Why the Banking Crisis Isn't Over Yet

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By MICHAEL HUDSON*

The magnitude of financial claims on the economy exceeds the ability to pay

The Silvergate, Silicon Valley Bank, Signature Bank and related bank failures are far more serious than the 2008-09 crash. The problem back then was dishonest banks making bad mortgage loans. Debtors were unable to pay and were in default and it was discovered that the properties they had pledged as collateral were fraudulently overvalued, that there were junk "cost-effective" mortgages made by false valuations of the real market price of the property and the borrower's income . Banks sold these loans to institutional buyers such as pension funds, German savings banks and other naive buyers who had drunk the neoliberal kool-aid by Alan Greenspan, believing that the banks would not deceive them.

Silicon Valley Bank (SVB) investments did not carry this risk of default. The Treasury could always afford it simply by printing money, and the major long-term mortgages whose packages Silicon Valley Bank bought were also solvent. The problem is the financial system itself, or rather the corner the post-Barack Obama Fed has put the banking system into. He cannot escape his 13 years of monetary relaxation (quantitative easing) without reversing asset price inflation and causing bonds, stocks and real estate to drop in market value.

In a nutshell, resolving the 2009 illiquidity crisis, which saved banks from losing money (at the cost of burdening the economy with huge debts), paved the way for the deeply systemic illiquidity crisis that is only now becoming clear. I can't resist pointing out its basic dynamic in 2007 (Harpers) and in my 2015 book, Killing the Host.

Accounting fictions versus market reality

There were no default risks for the government bond investments or long-term mortgage packages that Silicon Valley Bank and other banks purchased. The problem is that the market valuation of these mortgages has dropped as a result of rising interest rates. The interest yield on bonds and mortgages purchased a few years ago is much less than what is available on new mortgages and new Treasury notes and bills. When interest rates rise, these “old bonds” drop in price to bring their yield to new buyers in line with the Fed's rising interest rates.

This time, there is a market valuation problem: it is not a fraud problem.

The public has just discovered that the statistical picture that banks present about their assets and liabilities does not reflect the reality of the market. Bank accountants may price their assets at “book value” based on the price that was paid to acquire them – without regard to the value of those investments today. During the 14-year boom in bond, stock and home prices, this undervalued the real gain banks made when the Fed lowered interest rates to inflate asset prices. But that monetary easing ended in 2022, when the Fed began tightening interest rates to slow wage gains and make workers foot the bill for falling inflation.

When interest rates rise and bond prices fall, stock prices tend to follow suit. But banks don't need to lower the market price of their assets to reflect this decline if they simply hold their bonds or bundled mortgages. They only need to reveal the loss in market value if depositors withdraw their money and the bank actually has to sell those assets to raise the money to pay its depositors.

That's what happened at Silicon Valley Bank. In fact, it has been a problem for the entire US banking system. The following chart comes from Naked Capitalism, which tracks the banking crisis daily:

The SVP's short-term view failed to see where the financial sector was headed

During the years of low interest rates, the US banking system found that its monopoly power was very strong. He only had to pay depositors 0,1 or 0,2% on deposits. That was all the Treasury was paying in risk-free short-term Treasuries. Thus, depositors had few alternatives, but banks charged much higher rates for their loans, mortgages and credit cards. And when the Covid crisis broke out in 2020, corporations withheld new investment and flooded banks with money they weren't spending.

Banks were able to make an arbitrage gain – getting higher investment rates than they paid for deposits – by buying longer-term bonds. Silicon Valley Bank bought long-term Treasuries. The margin was not large – less than 2 percentage points. But it was the only safe “free money” available.

Last year, Federal Reserve Chairman Jerome Powell announced that the central bank would raise interest rates to slow supposed wage growth that came as the economy began to recover. This led most investors to realize that higher interest rates would drive down bond prices – more sharply for longer-term bonds. Most money managers avoided such price declines by shifting their money into short-term Treasuries or money market funds as house, bond and stock prices fell.

However, Silicon Valley Bank was left hanging when Mr. Jerome Powell announced that there weren't enough American workers out of work to contain his wage gains, so he planned to raise interest rates even more than he expected. He said a serious recession was needed to keep wages low enough to keep US corporate profits and therefore their stock prices high.

This reversed the monetary easing of the Obama bailout, which had steadily inflated real estate, stock and bond prices. But the Fed has cornered itself: If it restores the era of “normal” interest rates, it will reverse the 15-year increase in asset price gains for the financial sector as a whole (FIRE).

This sudden change on March 11th and 12th left Silicon Valley Bank SVB “sitting on an unrealized loss of nearly $163 billion – more than its equity base. Deposit outflows have started to show this through a realized loss.” Silicon Valley Bank was not alone. US banks were losing deposits.

This was not a “run on the banks” resulting from fears of insolvency. It was because the banks were strong enough monopolies to avoid sharing their growing earnings with their depositors. They were making increasing profits from the fees they charged borrowers and the fees generated by their investments. But they continued to pay depositors only about 0,2%.

The US Treasury was paying much more, and on Thursday, March 11th, the 2-Year Treasury Note was yielding nearly 5%. The widening gap between what investors could earn by buying risk-free Treasury bills and the pittance banks were paying prompted wealthier depositors to withdraw their money to earn a higher market return elsewhere.

It would be wrong to think of this as a “run on the banks” – let alone a panic. Depositors were not unreasonable or subject to the “madness of the crowd” when withdrawing their money. Banks were simply too selfish as they should be. And as customers withdrew their deposits, banks had to sell their bond portfolios – including the long-term bonds held by Silicon Valley Bank.

This is all part of the unfolding of Barack Obama's bank bailouts and quantitative easing. The result of the attempt to return interest rates to more normal historic levels is that, on March 14, ratings agency Moody's cut the outlook for the US banking system from stable to negative, citing the "rapidly changing operating environment" . They are referring to the falling ability of bank reserves to cover what they owed to their depositors, who withdrew their money and forced banks to sell securities at a loss.

President Joe Biden's Deceitful Play

President Joe Biden is trying to confuse voters by assuring them that the “bailout” of wealthy Silicon Valley Bank depositors without insurance is not a bailout. But, of course, it's a rescue. What he meant was that the bank's shareholders were not bailed out. But its large uninsured depositors who were saved from losing a single penny despite the fact that they did not qualify for this “goodness” and in fact they talked amongst themselves and decided to jump ship and cause the bank to collapse.

What Joe Biden really meant is that this is not a taxpayer bailout. It does not involve money creation or a budget deficit, just as the $9 trillion created by the Fed through monetary easing in 2008 and beyond was either money creation or a budget deficit increase. It's a balancing act – technically a sort of “swap” with Federal Reserve good credit offsetting against “bad” bank securities pledged as collateral – far above current market prices, to be sure. It was precisely this that “rescued” the banks after 2009. The federal credit was created without taxation.

The tunnel vision inherent in banking

One might echo Queen Elizabeth II and ask, “did no one see this coming?” Where was the Federal Mortgage Bank that was supposed to regulate Silicon Valley Bank? Where were the Federal Reserve examiners?

To answer this, one must look at who the bank's regulators and examiners are. They are scrutinized by the banks themselves, chosen to deny that there are any inherently structural problems in our financial system. They are “true believers” that financial markets are self-correcting by “automatic stabilizers” and “common sense”.

Deregulatory corruption played a role in the careful selection of such tunnel-vision regulators and examiners. Silicon Valley Bank was overseen by Federal Home Loan Bank (FHLB). The FHLB is known for regulatory capture of banks that choose to operate under its oversight. However, Silicon Valley Bank's business is not mortgage lending. It is the loan for private entities (private equity) high tech companies that are being prepared for IPOs – to be issued at high prices, talked about and then often left to fall in a bomb and dump game. Bank employees or examiners who recognize this problem are fired from their jobs for being “overqualified”.

Another political consideration is that Silicon Valley is a stronghold of the Democratic Party and a rich source of campaign finance. The Joe Biden administration was not going to kill the goose that lays the golden eggs of campaign contributions. Of course, it would bail out the bank and its private equity clients. The financial sector is the Democratic Party's core of support, and the party's leadership is loyal to its supporters.

As President Barack Obama told bankers who feared he would make good on his campaign promises to write down mortgage debts at realistic market valuations in order to allow exploited junk mortgage customers to stay in their homes: “I am the only one among you bankers (who visited the White House) and the hanged crowd” – here is his characterization of voters who believed in his speech of “hope and change”.

Fed freaks out and rolls back interest rates

On March 14, stock and bond prices soared. Margin buyers have made a killing as they see the government's plan is the same: kick the bank problem into the future, flood the economy with bailouts (for bankers, not student borrowers) by election day in November from 2024.

The big question, therefore, is whether interest rates can return to a historic “normal” without turning the entire banking system into something like the Silicon Valley Bank. If the Fed really raises interest rates back to normal levels to supposedly slow wage growth, there should be a financial meltdown. To avoid this, the Fed must create an exponentially growing stream of quantitative easing.

The underlying problem is that interest-bearing debt grows exponentially, but the economy follows an S curve and then goes down. And when the economy slows down – or is deliberately slowed down when labor wages tend to keep pace with price inflation caused by monopoly prices and US anti-Russian sanctions that raise energy and food prices. That is, the magnitude of financial claims on the economy exceeds the ability to pay.

This is the real financial crisis facing the economy. Go beyond the bank. The entire economy is saddled with debt deflation, even in the face of Federal Reserve-backed asset price inflation. So the big question – literally the “bottom line” – is how can the Fed maneuver out of the low-rate quantitative easing corner that the US economy has been put into? The longer and whichever ruling party continues to prevent financial sector investors from suffering losses, the more violent the final resolution must be.

*Michael Hudson is a professor at the University of Missouri, Kansas City. Author, among other books by Super Imperialism: The Economic Strategy of the American Empire (Island).

Translation: Eleutério FS Prado.

Originally published on the portal counter punch.


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