Why the Bank Crisis isn’t Over
Photograph by Nathaniel St. Clair.
When interest rates rise, bond prices fall (and stock prices tend to follow). However, banks don’t have to mark down the market price of their assets to reflect this declining valuation. They can simply hold on to their securities. They only have to reveal the market-price decline when there is a run on the bank and they have to actually sell these bonds or packaged mortgages to raise the cash to enable the withdrawals to be made.
For Silicon Valley Bank, it turned out that they gambled to make a capital gain by buying long-term Treasury bonds, whose interest rates were being raised sharply by the Fed’s tightening. The bank expected that the Fed couldn’t keep rates high without bringing on a serious recession – and indeed, Fed Chairman Powell said that a recession was indeed what he wanted.
But instead of lowering interest rates, Mr. Powell announced that not enough American workers were unemployed, so he planned to raise interest rates even more than he had expected to. Interest rates rose, and bond prices fell. SVB “was left sitting on an unrealized loss of close to $163bn – more than its equity base. Deposit outflows then started to crystallize this into a realized loss.” (Huw van Steenis, “History can instruct us on the fallout from SVB’s collapse,” Financial Times, March 13, 2023.)
Banks across the country were losing deposits sharply. This was not a “run on the banks” resulting from fears of mismanagement. It was because banks have behaved in so selfish and greedy way that as they have made soaring profits on rising interest rates – the rates they charge borrowers, and the rates yielded by their investments – they have been paying depositors only about 0.2%. Banks were acting as monopolies, together refusing to pay depositors a fair rate – but their monopoly did not extend to control of the U.S. Treasury.The result is a widening gap between what investors can earn by buying risk-free Treasury securities – about 4% — and the pittance that banks pay their depositors. So depositors were taking their money away from the banks to earn a more fair market return elsewhere.
It would be wrong to call this a “bank run” or “panic.” The depositors withdrawing their money were not irrational. They were fed up with the bank’s selfishness. And SVB was one of the worst offenders. That’s why its stock had soared so sharply in the last few years.
The threat of a “bank run” may apply more to foreign depositors. On Monday, March 13, the US dollar index fell by 1 percentage point. That actually is a lot for one day. Europeans were selling U.S. stocks. That is why the Dow Jones Industrial Average fell at the opening (9:30 AM EST was 3:30 in the afternoon continental European time, so the European sell orders had piled up.) Will Europeans withdraw from the American bank market? Are they losing trust?
President Biden has done everything that he could to confuse the public as to what is happening. His Monday speech assured voters that the SVB “rescue” was not a bailout. But of course it was a bailout. Uninsured depositors who did not qualify for safety from losing a penny were rescued without losing a penny.
What Biden implied, correctly, was that it was not a taxpayerbailout. But then what was it?
It was a demonstration of how powerful Modern Monetary Theory (MMT) is. The banking assets sufficient to “make depositors whole” was simply created by the banking authorities. The $9 trillion in the Fed’s Quantitative Easing for the banks since 2008 was not money creation. It was a balance-sheet exercise – technically a kind of “swap” with offsets of good Federal Reserve credit for “bad” bank securities pledged as collateral – way above current market pricing. That is what “rescued” the banks after 2009. Federal credit was created without taxation.
A few political considerations are appropriate here. For one thing, deregulatory corruption played a role. SVB was overseen by the Federal Home Loan Bank (FHLB). The FHLB is notorious for regulatory capture by the banks who choose to operate under its supervision. Yet SVB’s business was not mortgage lending. It was high-tech private equity entities being prepared for IPOs – to be issued at high prices and then talked up – and left to fall in the usual pump and dump ploy.
Another political consideration is what Silicon Valley is a Democratic Party stronghold – and a rich source of campaign financing. The Biden Administration was not going to kill the goose that lays the golden eggs of campaign contributions. Of course it was going to bail out the bank and its private-capital customers. The financial sector is the core of Democratic Party support, and it is loyal to its supporters. As President Obama told the bankers who worried that he might follow through on his campaign promises to write down mortgage debts to realistic market valuations in order to enable exploited junk-mortgage clients to remain in their homes, “I’m the only one between you [the bankers visiting the White House] and the mob with the pitchforks,” that is, his characterization of voters who believed his “hope and change” patter talk.
The Biden Administration’s plan is the usual one: kick the bank problem down the road, flood the economy with bailouts (for the bankers, not for student debtors) until election day in November 2024.
The Federal Reserve did indeed pull back on Monday, just as SVB had anticipated. That reduction of interest rates by the Plunge Protection Team did indeed make huge gains for investors in the long-term government bonds that SVB had bought.
The problem was timing. That’s always the problem when there’s a crash.
And there must always be a financial crash at some point. That is because interest-bearing debt grows exponentially, but the economy follows an S-curve and then turns down. And when the economy turns down – or is deliberately slowed down when labor’s wage rates tend to catch up with the price inflation caused by monopoly prices and U.S. anti-Russian sanctions that raise energy and food prices, the magnitude of financial claims on the economy exceeds the ability to pay.
That is the real financial crisis that the economy faces. And it goes beyond banking. The entire economy is saddled with debt deflation (of incomes), even in the face of Federal Reserve-backed asset-price inflation.