Issue link: https://maltatoday.uberflip.com/i/1495507
23.3.2023 11 WORLD NEWS e longer the duration of a bond, the more its price drops when rates are ris- ing. Because Silicon Valley Bank had more of its holdings in those long-dated bonds, it started suffering paper losses as those bonds declined in value. And because it was not so large that it had been classified as systemically danger- ous like banks with over $250 billion in assets, it did not face as stringent capi- tal and regulatory requirements as, say, Chase. When it sold a tranche of those bonds at a loss to cover customer withdraw- als, the entire VC industry in California and elsewhere got spooked, told their clients to pull their funds, and voila, a bank run. It may well be true that the manage- ment of Silicon Valley and Signature failed in their risk controls. It is undeni- ably true that the assets they held, U.S. government bonds, were about as vanil- la as possible. In fact, the Federal Reserve and oth- er banking regulators had made a point since the 2008-2009 financial crisis that banks that held a significant reserve of U.S. government bonds were to be viewed more favourably and as better inoculated against possible problems. at is precisely what Silicon Valley Bank did, and that is precisely why it imploded. Which brings us to the real cause of what happened: a Fed that has been so focused on curbing inflation that it has essentially ignored the risks of its policy of raising rates more quickly than at any point in history. It has acted as if infla- tion is such a threat to financial stability that it lost sight of the fact that fighting inflation can, if pursued in too draco- nian a fashion, can itself be a threat to financial stability. e Fed is a technocratic agency. It takes its mandates of price stability and the guarding the health of the financial system seriously, and its mandarins have been utterly crucial in times of crises, especially in 2008-2009 and in March of 2020. But the flip side is a tendency to become detached from the real-world implications of their decisions, and the past year of aggressive rate hikes have gone from a legitimate (albeit debata- ble) response to higher-than-expected inflation to a zealous crusade to tame higher-wages, a tight labour market and robust consumer spending in the belief that sometimes, you have to harm the economy to help it. Short-term pain for long-term gain. at includes a seeming indifference to the secondary effects of inflation fighting. Fed officials have spoken of a labour market that is too tight "to an unhealthy level." In the abstract, a tight labour market might be a negative for inflation given that it leads employer to pay higher wages in order to attract scarce workers, but in the real world, a tight market means that more people are employed and getting paid more. Treating that as a negative will likely enrage a substantial portion of the actu- al humans who comprise the economy and that in turn will eventually under- mine the credibility that the Fed needs to do its job. Even more troubling is the failure to respect the structural risks of raising interest rates so aggressively. Yes, runa- way inflation at points in the past, such as Weimar Germany in the 1920s and multiple Latin American and African nations in the last decade of the 20th century, can be perilous to societal sta- bility. But does 6% inflation for a year after a global pandemic pose a danger sufficient to push the financial system to the brink and punish banks for not ad- justing quickly enough to sharply high- er rates? And the Fed can't claim ignorance here. e balance sheets of Silicon Valley Bank and others were hardly secret, and any credible regulator could have noticed months ago that the composition of the holdings in the face of rapidly rising rates was a potential problem. No one flagged that, and while the management of mul- tiple banks might indeed have been slop- py, careless, venal and even downright incompetent, none of that excuses the Fed, with its hundreds and hundreds of highly trained economists and a culture steeped in gaming out risk scenarios, from its carelessness here. It is unclear yet whether this particu- lar own-goal is a one-off or the start of a crisis. Either way, it was an entirely pre- ventable one, and the result of reckless policy. e best the Fed can do now is pause and re-assess its current inflation fighting path. Otherwise, it may suc- ceed in taming inflation but only at the cost of ravaging an otherwise stable and sound economy. SVB and the banking crisis CREDIT Suisse, the 167-year-old Zu- rich-based lender, was bought by its bigger rival UBS over the weekend in a deal backed by the Swiss government. e emergency merger with UBS for £2.6bn took place on Sunday in a frantic attempt to prevent damage to the wider Swiss and global financial markets. Credit Suisse's customers are wealthy international individuals and businesses rather than ordinary sav- ers, but as Switzerland's second larg- est lender, and Europe's 17th largest, it is a far bigger beast than Silicon Valley Bank (SVB). As such it is strategically more important to the global financial system. e beleaguered bank was widely re- garded as "too big to fail" by experts but trouble has been brewing for years thanks to a series of controversies – including its connection with now bankrupt supply chain lender Green- sill Capital where former prime min- ister David Cameron was an adviser. is long string of scandals as well as management changes and finan- cial losses culminated last week, in the wake of the collapse of SVB, when spooked investors speculated about which bank would be next. When Credit Suisse's largest share- holder, Saudi National Bank, an- nounced on Wednesday that it wouldn't be adding to its investment due to regulatory rules, it added fuel to the fire of investors' existing con- cerns. e value of its stocks and bond prices fell dramatically, and there was a surge in clients attempting to with- draw their deposits. What is happening now? UBS has bought rival Credit Suisse, in a Swiss government-backed deal after regulators worked around the clock to secure a deal. is led to shares in European banks falling with Deutsche Bank and UBS trading 1.8 per cent and 3.7 per cent lower respectively, after regaining some ground. One controversial aspect of the res- cue deal is that any investor holding additional tier one bonds (AT1) will get no recompense after the Swiss fi- nancial regulator, Finma, ruled that al- most £14bn of the AT1s be written off. It has caused some to question the hierarchy of investor claims – Credit Suisse's shareholders are set to receive over £2.5bn as part of the deal. e move has also spooked the AT1 bond market which is worth more than £200bn. Does this mean we're heading for another global financial crisis? In the wake of Credit Suisse's trou- bles, banking shares tumbled and economist Nouriel Roubini – nick- named Dr Doom for predicting the fall of Lehman Brothers which led to the global financial crisis in 2008 – has voiced fears that we could be teetering on the edge of another sys- temic crisis. But so far most experts are not fore- casting a repeat of the 2008 financial crisis which saw the collapse of several large banks and triggered a global re- cession. Former Bank of England dep- uty governor, Sir John Gieve, said the support to save Credit Suisse marked a key difference to this scenario and Lehman Brothers. "Credit Suisse is like Lehman Broth- ers in terms of scale and complexity and importance but there's a big dif- ference if you remember the Amer- icans didn't save Lehman Brothers. at was what spooked the markets as a whole because they didn't stand behind it," he said. "If you go back a couple of months, the first sort of problem arising in the financial market from higher inter- est rates was here in the UK with our pension funds. "If you remember, our central bank stepped in and provided the money to ensure it didn't have repercussions elsewhere, so the message is abso- lutely clear that the central banks are standing behind these banks that are getting into trouble," he added. What happened to Credit Suisse? that are perceived to be in a similar position to SVB could lead to more bank runs. The most at-risk banks are mid-size regionals that focus on venture-backed startups and have large uninsured deposit bases and a less-diversified clientele. Big Six US banks are unlikely to be at risk The biggest Wall Street lenders will have some exposure to the uncertainty surrounding regional banks, but they're well prepared to weather the storm that's hurting less established lenders. Due to regulation introduced after the financial crisis, major banks are sitting on billions of dollars of capital and have strong liquidity to shield against incidents like this. And they must pass stress tests and keep to capital and liquidity requirements . The Big Six lenders may even benefit from the situation. They've been swamped with applications from customers aiming to move their money out of smaller banks amid fears that SVB contagion could wipe out other regional lenders.