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How important is the banking mess?

2023-03-22T15:28:31.941Z


A murky economic picture just got even murkier. I'm on vacation and I try to spend a few weeks without thinking about the usual. But it turns out that I cannot completely stay out of the debate about the sudden wave of banking crises and their effect on the economic outlook. The Silicon Valley Bank (SVB) logo REUTERS/Dado Ruvic/ As everyone knows, Silicon Valley Bank - not a very large entity, but an integral part of the financial ecosystem


I'm on vacation and I try to spend a few weeks without thinking about the usual.

But it turns out that I cannot completely stay out of the debate about the sudden

wave of banking crises

and their effect on the economic outlook.

The Silicon Valley Bank (SVB) logo REUTERS/Dado Ruvic/

As everyone knows,

Silicon Valley Bank

- not a very large entity, but an integral part of the financial ecosystem of the technology industry - has been intervened by the Federal Deposit Insurance Corp. after facing a classic bank run.

Signature Bank

followed soon after;

First Republic Bank

is under severe pressure.

The Swiss authorities have organized the takeover of

Credit Suisse

, a major bank, by its rival UBS.

And everyone is wondering what other

landmines

may be about to go off.

There will and should be a lot of investigation into how and why these banks got into so much trouble.

In the case of Silicon Valley Bank, it appears that regulators have known for a long time that the bank

was a problem case,

but for whatever reason they were unable or unsuccessful in stopping it.

But the most pressing questions are for the future.

To what extent does the banking disaster change economic conditions?

To what extent should economic policy change?

Some commentators – mainly, from what I see, cryptocurrency enthusiasts – are issuing

doomsday warnings

about hyperinflation and the impending collapse of the dollar.

But that's almost certainly the opposite of the truth.

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

That is certainly what happened in the early years of the

Great Depression.

The savings and loan crisis of the 1980s was not a Depression-level event, largely because depositors were generally insured, so they recovered (at taxpayer expense) despite huge losses from the industry.

Even so, the crisis may have slowed business lending, especially in commercial real estate, contributing to the 1990-91 recession.

And the 2008 financial crisis—which was functionally a run on banks, even though the crisis focused on "shadow banks" and not traditional depository institutions—was also disinflationary and helped cause the worst economic downturn since the Great Depression

. .

What is the current situation?

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

But of what magnitude?

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

The answer is simple:

Nobody knows.

This is what we know:

Depositors don't seem to be asking for cash and stuffing it under their mattress.

However, they are moving funds out of small and medium banks, to some extent

into the big banks

, and to some extent into money market funds.

Both types of institutions are likely to make fewer commercial loans than smaller banks now under pressure.

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

Money market funds also face quite stringent liquidity requirements.

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

severe credit crunch

.

In effect, the banking turmoil will look a lot like a rate hike by the Federal Reserve.

But of what magnitude?

I see that intelligent and well-informed people present very different figures.

Goldman Sachs

says we will see the equivalent of a 0.25 to 0.5 percentage point rate hike;

Torsten Slok of

Apollo

Global Management

says 1.5 percentage points.

I have no idea who is right.

However, the direction of the shake seems clear.

I wrote a couple of weeks ago that the

Fed

is picking its way through a dense data fog, trying to navigate the danger of inflation if it squeezes too little and recession if it squeezes too much (or maybe it's the other way around). ; the opinion of Homer scholars is welcome).

Well then, the fog has grown even thicker.

But it is clear that the risk of recession has increased and the risk of inflation has decreased.

So it makes sense that the Fed would lean a bit to the left.

What this probably means in practice is that the Fed should pause raising rates until there is

more clarity

on the inflation outlook and the effects of the banking mess - and it should be clear that this is what it is doing.

There doesn't seem to be much danger that the Fed will lose its credibility in fighting inflation if it takes time to get its bearings.

Inflation expectations seem very well anchored.

Should the Federal Reserve go further and lower interest rates?

While I'm generally a monetary dove, I wouldn't call for a real cut, 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, the Fed continuing to hike rates right now could send the opposite signal: a sense of cluelessness.

It seems time to say:

"Don't just do something: stay there."

For what it's worth - and these may be some famous last words - I actually take some comfort in the way policy makers have been responding to the current wave of banking troubles.

Some of us remember the bitter 2008-09 debates over how to stabilize the financial system: Troubled institutions were complex and opaque, and no one in power seemed willing to seize them in order to bail them out without also bailing out shareholders.

This time we're talking about conventional banks that can and have been seized by the FDIC, protecting depositors without putting shareholders out of business.

The upshot is that, so far at least, this doesn't look like a full-blown financial crisis.

But stay tuned.

c.2023 The New York Times Company

look also

Amid banking turmoil and inflation, the Fed decides today whether to raise interest rates

Does the purchase of Credit Suisse by UBS end a mini banking crisis?

Nobody knows

Source: clarin

All news articles on 2023-03-22

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