy if these losses are realised.
A recent study found that the banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets when accounting for loan portfolios held to maturity. That’s because ‘marked-to-market’ bank asset prices have declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline of 20%. Worse, if the Fed continues to raise interest rates, bond prices will fall further and the unrealised losses will increase and more banks will face a ‘lack of liquidity’. No wonder US banks are sucking up funding from the Fed through its so-called ‘discount window’ and from the Federal Home Loans Bank provision.
It’s the smaller and weaker regional banks that are vulnerable from depositor withdrawals. The regional bank stock index has collapsed.
And the problem of unrealised losses isn’t limited to US regional banks either. For example, the mark-to-market value of Bank of America’s held-to-maturity bond portfolio declined 16% in 2022. That’s the same size as the unrealised loss at Silicon Valley Bank and not much less than First Republic’s 22%, according to JP Morgan.
All this is bad news for the US economy because regional banks have done a larger share of US lending to ‘Main Street’ in recent decades. Banks with less than $250bn in assets make about 80% commercial real estate loans, according to economists at Goldman Sachs, along with 60% of residential real estate loans and half of commercial and industrial loans. If they come under stress, they won’t lend so much and the US economy will grow more slowly than previously thought.
Economists at Goldman Sachs reckon that the crisis has already reduced real GDP growth estimates by 0.3pp to 1.2% for this year. Torsten Slok, chief economist at Apollo Global Management, estimates that banks holding roughly 40% of all financial assets across the sector could retrench, which would lead to a sharp recession this year. Slok estimates that the combination of tighter financial conditions and lending standards following the recent bank failures has in effect raised the federal funds rate — the rate at which banks lend to each other — by 1.5 percentage points from its current target range of between 4.50-4.75%. The banking crisis and the bond market is doing the Fed’s work for it in driving the economy into a slump.
What can be done? There are various solutions offered to stop the ‘contagion’ of bank crashes spreading and to mitigate them in future. Martin Wolf in the FT makes the point that bank crashes are inevitable and cannot be avoided. “Banks are designed to fail. Governments want them to be both safe places for the public to keep their money and profit-seeking takers of risk. They are at one and the same time regulated utilities and risk-taking enterprises. The incentives for management incline them towards risk-taking, just as the incentives for states incline them towards saving the utility when risk-taking blows it up. The result is costly instability.”
That’s nice to know! Marx explained it better. Capitalism is a money or monetary economy. Under capitalism, production is not for direct consumption at the point of use. Production of commodities is for sale on a market to be exchanged for money. And money is necessary to purchase commodities. But money and commodities are not the same thing, so the circulation of money and commodities is inherently subject to breakdown. It is a fallacy (contrary to Say’s law) that the production of commodities guarantees equal demand for their purchase. At any time, the holders of cash may decide not to purchase commodities at going prices and instead ‘hoard’ the cash. Then those selling commodities must cut prices or even go bust: “with the commodity splitting into commodity and money, and the value of a commodity becoming independent in the form of money, the direct exchange of products divides into the processes of sale and purchase, which are internally mutually dependent and externally mutually independent. And here is posited, at the same time, the most general and most abstract possibility of crisis.” Many things can trigger this breakdown in the exchange of money and commodities, or money for financial assets like bonds or stocks (‘fictitious capital’, Marx called it). And it can happen suddenly.
So what to do? The first solution offered is to let the market prevail. Banks that get into trouble and can’t pay their depositors and creditors must be allowed to fail, to be liquidated. That solution gets little support from governments which fear the political backlash and from economists who fear that liquidation would lead to outright slump and depression as in the 1930s.
So the fall-back solution is more and stricter ‘regulation’. Regulation could take many forms. The usual one is making banks hold more equity capital relative to their lending and investments; another is to reduce the amount of borrowing they do to invest speculatively. So there is a great paraphernalia of banking rules, the latest of which is the Basel 3, brought in after the global financial crash of 2008.
Three things here: first, regulation does not work because crashes continue even in banks keeping to the rules (eg Credit Suisse); second, many banks fudge the rules and try to mislead the regulators; and third, capitalist governments are continually under pressure to relax the rules that make it difficult to invest or lend and reduce profitability, not only in the financial sector, but also for the borrowers in the productive sectors.
When the profitability of capital in the major economies plunged during the 1970s, one of the policies of neo-liberal governments of the 1980s was to make a ‘bonfire’ of regulations, not only in finance but also in the environment, in product markets and in labour rights. In the three decades leading up to the Global Financial Crash in 2007-8, regulations were swept away: including barriers between commercial and investment banking; and allowing banks to borrow hugely and issue all sorts of ‘financial instruments of mass destruction’ (Warren Buffet).
Indeed, after Margaret Thatcher’s ‘big bang’ of the 1980s which created a free-for-all in banking, it was social democratic governments that presided over ‘deregulation’ – Clinton in the US and Blair in the UK. In 2004, Chancellor Gordon Brown opened Lehman Bros’ new Canary Wharf office, saying “Lehman brothers is a great company that can look backwards with pride and look forwards with hope”(!) The City minister of the time was Ed Balls who adopted enthusiastically what he called ‘light touch regulation’ of banking activities in the City of London, because the banks and financial institutions were the heroes, vital to Britain’s prosperity. Instead, the eventual UK financial sector crash cost the economy something like 7% of GDP, huge rise in pubic sector debt and permanently low growth since.
Deregulation turned the modern banking system into a series of giant ‘hedge fund’ managers speculating on financial assets or acting as conduits for tax avoidance havens for the top 1% and the multi-nationals. It may be true that international banks are better capitalised and less leveraged with bad debts after the gradual implementation of the Basel III capital and liquidity accords and the widespread adoption of ‘stress testing’, but even that can be disputed. As IMF admits: “in many countries, systemic risks associated with new forms of shadow banking and market-based finance outside the prudential regulatory perimeter, such as asset managers, may be accumulating and could lead to renewed spillover effects on banks”.
Generally, the left seems unable to come up with any solution except more regulation. Take liberal economist, Joseph Stiglitz. At the time of the Global Financial Crash, he proposed that future meltdowns could be prevented by empowering ‘incorruptible regulators’, who are smart enough to do the right thing.“[E]ffective regulation requires regulators who believe in it,” he wrote. “They should be chosen from among those who might be hurt by a failure of regulation, not from those who benefit from it.” Where can these impartial advisors be found? His answer: “Unions, nongovernmental organizations (NGOs), and universities.”
But all the regulatory agencies that failed in 2008 and are failing now were well staffed with economists boasting credentials of just this sort, yet they still manage to get things wrong. In a 2011 book, Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation, Jeffrey Friedman and Wladimir Kraus contested Stiglitz’s claim that regulations could have prevented the disaster, if implemented by the right people. Friedman and Kraus observe: “Virtually all decision-making personnel at the Federal Reserve, the FDIC, and so on, are . . . university-trained economists.” The authors argue that Stiglitz’s mistake is “consistently to downplay the possibility of human error—that is, to deny that human beings (or at least uncorrupt human beings such as himself) are fallible.”
David Kane at the New Institute for Economic Thinking points out that banks have managed to avoid most attempts to regulate them since the global crash as “the instruments assigned to this task are too weak to work for long. With the connivance of regulators, US megabanks are already re-establishing their ability to use dividends and stock buybacks to rebuild their leverage back to dangerous levels.” Kane notes that “top regulators seem to believe that an important part of their job is to convince taxpayers that the next crash can be contained within the financial sector and won’t be allowed to hurt ordinary citizens in the ways that previous crises have.” But “these rosy claims are bullsh*t.”
Even the IMF quietly admits this: “As the financial system continues to evolve and new threats to financial stability emerge, regulators and supervisors should remain attentive to risks… no regulatory framework can reduce the probability of a crisis to zero, so regulators need to remain humble. Recent developments documented in the chapter show that risks can migrate to new areas, and regulators and supervisors must remain vigilant to this evolution.”
One other solution offered is the so-called Chicago Plan, which is promoted by Martin Wolf and some leftist post-Keynesians. Originally this was an idea of a group of economists at the University of Chicago in the 1930s who responded to the Depression by arguing for severing the link of the commercial banks between the supply of credit to the private sector and creation of money. Private banks would lose the power to create deposits by making loans, as all deposits would have to be backed by public sector debt or by bank profits. In effect, lending would be controlled directly by government. “The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business,” says an IMF paper on the plan. “Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend.” And that outside funding would be the government. The banks would still be privately owned, but could not lend. Ironically, to exist they would have to turn into outright speculative investment operations like hedge funds to make a profit. That could create even more instability in the banking system than before. The Chicago Plan would only work if the banks were brought into public ownership and made part of an overall funding and investment plan. But if that happened, there would be no need for a Chicago Plan.
What is never put forward is to turn modern banking into a public service just like health, education, transport etc. If banks were a public service, they could hold the deposits of households and companies and then lend them out for investment in industry and services or even to the government. It would be like a national credit club. We could then make a state-owned banking system democratic and accountable to the public. That means directly elected boards, salary caps for top managers, and also local participation. Way back in 2012, I presented such an idea to the Institute of Labour Studies in Slovenia, as structured below.
Don’t hold your breath for anything like this being proffered by any leftist party, let alone governments.
This week the Federal Reserve and the Bank of England meet to decide on whether to continue to raise interest rates to ‘fight inflation’. As we now know, this policy is causing instability and bank crashes, as well as lowering growth. Meanwhile, inflation (core) remains ‘sticky’ at over 5-6% a year in the major economies. The European Central Bank at its latest meeting did hike its rate further, arguing that there is “no trade-off” between fighting inflation by raising interest rates and financial instability . Yet that has already proved demonstrably untrue.
The ECB claims that European banks are ‘resilient’ and in better shape than even US banks – tell that to CS bond holders. Bank lending in the Eurozone is contracting fast – down €61bn between January and February, the biggest monthly decline since 2013. And the ECB admitted in its quarterly survey of lenders that banks have tightened their lending criteria on business loans by the most since the region’s sovereign debt crisis in 2011. Demand for mortgages fell at the fastest pace on record.
Will the Fed, the ECB and the BoE go on tightening until even more banks break down and economies dive into recession? Or will they pause or reverse policy to avoid a financial meltdown? Many financial institutions are screaming for a pause and the markets are rising on the prospect. But as one Fed member observed in supporting a further quarter-point rate rise, it is necessary to “preserve the credibility that Powell at the Fed had gone to great lengths to restore over the past year,” she said. “I wouldn’t think he would want to let that go at this point.” This Fed is not for turning – or is it?
20 thoughts on “Bank busts and regulation”
So the situation is indeed irreversible. It is happening, guys.
Wow, I never thought I would live to see that day: the day of the fall of the United States of America.
Has been over the past 2 decades, frankly
And exactly how many times have you said this to yourself in the past decade alone?
The US decline began in the late 60’s, declining now for half a century, yet the largest economy on Earth.
Are all those union organizing campaigns in America also a part of “the fall” you love to repeat so much?
I don’t remember ever declaring the fall of the USA before.
The distance between the two structural crises of the USA was 79 years (1929; 2008). The distance between its last structural crisis and the next one was just 15 years (2008; 2023). That, combined with many other objective factors (military defeat in Afghanistan; the rise of the far-right in 2016; the continuous rise of China after 2012; the soon-to-come defeat in Ukraine; the Long Depression etc.), makes it clear to me that we can already state with 99.999% surety that the USA is over.
Just to be clear: when I say “USA” I’m saying the American Empire as a whole, not just the Mainland USA (USA proper, the nation-State called USA). It includes the rest of the First World and its periphery (the Third World). It is the so-called “Western Civilization”. So, for example, this recent strategic defeat of the French workers are another sign of decline of the West (American Empire) as a whole, even if its specific nature being the collapse of Western European social-democracy (Western Marxism; Trade-Unionism).
If the federal reserve decides to pause or pivot in order to stave off the panic that would inevitably break out to resolve the current industrial overproduction of commodities relative to money (gold), the price of gold will soar, followed by the prices of primary commodities, wholesale commodities, and finally retail commodities. This dollar devaluation inflation would then lead to a higher rate of interest that would be necessary to break the demand for gold, leading to an even sharper panic than otherwise. And that’s assuming that the money capitalists wouldn’t just dump their dollars on a massive scale and hoard money (gold). As Sam Williams explained, modern financial crises don’t occur until the monetary authorities are facing a choice between the freezing up of credit on one hand and a run on the currency that forms the basis of credit on the other.
”The government insisted that this was the only solution; otherwise CS would have to be nationalized and we can’t allow that! Thus, the strong (UBS) has swallowed the weak (CS).’’
This is the underlying phenomenon of all economics, the underlying current on which all other economic events are based: the big fish eats the small one. In socialist economics, since Marx, it is called Concentration of Capital. And the Concentration of Capital, in my point of view, is the ultimate cause of the decreasing rate of profit. With the sequence: concentration (competition)-overproduction-decreasing rate. If the capitalist banking sector is in a decreasing rate of profit, and it is according to its data of the productive capitalist sector, data that can be perfectly extrapolated to the banking sector, it is also true that the rate decreases ONLY for its small fish (non-companies). monopolists such as Creditt Suise) but does not decrease for its monopoly bigwigs (UBS). The crisis must occur if or if at some point due to the accumulation of companies in losses. If the time of the banking crisis is now in 2023 I don’t know because I don’t know the short-term banking and financial data, but according to M. Roberts’ excellent analysis and short-term data. and according to the sum of the geopolitical conflict (Russia-Ukraine) with its corresponding increase in inflation and increase in interest rates in the last year, the suspicion is that many more small banker fish are going to fall.
Of course, providing a solution to this terrible economic model that some (capitalists and ruling elite) insist on supporting only for their benefit, the only solution is a single company: Democratic and egalitarian Socialism.
Michael, were there signs of the current crisis (among others) in the September 17, 2019 repo market interest rate surge? It was a curious event to occur just before the pandemic shuttered the world’s economic engine.
Alfredo That event was a first sign of a lack of liquidity in short-term banking transactions. “the accumulation of reserves in the Treasury account and the uneven distribution of remaining reserves across banks were possibly the proximate causes of the Treasury repo rate spike in September 2019 – though Fed studies earlier in that year suggested the banking system had ample reserves, even accounting for unexpected variations such as in the Treasury’s Fed account (see Logan 2019). Our evidence suggests that the shrinkage of aggregate reserves without a commensurate decline in aggregate claims on liquidity was the likely deeper cause. At a minimum, by leaving the system vulnerable, it amplified other channels.” https://cepr.org/voxeu/columns/demandable-claims-bank-liquidity-complicate-unwinding-central-bank-balance-sheets
May be related:
By the way, the NYT and co. were spreading headlines that the First Republic was being “bailed out” by a constellation of private sector banks.
This is a lie. There’s no such thing as a “private bail out”. Private bail out is just another term for realization of loss. Or, a bigger and more dramatic version of “the price of doing business”, depending on how much faith one has in capitalism.
The BOE raised its rate by 0.5% and the FED by 0.25%. In the US the FED rate is above even the 30 year market rate for treasuries, an abnormality only found in recessions. There are two stages to a financial emergency. If market rates predominate, not rates repressed by Central Banks, then the shattering of the chain of credit begins within production and circulation first in the form of the drying up of trade credit. Trade credit comrades which reduces money from the means of circulation to the means of payment is the single biggest form of credit in the economy. I will never tire of saying this which is why Marx spent so much time discussing and analyzing it and so little time discussing the issue of speculative crises. Thus in general, the credit crisis in production which further impairs the rate of profit because of the crisis of realization, then transfers this over to the world of fictitious assets because it is the flow of surplus value and expectations for this flow, which prices and reprices fictitious capital.
What my article shows is that the order will now revert. The tightening of lending criteria will add to the bullwhip effect of slowing sales driving down profit margins which will escalate insolvencies adding bad debts to the current repricing of assets, and it is this combination which will be fatal to the banking system despite the best efforts of the FED. It is for these reasons that my inaugural post this year in early January predicted a financial crash in 2023. http://theplanningmotive.com/2023/03/22/the-stark-choices-facing-the-fed-inflation-vs-saving-the-banks-or-is-it-so-stark/
Obviously, if the central banks’ rates stop to predominate, the system is already dead.
But, even if the do predominate, the system is also already dead, just slower (given the present conditions).
If every central bank rises their interest rates, nobody is raising their interest rates. That’s because there is no “natural” interest rate: your interest rate is only high because it is above the interest rates of the competition – in the case of the central bank, other central banks.
So let’s take the case of Brazil, whose Central Bank – in open disobedience to its democratically elected president – kept Brazil’s interest rate at +13.75% (+0.00%) yesterday. Its head, proudly, claimed this interest rate is high and that this is good. But +13.75% is high for now — the Fed has already risen its interest rate by +0.25% the day before, and there will come a moment when +13.75% won’t be high anymore. That’s because, the USA apart (since it issues the universal fiat currency), a country’s base interest rate only strengthens its currency if it can attract USDs from abroad. Well, Brazil may be attractive at a +6.75% real interest rate, but only in as long as the real rates at France, Germany, Japan, Turkey, South Africa, and, specially, the USA are x% lower than that. If the USA pulls a Paul Volcker, the smile of the head of Brazil’s Central Bank will be wiped out in a split second — the reason being Brazil is a very poor, deindustrialized, insignificant country, that has no business attracting so much of those precious US dollars.
Of course, the heads of the central banks around the world, in practice, are a cartel: they probably plan the game before making any move. But the game is only played within the four lines as long as there is plenty for everybody (of the elites).
P.S.: journalist Paul Blustein, in his book about the Asian Crisis from the point of view of the IMF, explained why Brazil historically in the neoliberal era (1989-present), keeps the highest real interest rates in the world. According to him, when the Asian Crisis reached Brazil, Larry Summers and the IMF elaborated an eschatological theory that stated that, if Brazil fell, the whole Third World would fall, opening the “Gates of Hell”, i.e. paving the way for the crisis to reach the First World. They then elaborated a rescue plan for Brazil that eventually saved it in 2002. This episode was traumatic to the world’s capitalist class, and imprinted in the Brazilian capitalist class’ mind that, no matter what, any Third World financial crisis should stop with them. Thus the doctrine of Brazil as the gatekeeper of the “Gates of Hell” (which I like to call the “Gates of Hell Theory/Doctrine” to shorten) was born, and it is still deep engraved into every Brazilian elite member up to this day — their noble mission as a comprador elite, their contribution to the greater good which is the capitalist system.
VK often it is the pattern of interest rates that describes the economic situation. It is a very concrete observation.
One aspect of these Interest Rates hikes that have been seldom discussed (alas, here as well) is the detrimental effects it has had on developing economies ability to borrow, driving them to practical bankruptcy.
And of course that was no reason to think twice about raising the rates.
But once the proverbial shit hits the fan, and the US financial system is in jeopardy, then everyone starts saying, maybe we shouldn’t raise the rate so much and so fast!
I quote: “the worst is to come for the so-called global south. If the Fed continues to hike, then the US dollar will regain strength after the recent brief pause” As much of the debt owed by economies in the Global South is in dollars, an appreciating dollar relative to their own currencies is an extra burden. Developing economies now spend more on external debt service than on the health of their citizens! So not only is recession on the agenda in the G7 economies, but debt default and slump is already beginning in ‘developing’ economies (e.g. Sri Lanka, Zambia, Pakistan, Egypt). from a recent report and many others
Can anyone explain to me why in the past interest rate hiking did not lead to such devastating consequences for the banks? Is it unprecedented now? Or do banks rely too heavily on government bonds now?
In the GFC it was mortgage bonds that suffered as interest rates rose and housing demand plummeted and the banks were infected by speculative derivative instruments that connected them all. This time it is rising interest rates hitting bond prices and those banks that bought these to boost their profitability AND the fallback in the tech sector profits leading to a withdrawal of deposits. In both cases, it was a combination of rising interest rates and falling profitability
Michael it is a lot more than govt bonds. Commercial property is another especially REITS, then of course who knows what is happening with hedge funds and private equity given their leverage. By the time this progresses govt bonds will be the least of their worries.
Why not introduce a new “Glass Steagall” act…ore would that need a revolution?