Janet Yellen is a shrewd finance scholar with a wide reputation in both academic and political circles. For four years she headed the Fed, by far the most powerful central bank in the world. Since January 2021 she has been Finance Minister of the largest economy.
Nevertheless, Yellen apparently has to do things that she no longer wanted to do as a representative of the state: design emergency programs for banks and their customers in hectic ad hoc actions so as not to endanger the stability of the system. As a result, Yellen has been forced to work with the Fed and the FDIC to fully protect Silicon Valley bank deposits – even though this is not required by law. It only guarantees protection up to $250,000 through the FDIC.
Even Yellen’s comment that neither the bank nor its shareholders were rescued cannot disguise the fact: it is the eternal recurrence of the same. Banks take risks that they cannot bear, because in the end they can count on the protection of the state and its central bank. For the state actors, it is still the more rational option to intervene than to risk a loss of trust in the system.
Stock markets experience bank tremors
After a second institution, the Signature Bank, had to be taken over by the deposit insurance scheme on Sunday and a bank run threatened, the head of the central bank and the finance minister did what they always do in such cases: they rescued. The Fed made additional funds available with a “Bank Term Funding Program”. Yellen spoke soothing words. It only helped to a limited extent: the stock markets experienced a bank earthquake on Monday.
“Too big to fail” – that was and is the appropriate formula as a lesson from the Lehman Brothers bankruptcy that triggered the financial crisis in 2008. And the fact that the risk of contagion is so great even for a specialist bank focused on the technology sector with total assets of $200 billion shows two things:
- Firstly, institutions still do not appear to have sufficient capital buffers to absorb external shocks.
- Second, financial reformers have not gotten far enough in trying to break the toxic symbiosis between banks and sovereigns.
The proximity and mutual dependency remain the weak points of the global financial system: the states create a regulatory environment for the banks that finance them, in which the financial institutions do not have to deposit any equity for government bonds. Accordingly, the banks soak up the supposedly safe government bonds. The SVB also ultimately failed due to the decline in the value of the bond holdings on their books.
Now, however, there is a new, possibly decisive factor that could severely disrupt the rescue regime: inflation. This week, the Fed and the European Central Bank will decide on their further rate hike cycle.
In doing so, they have little choice but to take current financial risks into account – and potentially slow the pace of rate hikes. Because at the latest with the bankruptcy of the SVB it is clear that the overdue turnaround in interest rates would not be as quiet as it seemed to be in the markets and financial players. The sharp rise in capital market interest rates is causing the banks’ lavish bond portfolios to fall in price.
Central banks will probably not be able to avoid raising interest rates
The persistently high rates of inflation leave the central banks, which had completely underestimated the price dynamics for a long time, little choice but to raise key interest rates further. But that means: The limits of the rescue policy lie where the decisive fight against inflation begins. The times when central banks acted as insurers against major macroeconomic risks could soon be over. The situation is therefore delicate – and the problems are evident in a wide variety of areas.
Because it’s not just the banks. There are also highly indebted countries like Italy, which could quickly run into refinancing problems again if long-term capital market interest rates continue to rise. The same is true in the real estate markets, where the risk that private and institutional investors will be unable to service or refinance their mortgage loans is increasing with every tenth of a point on the interest rate scale. There are also shaky auto loans, notably dubbed “subprime,” and auto leases. Or the risk of contagion in the emerging markets, which are indebted in dollars and are suffering from the interest-driven dollar strength.
cracks in the system
In other words, the return of inflation and the associated higher interest rates make the fractures in the system visible. And if state actors remain in bailout mode, taxpayers will have to face a lot.
Yellen emphasizes that she does not want to use taxpayers’ money in the rescue operation. The security fund will pass on possible losses to the banks. The only thing missing is faith. Nobody knows what the losses will be beyond the actual liable amount of $250,000. And voices are already being raised that the state must do more, possibly even rescue bond investors, in order to calm the markets.
The soothing assertion that the SVB’s case is a liquidity problem and not a solvency problem is also questionable. Write-downs on the price losses of the bond holdings can very quickly become a solvency problem – especially if the bank is forced to sell bond holdings for liquidity reasons – as was the case with the SVB.
Ultimately, the current bank failures are a symptom of an economic “turning point”. The return of inflation heralds the end of an era after almost 20 years of extremely low and sometimes negative capital market interest rates. The turnaround in interest rates is now causing the risks to be priced back into the system.
This necessarily goes hand in hand with friction and sometimes bankruptcies. Some call it cleanup. One thing is certain: the real endurance test is yet to come.
More: Unrest, but no panic – that means the bankruptcy of the SVB for German financial institutions