The poker game that threatens the world economy

A group of friends meet at a house near the beach to play poker in Pajaro Dunes (California), in the early 1980s. Some win and others lose, but they all decide to participate in the creation of a new bank to provide service to companies in the area, which is becoming more and more known as Silicon Valley.

They choose that name for the entity, without even being aware that it will be their best business letter of introduction.

That game from more than 40 years ago has cost investors around the world tens of billions this week and is testing the ability to respond to prevent financial turmoil from escalating into a full-blown economic crisis.

The experts consulted believe that the authorities will be able to contain the contagion because they have the tools prepared from previous crises.

Still, they acknowledge that downside risks and the likelihood of a US recession have increased.

The global impact for now is minor.

No one expects a financial crisis like the one in 2008, triggered by the bursting of the US mortgage bubble.

Now, the trigger for the crisis has been the most aggressive interest rate hike since the early 1980s, just when Silicon Valley Bank was created.

This was the fall of Silicon Valley Bank

The crisis broke out after the

bank and venture capital firms put their cards on the table.

In early March, Moody's quietly warned him that a downgrade was being considered.

The reason was that he had invested his clients' deposits in Treasury securities, initially very safe, but which had lost value with the sharp rises in interest rates approved by the Federal Reserve last year to combat inflation.

Silicon Valley Bank hired Goldman Sachs and sold it a portfolio of bonds in which it meant materializing 1,800 million in losses. It also decided to increase capital by 2,250 million to reinforce its solvency.

I thought it was a winning hand.

The execution of the operation was disastrous.

The presentation to analysts made by the bank on Wednesday afternoon, March 8, for that placement shows how far the managers were from what was coming their way.

The bank was selling the strategy designed with Goldman Sachs as a way to improve its results.

At that time, it did not raise money because it needed liquidity to return deposits, but to defend its rating and reinvest with higher interest rates.

In the prospectus for the operation, Silicon Valley Bank lowered its forecasts and acknowledged that deposits were being lower than expected because clients, mainly technology companies, were consuming more cash.

The bank decided to sell the debt portfolio first and write down the losses and wait for the next day to issue the new shares.

It was a blunder: “The delay in the capital increase opened a window for panic on Thursday to which the SVB was vulnerable, with more than 95% of deposits uninsured and a deposit base concentrated in capital-backed companies risk, which caused large outflows”, explain the Citibank analysts, who describe the fall of the bank as “self-inflicted”.

SVB shares tumbled on the stock market at the opening of Thursday's session.

The entity failed to place the new titles.

The withdrawal of deposits broke records of amount and speed.

Clients asked to withdraw 42,000 million dollars from the bank in a few hours.

The concentration of deposits in a single sector, the fact that the vast majority did not enjoy a public guarantee (which only extends up to $250,000 per client) and herd behavior made the prophecy self-fulfilling.

No bank has the liquidity to return the money if all the clients request it at the same time.

That is why bank runs are so dangerous.

In addition, deposit leaks are no longer in the style of

, the 1946 film in which James Stewart plays George Bailey, an honest banker who decides to commit suicide after a large sum of money disappears.

In the digital age, you don't even need long queues or crowds, just transfer orders with your mobile or computer.

Nor is there the option of a George Bailey calling for calm ("the money is not here, it is in Joe's house, next to yours, in the Kennedys, in hundreds of houses...").

On the morning of Friday, March 10, the authorities intervened in the bank.

After almost 40 years of existence, Silicon Valley Bank disappeared in about 40 hours.

It was the largest bank failure since the fall of Washington Mutual in 2008 and the second largest in the history of the federal deposit insurance fund (FDIC).

This body, in charge of intervening banks in crisis, was created after the Great Depression, after some 9,000 entities disappeared between 1930 and 1933 due to bank panics.

By granting a public guarantee on deposits up to a certain level, citizens do not need to run for their money at the slightest hint of distrust.

the contagion arrives

After the SVB intervention, the contagion began immediately.

That same Friday, the stock prices of other medium-sized banks in the United States fell and, as was later learned, there were more deposit runs.

The Treasury Department, the FDIC and the Federal Reserve began to analyze how to contain the crisis.

On Sunday night (in the tradition of the previous financial crisis) they announced the intervention of another entity, Signature Bank and that the federal guarantee was extended to 100% of the deposits of both banks, something that they could only do exceptionally declaring a situation of systemic risk.

The New York Stock Exchange, this Thursday.

SPENCER PLATT (Getty Images via AFP)

The characteristics of Silicon Valley Bank (with its concentration of VC clients) and Signature Bank (for its cryptocurrency exposure) were unique, but regulators had recently estimated that the banks had some $620 billion of unrealized losses in their portfolios. fixed income due to increases in interest rates.

Along with guaranteeing the deposits of the two failed entities, the Federal Reserve approved a measure to provide liquidity to other banks for the original value of the bonds, as if they had no losses, and thus prevent new deposit leaks.

The authorities fired the managers of the banks, made it clear that they would not protect shareholders or bondholders (“This is capitalism,” said the president, Joe Biden).

In practice, they bailed out depositors, including some investment firms that renounce public intervention in the economy.

Biden has called for tougher punishments for bankers of failing banks and has blamed his predecessor, Donald Trump, for relaxing supervision of mid-market banks.

Both Biden and Treasury Secretary Janet Yellen have insisted that the financial system is sound.

The Federal Reserve has set out to investigate what has gone wrong, why its supervision could not prevent the risks that have materialized.

Banks around the world, including European ones, have suffered on the stock market since Monday.

There are various routes of contagion, on a continuum that goes from direct exposure to fallen entities to irrational fear.

But Credit Suisse was hit squarely by the shock wave, partly because of its own blunders.

The bank has been dragging problems for years, but on Tuesday it published its annual report and in it it recognized "relevant weaknesses" in its financial information control systems.

It's never a good time to say something like that, but doing it in the middle of a storm... To top it off, on Wednesday the president of Saudi SNB, Credit Suisse's largest shareholder, was asked if he would be willing to increase his stake in the Swiss entity and instead going off on a tangent, he said, "Absolutely not."

The collapse was immediate.

After a multimillion-dollar liquidity lifeline provided in the early hours of Wednesday to Thursday, the Swiss authorities are working this weekend to find a solution, which may include the sale of the bank or part of it.

“Restore confidence in Credit Suisse is important for Switzerland,” Canadian firm DBRS Morningstar said this week.

"Credit Suisse is too big to fail and too big to bail out, so it's too big for Switzerland anyway," said an economist at a US firm.

ready to act

In the face of the SVB crisis and its ramifications, the good news is that the economic authorities have the toolbox at hand.

The 2008 financial crisis, the euro crisis and the pandemic have meant that central banks and policy makers are trained, know what to do and how to do it.

“That mental block that sometimes aggravates crises has been avoided.

The authorities do not like bailouts because of the moral hazard involved, they tend to wait until there is clear suffering, until it is seen that there is no other remedy and it ends up being worse.

This time they have reacted very quickly.

In two days, many people have gone from finding out that there was a bank called Silicon Valley to knowing that it was intervened, with guaranteed deposits," says an executive from one of the largest investment firms in the United States from New York. which also highlights the speed at which the Federal Reserve has implemented a tailored mechanism to respond to possible liquidity leaks.

"Although there is no doubt that banking problems will attract attention, we believe that it is not a systemic problem, but rather a liquidity problem that the Federal Reserve can contain with its lending mechanisms," they point out from the Oxford firm. Economics.

"It may seem like another financial crisis, but it is not," they say.

In Europe, the ECB has raised interest rates while ensuring that it sees no risk of contagion and guarantees that it is prepared to deal with liquidity problems.

“The expected rise of 50 basis points comes with a warning about risks to financial stability.

That said, the banking system shows no weaknesses or significant exposure to troubled foreign institutions”, summarized Axel Botte, global market strategist at Ostrum AM.

View of a euro symbol at the gates of the European Central Bank, in Frankfurt (Germany).

EFE

Eurozone banks have lower exposure to fixed income securities, more stable deposit bases and tighter interest rate risk regulation, even for smaller banks.

In any case, as María Rivas of DBRS Morningstar warned, "the recent bankruptcies show that bank runs and liquidity crises can develop at a speed never seen before."

For this reason, it advocates for more tools to deal with liquidity crises.

economic ballast

The financial storm is fulfilling the liturgy of these cases.

Falls in the Stock Market, intervention by the authorities, actions on the weekend, shocks, relief... But if that is a tradition, it is also a tradition that banking crises take their toll on the economy.

Michael Hartnett, investment strategist at Bank of America, notes that

since 1870 there have been 14 major global recessions, all caused by wars, pandemics, and banking crises.

This time, in full recovery from a pandemic, a war has fueled inflation and rate hikes have contributed to a (so far small) banking crisis, but it is not yet clear what its effect will be.

“The US economy will eventually slow down, probably a bit sooner than expected after these events, but it could still take a while,” says Vincent Vinatier, a portfolio manager at AXA Investment Managers, in a cautious sentence.

“Nobody has any idea nor can they have it yet,” says an economist from a US investment giant more forcefully, explaining that deposits have passed from one entity to another and that it is not clear how intense the credit restriction will be.

What does seem clear is that downside risks or recession probabilities have increased, which Goldman Sachs has raised to 35%.

“These events could lead to a recession,” agrees Tiffany Wilding, US economist at PIMCO.

In her view there are very good reasons to believe that credit growth, which was already slowing, will slow further.

“Regional banks are likely to be more risk averse, at least in the short term,” she says, because “it is hard to believe that these banks, fearing a possible sudden outflow of deposits, will not tighten up their lending rules” .

The Federal Reserve is also likely to tighten regulation and supervision of large regional banks, indirectly restricting credit.

Even so, the United States has been announcing an imminent recession for almost a year and it hasn't quite arrived.

The labor market has shown great strength.

The Federal Reserve intends to cool demand to combat inflation and this episode of instability could make it necessary to raise rates a little less, but it does not change the economic outlook excessively (at least for now).

Something similar happens in the rest of the world.

Obviously, what happened is not good news and the risks have increased, but it is too soon to gauge a real impact on the global economy.

Emerging countries, and Latin Americans among them, are in a little more danger: “The financial turmoil in the United States after the bankruptcy of two regional banks has increased volatility and has caused the value of Latin American assets to fall.

The episode of risk aversion has not changed our baseline forecast, but it has highlighted the region's sensitivity to a severe tightening of financial conditions”, they explain from Oxford Economics.

The experts of the International Monetary Fund (IMF) are working these days to adjust their world economic forecasts.

They will present their conclusions in less than a month.

If the damage in the United States remains a couple of scratches in its financial system, the impact on the rest of the world should not be great.

The next few days may be key.

It's not yet clear that the private bailout of First Republic Bank, another San Francisco-based regional bank with $30 billion in deposits from big Wall Street banks, has worked.

First Republic has continued to fall on the stock market after the injection and no one rules out a surprise this Sunday.

The operation has been led by Jamie Dimon, the president of JP Morgan Chase.

With it, he was honoring John Pierpont Morgan, who orchestrated the response to the financial panic of 1907 and committed his own money to it, aware that it was to the benefit of the entire industry to support the weakest.

Banks live on trust and for a banker it must not have been very pleasant to see that bitcoin has skyrocketed this week due to money fleeing banks in search of

The Federal Reserve makes a move

The fall of Silicon Valley Bank (SVB) will largely mark the meeting of the Federal Reserve's monetary policy committee this Tuesday and Wednesday.

After the rise in rates of the European Central Bank (ECB), now it is the turn to make a move for the US central bank.

Before the current financial storm, analysts were divided between whether Jerome Powell would choose to raise interest rates by 0.25 points or half a point, as inflation is barely abating (it stood at 6% in February).

Now, after the intervention of the SVB and the Signature Bank and the other financial turbulence of the last week, there were those who even bet on a pause after the eight consecutive rises in the last year, which have left the price of money at 4.5%. -4.75%, its highest level since 2007. Rate hikes are what have contributed to the problems of medium-sized banks, by lowering the value of the bonds they have in their portfolio, and further increases may increase financial instability .

But Powell does not want to risk his credibility in the fight against inflation, so the dilemma is served.  

"You have to choose which mistake you prefer to make," says an economist with a sneer who believes that the separation principle is appropriate in which the central bank uses rates to fight inflation and liquidity for financial stability.

Not only the decision, but Powell's statement and press conference on Wednesday are of particular interest.

“We continue to expect a 25 basis point rate hike at the meeting as the Federal Reserve believes it can prevent contagion by providing the necessary liquidity and get ahead of the inflation curve by raising rates.

But the financial turbulence will probably eliminate the possibility of a rise of 50 basis points, which was what was expected until recently ”, summarized in Oxford Economics.

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