One consequence of the unprecedented tightening of monetary policy imposed by central banks in most countries (including Canada) over the past year has been growing fragility in the broader financial system. Banks, near-banks, and other financial players—many of them highly leveraged after 15 years of near-zero interest rates—are now grappling with the impacts of higher interest rates on their investments and balance sheets.
The fast increases in interest rates have caused major declines in the prices of bonds, including safe government bonds. There is no question those debts will be repaid by governments: they are the lowest-risk borrowers in the whole economy. But the speculative resale value of bonds, we have been reminded, is not stable at all: bond resale prices rise and fall rapidly with changing expectations among market-players about the future direction of interest rates. Financial institutions which bought bonds as a safe ‘foundation’ for other lending and speculative activities are finding out that even government bonds can be very risky, indeed.
A near miss was encountered last September, when several UK pension funds almost collapsed as a result of falling bond prices and huge resulting losses. They were rescued at the last minute by a massive market intervention by the Bank of England.
That was the canary singing in the coal mine. Now, in rapid succession, five banks have collapsed in two weeks: four in the U.S., and one (Credit Suisse, one of the biggest banks in the world) in Switzerland. Could this be the precursor to another global financial crisis, similar to the meltdown of 2008-09? Financial and political leaders are all saying, in learned lecturing tones, that the financial system is safe, and banks are stable and well-capitalized. That’s what they are paid to say: and that’s what they said early in 2008, as well. They are desperate to keep everyone calm, whether there is reason to worry or not—because panic itself can become a self-fulfilling prophecy, fracturing a system that always depends on trust.
Rules regarding capital adequacy were tweaked after the 2008-09 crisis, via the Basel process and other channels. Nevertheless, the fact remains that private banks are empowered to create money out of thin air by issuing new loans, leveraging their initial capital 30 times or more. That means there is still little ‘real’ money underpinning their vast placements—and hence even the strongest-seeming banks are vulnerable to fracture when the tides of confidence turn the wrong way.
It is instructive how quickly governments and central banks have ridden to the rescue of these troubled institutions, retroactively changing the rules of the banking system to protect investors and stabilize other shaky banks.
For example, the $1.4 trillion in assets of Credit Suisse were transferred to another huge Swiss bank, UBS, in a fire sale orchestrated by the Swiss government and central bank over a single weekend. UBS will have to ‘pay’ just $4.5 billion worth of its own shares (not real money) to get control of an enormous bank. The Swiss government will guarantee (with actual money!) some $14 billion in future potential losses from the Credit Suisse business. Meanwhile, the Swiss central bank will inject $150 billion in short-term loans (known as liquidity support) to facilitate the takeover and calm investor nerves, on top of $75 billion it injected (fruitlessly) into Credit Suisse last week.
This transaction effectively gives UBS another giant bank for free: simply because it was a relatively stable bystander, with the balance sheet and confidence to outlast the panic (or so the government hopes).
The four U.S. bank collapses have also been met with equally extraordinary, unilateral, retroactive actions by the U.S. central bank, the Federal Deposit Insurance Corporation, and other public agencies. The FDIC guaranteed all of the deposits of collapsed Silicon Valley Bank—even those many times above the normal $250,000 limit that applies to ordinary depositors. The fact that SVB’s deposits were mostly from wealthy Bay-area tech investors might have something to do with that.
Like the bank bailouts of 2008-09, which in many countries (especially the UK) left a legacy of scorched-earth government austerity as socialized losses were repaid, the contrast between governments’ fast and forceful actions to protect banks and finance capital, and the austerity imposed on the rest of society, is shocking. We see again that banks have access to the support and protection of an unlimited nanny state, while others are left to fend for themselves. This provides instructive insight into the power imbalance in economic policy, and in society.
Underlining this, within days of the bank collapses the U.S. Federal Reserve renewed its campaign of higher interest rates to recreate ‘desirable’ levels of unemployment, undermine wage growth, and (it assumes) thus cure the scourge of inflation. It raised its policy interest rate again by another 0.25 percent. This came days after the same Fed created $300 billion of new money in the form of emergency liquidity assistance for the banks. In essence, the Fed is sucking and blowing at the same time.
In the Fed’s view, inflation is caused by workers having “too much money,” and this must be cured with higher interest rates and monetary austerity. But inflation is not a problem when it comes time to pumping a flood of cheap money into the banks.
Jim Stanford is Economist and Director of the Centre for Future Work in Vancouver. Hear a longer discussion of this latest banking crisis, its potential impact in sparking another recession, and the contradictions of anti-inflation policy, on CBC’s podcast series Front Burner.