The international monetary system is looking increasingly shaky
When is a banking crisis a banking crisis? These past few days we have seen the failure of multiple banks. The action started with Silicon Valley Bank and soon spread to Signature Bank, making those two the second and largest bank failures in American history respectively. Significant pressure has also been felt on other institutions, like First Republic.
However, the crisis has now gone international, with UBS agreeing an emergency rescue deal with Credit Suisse. While Silicon Valley Bank and Signature Bank had their own idiosyncrasies in the tech sector — with oversize deposits held by venture capitalists in the former and cryptocurrency exposure in the latter — Credit Suisse was simply a normal international bank with some structural weaknesses.
Its failure thus raises the prospect of a more general banking crisis of the sort that we saw in 2008. It indicates that the tech banks may have just been the weakest dogs in the pack and now the problems are spreading to more established banks. Does that mean we are now in a full-blown crisis?
Typically, economists and regulators view a true banking crisis as one in which there is systemic failure. That is, when the failure of one or more banks starts to spread to the system as a whole. The failures of the banks we have seen so far are related, but they are not interconnected. They are all caused by the pressures that rising interest rates are putting on the banking system but, importantly, they are not linked to one another and thus not truly part of a systemic issue.
Yet certain indicators are flashing bright red. For example, the KBW Bank Index (pictured above) — the index which tracks banking stocks — has collapsed by more than 30% in just over a week. Other indicators are more reassuring: the TED Spread — which tracks the rate at which banks lend to each other — is still muted.
What may explain this discrepancy is the huge spike in liquidity that the Federal Reserve is pumping into the system through the discount window. The discount window allows banks to borrow a potentially infinite amount of liquidity on a short-term basis to stymie banking crises. Its use tends to come with penalties and so banks avoid using it. But the recent data suggests that the Federal Reserve may be using the window to engage in a sort of surreptitious bailout.
So it appears we are not in a banking crisis — yet. It does appear to be incipient, and the smart money says that when chaos starts in the banking sector, it usually spreads. Indeed, there are some notable ructions occurring in the system, with record outflows of deposits in banks and into money market funds. The coming days and weeks will determine whether this wave of bank runs is some short-term turbulence or, rather, the start of the real thing.
One area to watch which is currently getting scant attention is the mortgage market. House prices have been falling since at least the summer, and the wave of bank failures may lead to lenders becoming more conservative in their lending. This would entail a collapse in both the demand for and supply of credit for home purchases, which could instigate a cascade effect where homeowners are forced into negative equity and, from there, into default.
The system is looking shaky, but it’s holding — for now.