To what extent is the bank mess serious?

I'm on vacation and try to spend a few weeks without thinking about the usual, but in the end I can't stay out of the debate about the sudden wave of banking crises and its effect on the economic outlook.

As everyone knows, Silicon Valley Bank (SVB) has been seized by the Federal Deposit Insurance Corporation after dealing with a classic case of a bank run.

Signature Bank soon followed, and First Republic Bank is under heavy pressure.

The Swiss authorities have organized the takeover of Credit Suisse, one of the main banks, by its rival UBS.

And everyone wonders what other landmines are about to go off.

There are going to be a lot of inquiries into why these banks got into such a mess and how they managed to do it.

In the case of the SVB, it seems that the regulators knew for a long time that this was a problematic case, but for some reason they did not or could not stop it.

However, the most pressing questions have to do with the future.

To what extent does the banking disaster change the conditions of the economy?

To what extent should economic policy change?

Some analysts are issuing doomsday warnings about hyperinflation and the impending collapse of the dollar.

But, almost certainly, this is the opposite of the truth.

When depositors withdraw their money from banks, the effect is disinflationary, even deflationary.

That was, of course,

The savings and loan crisis of the 1980s did not reach the level of the 1929 crash, largely because depositors were generally insured, so their funds were fully repaid (at enormous cost to taxpayers) despite the huge losses in the sector.

Even so, the crisis possibly slowed business lending, especially in commercial real estate, contributing to the 1990-1991 recession.

And the financial crisis of 2008 was also disinflationary and helped cause the worst economic recession since the Great Depression.

How is the current chaos different from them?

There is no doubt that it will be a drag on the economy.

But how big?

And to what extent should economic policy, particularly the Federal Reserve's decisions on interest rates, change?

The answer is simple: nobody knows.

Here's what we do know: It doesn't look like depositors are asking for cash and putting it under their mattress.

However, they are transferring funds from small and medium banks, partly to large banks, and partly to money market funds.

Both types of banks are likely to lend less to businesses than the smaller banks now under pressure.

Large banks are subject to stricter regulation than small ones, as they are required to hold more capital (excess assets over liabilities) and more liquidity (a higher proportion of their assets dedicated to investments that can be easily converted in hard cash).

Money market funds also have to meet fairly stringent liquidity requirements.

Add in the likelihood that even banks that have not seen a run on deposits will become much more cautious, and we are likely looking at a severe credit crunch.

In fact,

I wrote a couple of weeks ago that the Federal Reserve is navigating through a dense data fog, trying to bridge the strait between Scylla, the inflation monster, if it falls short, and Charybdis, the recession monster, if it falls short. goes too far (or maybe the other way around; input from Homer experts is welcome).

Well then, the fog has grown even thicker.

But it's clear that recession risk has increased and inflation risk has decreased, so it makes sense for the Federal Reserve to veer a bit to the left.

What this probably means in practice is that the Fed should suspend raising rates until the inflation picture and the effects of the banking mess clear up a little more, and should make it clear that this is what it is doing.

There does not seem to be much danger that the US central bank will lose its credibility in fighting inflation if it takes time to get its bearings.

Inflation forecasts seem very well anchored.

Should the institution go further and lower rates?

While I'm generally a money pigeon, I wouldn't ask for a real downgrade, at least not yet.

Among other things, that could convey a sense of panic.

And while the wave of banking troubles has shocked almost everyone, panic doesn't seem like the appropriate response.

On the other hand, for the Federal Reserve to continue raising rates right now could send the opposite signal: a sense of disorientation.

It seems that it is the moment to say: do not act for the sake of acting;

stay still.

For what it's worth, I'm actually somewhat reassured by the way policy makers are responding to the current spate of banking troubles.

Some of us remember the bitter debates of 2008-2009 about how to stabilize the financial system.

The troubled institutions were complex and opaque, and no one in power seemed willing to intervene in order to rescue them without also rescuing the shareholders.

This time we are talking about conventional banks that can be and have been intervened, protecting depositors without letting shareholders off the hook.

The bottom line is that, for now, this doesn't look like a full-blown financial crisis.

But stay tuned.

Paul Krugman is a Nobel Prize Winner in Economics.

© The New York Times, 2023. Translation of News clips

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