By Michael Hudson
March 17, 2023:
Information Clearing House
--
The collapses of
Silvergate and Silicon Valley Bank are like
icebergs calving off from the Antarctic glacier.
The financial analogy to the global warming
causing this collapse of supporting shelving is
the rising temperature of interest rates, which
spiked last Thursday and Friday to close at 4.60
percent for the U.S. Treasury’s two-year bonds.
Bank depositors meanwhile were still being paid
only 0.2 percent on their deposits. That has led
to a steady withdrawal of funds from banks – and
a corresponding decline in commercial bank
balances with the Federal Reserve.
Most media reports
reflect a prayer that the bank runs will be
localized, as if there is no context or
environmental cause. There is general
embarrassment to explain how the breakup of
banks that is now gaining momentum is the result
of the way that the Obama Administration bailed
out the banks in 2008 with fifteen years of
Quantitative Easing to re-inflate prices for
packaged bank mortgages – and with them, housing
prices, along with stock and bond prices.
The Fed’s $9 trillion of
QE (not counted as part of the budget deficit)
fueled an asset-price inflation that made
trillions of dollars for holders of financial
assets – the One Percent with a generous
spillover effect for the remaining members of
the top Ten Percent. The cost of home ownership
soared by capitalizing mortgages at falling
interest rates into more highly debt-leveraged
property. The U.S. economy experienced the
largest bond-market boom in history as interest
rates fell below 1 percent. The economy
polarized between the creditor
positive-net-worth class and the rest of the
economy – whose analogy to environmental
pollution and global warming was debt pollution.
But in serving the banks
and the financial ownership class, the Fed
painted itself into a corner: What would happen
if and when interest rates finally rose?
In Killing the Host
I wrote about what seemed obvious enough. Rising
interest rates cause the prices of bonds already
issued to fall – along with real estate and
stock prices. That is what has been happening
under the Fed’s fight against “inflation,” its
euphemism for opposing rising employment and
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 on their balance sheet to back
their deposits.
The result threatens to
push down bank assets below their deposit
liabilities, wiping out their net worth – their
stockholder equity. This is what was threatened
in 2008. It is what occurred in a more extreme
way with S&Ls and savings banks in the 1980s,
leading to their demise. These “financial
intermediaries” did not create credit as
commercial banks can do, but lent deposits out
in the form of long-term mortgages at fixed
interest rates, often for 30 years. But in the
wake of the Volcker spike in interest rates that
inaugurated the 1980s, the overall level of
interest rates remained higher than the interest
rates that S&Ls and savings banks were
receiving. Depositors began to withdraw their
money to get higher returns elsewhere, because
S&Ls and savings banks could not pay higher
their depositors higher rates out of the revenue
coming in from their mortgages fixed at lower
rates. So even without fraud Keating-style, the
mismatch between short-term liabilities and
long-term interest rates ended their business
plan.
The S&Ls owed money to
depositors short-term, but were locked into
long-term assets at falling prices. Of course,
S&L mortgages were much longer-term than was the
case for commercial banks. But the effect of
rising interest rates has the same effect on
bank assets that it has on all financial assets.
Just as the QE interest-rate decline aimed to
bolster the banks, its reversal today must have
the opposite effect. And if banks have made bad
derivatives trades, they’re in trouble.
Any bank has a problem of
keeping its asset valuations higher than its
deposit liabilities. When the Fed raises
interest rates sharply enough to crash bond
prices, the banking system’s asset structure
weakens. That is the corner into which the Fed
has painted the economy by QE.
The Fed recognizes this
inherent problem, of course. That is why it
avoided raising interest rates for so long –
until the wage-earning bottom 99 Percent began
to benefit by the recovery in employment. When
wages began to recover, the Fed could not resist
fighting the usual class war against labor. But
in doing so, its policy has turned into a war
against the banking system as well.
Silvergate was the first
to go, but it was a special case. It had sought
to ride the cryptocurrency wave by serving as a
bank for various currencies. After SBF’s vast
fraud was exposed, there was a run on
cryptocurrencies. Investor/gamblers jumped ship.
The crypto-managers had to pay by drawing down
the deposits they had at Silvergate. It went
under.
Silvergate’s failure
destroyed the great illusion of cryptocurrency
deposits. The popular impression was that crypto
provided an alternative to commercial banks and
“fiat currency.” But what could crypto funds
invest in to back their coin purchases, if not
bank deposits and government securities or
private stocks and bonds? What is crypto,
ultimately, if not simply a mutual fund with
secrecy of ownership to protect money
launderers?
Silicon Valley Bank also
is in many ways a special case, given its
specialized lending to IT startups. New Republic
bank also has suffered a run, and it too is
specialized, lending to wealthy depositors in
the San Francisco and northern California area.
But a bank run was being talked up last week,
and financial markets were shaken up as bond
prices declined when Fed Chairman Jerome Powell
announced that he actually planned to raise
interest rates even more than he earlier had
targeted, in view of the rising employment
making wage earners more uppity in their demands
to at least keep up with the inflation caused by
the U.S. sanctions against Russian energy and
food and the actions by monopolies to raise
prices “to anticipate the coming inflation.”
Wages have not kept pace with the resulting high
inflation rates.
It looks like Silicon
Valley Bank will have to liquidate its
securities at a loss. Probably it will be taken
over by a larger bank, but the entire financial
system is being squeezed. 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.
The obvious question is
why the Fed doesn’t simply bail out banks in
SVB’s position. The answer is that the lower
prices for financial assets looks like the New
Normal. For banks with negative equity, how can
solvency be resolved without sharply reducing
interest rates to restore the 15-year Zero
Interest-Rate Policy (ZIRP)?
There is an even larger
elephant in the room: derivatives. Volatility
increased last Thursday and Friday. The turmoil
has reached vast magnitudes beyond what
characterized the 2008 crash of AIG and other
speculators. Today, JP Morgan Chase and other
New York banks have tens of trillions of dollar
valuations of derivatives – 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. So the chickens are coming
hope to roost – with the “chicken” being,
perhaps, the elephantine overhang of derivatives
fueled by the post-2008 loosening of financial
regulation and risk analysis.
Michael Hudson is an
American economist, Professor of Economics at
the University of Missouri–Kansas City and a
researcher at the Levy Economics Institute at
Bard College, former Wall Street analyst,
political consultant, commentator and
journalist.
https://michael-hudson.com/
Views expressed in this article are
solely those of the author and do not necessarily
reflect the opinions of Information Clearing House.
in this article are
solely those of the author and do not necessarily
reflect the opinions of Information Clearing House.
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