Why the Banking System is Breaking Up--from Michael Hudson
This is a post from Michael Hudson. It will be posted later today on his site https://michael-hudson.com/, but the site admin is in Australia, and won't be up for several hours. Since this is a fast moving story, Michael wanted his info up ASAP, hence this cross post.
I do recommend that people follow Michael in general, and especially on this topic. Other bloggers who are must reads on this are:
Frances Coppola, whose post on this topic pre-dated the actual collapse of Silicon Valley Bank by one day:
But there's another problem. A bank can't raise more cash than the market value of the securities it is selling, and if it is pledging securities, it will raise less. So if the market value of the securities is less than the value of the deposits they are backing, the bank may be unable to raise the money it needs to honour deposit requests. Silicon Valley Bank is is already suffering significant deposit outflows. It could be in deep trouble if this became a full-scale flood. (Though right now, the tanking share price seems to be a more immediate concern...)
Dean Baker, who is calling for Federal Reserve retail banking:
The most obvious solution would be to have the Federal Reserve Board give every person and corporation in the country a digital bank account. The idea is that this would be a largely costless way for people to carry on their normal transactions. They could have their paychecks deposited there every two weeks or month. They could have their mortgage or rent, electric bill, credit card bill, and other bills paid directly from their accounts.
and Alf Peccatiello at The Macro Compass, who explains the role of failing to hedge for interest rate risk in Banking Crisis?:
When you buy Treasuries, you lock in a fixed yield you receive and rising interest rates represent a risk.
To hedge that risk, you enter into an interest rate swap: this time, you pay away a fixed yield and receive variable payments in exchange...
SVB had a gigantic investment portfolio as a % of total assets at 57% (average US bank: 24%) and 78% was in Mortgage-Backed Securities (Citi or JPM: around 30%) …and most importantly they DID NOT hedge interest rate risk at all!
I'm working on a Minsky model to illustrate the systemic danger of rising interest rates for banks which hold much of their assets in bonds; I hope to post that later today.
Without further ado, here is Michael Hudson's perspective on the Silicon Valley Bank collapse:
The breakup of banks that is now occurring is the inevitable result of the way in which the Obama Administration bailed out the banks in 2008. When real estate prices collapsed, the Federal Reserve flooded the financial system with fifteen years of Quantitative Easing to re-inflate real estate prices – and with them, stock and bond prices.
What was inflated were asset prices – above all for the packaged mortgages that banks were holding, but also for stocks and bonds across the board. That is what bank credit does. It made trillions of dollars for holders of financial assets – the One Percent and a bit more. The economy polarized as stock prices recovered, the cost of home ownership soared (on low-interest mortgages) and the U.S. economy experienced the largest bond-market boom in history as interest rates fell below One Percent.
But in serving the financial sector, the Fed painted itself into a corner: What would happen when interest rates finally rose?
Rising interest rates cause bond prices to fall. And that is what has been happening under the Fed's fight against "inflation," by which it means rising wage levels. Prices are plunging for bonds, and also for the capitalized value of packaged mortgages and other securities in which banks hold their assets against depositors.
The result today is similar to the situation that S&Ls found themselves in the 1980s, leading to their demise. S&Ls had made long-term mortgages at affordable interest rates. But in the wake of the Volcker inflation, the overall level of interest rates rose. S&Ls could not pay higher their depositors higher rates, because their revenue from their mortgages was fixed at lower rates. So depositors withdrew their money.
To obtain the money to pay these depositors, S&Ls had to sell their mortgages. But the face value of these debts was lower, as a result of higher rates. The S&Ls (and many banks) owed money to depositors short-term, but were locked into long-term assets at falling prices.
This is what is happening to banks today. That is the corner into which the Fed has painted the economy. Recognition of this problem led the Fed to avoid it for as long as it could. But when employment began to pick up and wages began to recover, the Fed could not resist fighting the usual class war against labor. And it has turned into a war against the banking system as well.
Silverlake was the first to go. It had sought to ride the cryptocurrency wave, by serving as a bank for various brand names. After SBF's vast fraud was exposed, there was a run on cryptocurrencies. Their managers paid by withdrawing the deposits they had at the banks – above all, Silverlake. It went under.
That was a "special case," given its specialized deposit base. Silicon Valley Bank also was a specialized case, lending to IT startups. And New Republic was also specialized, lending to wealthy depositors in the San Francisco and northern California area. All had seen the market price of their financial securities decline as Chairman Jerome Powell raised the Fed's interest rates. And now, their deposits were being withdrawn, forcing them to sell securities at a loss. Reuters reported on Friday that bank reserves at the Fed were plunging. That hardly is surprising, as banks are paying about 0.2 percent on deposits, while depositors can withdraw their money to buy two-year U.S. Treasury notes yielding 3.8 or almost 4 percent. No wonder well-to-do investors are running from the banks.
This is the quandary in which banks – and behind them, the Fed – find themselves.
The obvious question is why the Fed doesn't simply bail them out. The problem is that the falling prices for long-term bank assets in the face of short-term deposit liabilities now looks like the New Normal. The Fed can lend banks for their current short-fall – but how can solvency be resolved without sharply reducing interest rates to restore the 15-year Abnormal Zero Interest-Rate Policy (ZIRP)?
Interest yields spiked on Friday, March 10. As more workers were being hired than was expected, Mr. Powell announced that the Fed might have to raise interest rates even higher than he had warned. Volatility increased.
And with it came a source of turmoil that has reached vast magnitudes beyond what caused the 2008 crash of AIG and other speculators: derivatives.
JP Morgan Chase and other New York banks have tens of dollars trillions of derivatives, that is, casino bets on which way interest rates, bond prices, stock prices and other measures will change. For every winning guess, there is a loser. When trillions of dollars are bet on, some bank trader is bound to wind up with a loss that can easily wipe out the bank's entire net equity.
There is now a flight to "cash," to a safe haven – something even better than cash: U.S. Treasury securities. Despite the talk of Republicans refusing to raise the debt ceiling, the Treasury can always print the money to pay its bondholders. It looks like the Treasury will become the new depository of choice for those who have the financial resources. Bank deposits will fall. And with them, bank holdings of reserves at the Fed.
So far, the stock market has resisted following the plunge in bond prices. My guess is that we will now see the Great Unwinding of the great Fictitious Capital boom of 2008-2015.
Michael Hudson also considers private banks to be parasites which I completely agree with because their loans are always exterior to the economic/productive process itself (because they are always either pre-production or post retail sale...commercial finance that only aggregates already created and saved money is a legitimate business model), but he like every other economic theorist I've followed never gets around to being a system's philosopher that analyses the philosophical concepts/paradigms that describe the most basic nature of the patterns they apply to and, mostly unconsciously, control our thinking regarding such system.
You have numerous times said economics needs a new paradigm, so why not investigate a new operant applied concept that REALLY changes things mentally and temporally instead of merely reforms a portion of the pattern...for a little while until its reversed like how Keynesianism got morphed into neo-liberal macro?
You once told me that I had "the worst case of verbal diarrhea you'd ever seen" which stylistically may be somewhat true (although its not my problem if people have difficulty holding several concepts in their minds simultaneously...even if they are all effective, historically verifiable and philosophically aligned) ...but that's actually just ad hominem not actually a valid economic critque.
So I challenge you to follow through with your own belief that we require a new paradigm by actually analyzing on that level and engaging me either here or via email at email@example.com. And please remember I've always agreed with yours and others work, I'm merely asking that we look at things from a higher, more comprehensively effective level of analysis.
I don't understand this:
"Treasury will become the new depository of choice for those who have the financial resources. Bank deposits will fall. And with them, bank holdings of reserves at the Fed."
If (Group A of) portfolio holders swap their M2/deposits with other (Group B) portfolio holders in exchange for bonds, the M2/deposits *don't disappear.* They just move to other accounts.
And their price doesn't, can't change. That is the defining characteristic of M2 instruments: their price is institutionally hard-pegged to the unit of account. One dollar in checking/money-market deposits is always worth $1.*
So if M2 doesn't disappear, neither do banks' offsetting MB/reserve holdings. ??
Meanwhile this round-robin of accounts swapping M2 for Ts will bid/ratchet up the prices hence total Q of (variable-priced!)Ts. So total assets/net worth increase.
The stock of M2/deposits/reserves would decrease if deposits actually disappeared in accounting writeoffs of depositors' balances. But the Fed seems unlikely to allow that to happen.
* That price-pegging is guaranteed and enforced by multiple private and public institutions, notably including but not limited to deposit insurance for bank accounts. When the $65-billion money market Reserve Fund/Primary Fund (not insured by the FDIC/FSLIC or any private bank-insurance institutions) “broke the buck” on September 15, 2008, only offering 97 cents in commercial-bank deposits for $1 in money-market deposits, the U.S. Treasury stepped in within 48 hours to guarantee and prop up the $1 share price of all money market funds. (The funds paid a fee for this temporary but mandatory insurance, dissolved in September 2009.) In practice, in normal times and even extraordinary ones, $1 in M assets always sells for $1 — by definition here, but more importantly by institutional enforcement. Fixed-price is M assets’ sine qua non — the thing that makes them what they are.