by Philip Pilkington
Wednesday, 3
May 2023
Analysis
15:45

Bailouts won’t prevent a financial crisis

First Republic's fall is another warning shot to the central banks
by Philip Pilkington
First Republic Bank was bailed out by JP Morgan this week. Credit: Getty

It appears that 2023 could be remembered as the year that marked the beginning of a new financial crisis. When Silicon Valley Bank and Signature collapsed in March, optimists argued that this was an idiosyncrasy driven by the banks’ large holdings of startup deposits. Shortly afterwards, when Credit Suisse fell, Americans shrugged it off as a foreign bank. With the bailout-buyout of First Republic by JP Morgan over the weekend, the prospect of a general banking crisis is being taken more seriously by the markets.

Earlier this week there were sell-offs in multiple bank stocks. PacWest tanked 42%; Western Alliance plunged 27%; and Metropolitan Bank fell 20%. Comerica and Zion Bancorp followed the pack, both down nearly 10%. The KBW regional banking index, which tracks smaller regional banks, fell 7%. Markets are finally waking up to the fact that a large portion of the banking system is potentially insolvent — around half of it, by some measures.


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The banking system is insolvent due to reckless central bank policy. Following the last financial crisis in 2008-09, central banks engaged in wild monetary experiments including quantitative easing (QE), which drove interest rates down to record lows. It is debatable whether these experiments had much of an impact on economic growth, but they certainly led to extreme overpricing in asset markets. QE juiced almost every financial market, from the stock market to the housing market to the market for used luxury watches. With the wave of bank failures, these markets will now likely experience heavy losses.

The bank failures themselves not only drove up the price for risky assets like those just mentioned, but also the price on riskless assets. Investors typically identify certain assets, like government bonds, as relatively lacking in risk. Governments print money, after all, so they can always pay back their loans. This means that banks feel comfortable holding large amounts of these riskless assets, and regulators are happy to let them.

But the QE policies have turned these riskless assets into risky assets. By driving interest rates on government bonds down substantially, the central banks have made these bonds sensitive to increases in interest rates. With central banks now raising rates to try to stamp out inflation, the price of these assets is falling off a cliff. 

The losses have spooked depositors, who are now heading for the exit. Data shows that in the past few weeks we have seen the biggest run on deposits since the beginning of the Great Depression. So far, this has mainly impacted the smaller, regional banks. Those holding deposits at these banks that are larger than the Federal Deposit Insurance Corporation (FDIC) limit of $250,000 are scared that the bank will collapse, and that they will lose their money. When the depositors take the cash and run, the bank soon collapses.

The recent use of bailouts and assisted buyouts may become increasingly difficult as more banks come under pressure. The only solution then will be to guarantee all deposits in the banking system.

Doing this, however, would be tantamount to the Government giving a blanket guarantee to all holdings of capital. With such a free insurance policy in place, investors could take as much risk with their investment as they saw fit — after all, if the investments go bad, the Government will pick up the tab. Economists call this problem “moral hazard”.

Yet, even then, the damage to the economy has likely already been done. Credit standards are now tightening rapidly, meaning that lending to the real economy will soon seize up. Consequently, businesses will pull back on investment and people will stop buying houses. At this point, unemployment should start to creep up as layoffs start in the construction sector. A recession should follow in short order — likely accompanied by a full-blown crisis.

The long-term legacy of this situation could be a partial socialisation of the banking system, though. After the last financial crisis, central banks around the world engaged in an unprecedented monetary experiment. The impact of this experiment on the real economy was uncertain at best, and past a certain point the central banks appeared to be doing the QE policies just to demonstrate that they could. But these policies had costs, and we are now seeing those chickens come home to roost. Just don’t expect mea culpas any time soon from the people in charge.

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Nik Jewell
Nik Jewell
29 days ago

The pandemic favoured Amazon etc., and small businesses went to the wall. People advertising with estate agents get letters from companies offering immediate cash buys, with all your fees paid. With the regional banks, we see a lack of panic, a lack of government intervention, and big banks quietly absorbing smaller banks in trouble.
A cynical person might think there is a pattern in all this.

J Bryant
J Bryant
29 days ago
Reply to  Nik Jewell

With the regional banks, we see a lack of panic,”
It’s not just lack of panic, it’s lack of reporting. The First Republic buyout/bailout has attracted very little attention, but it’s the fourth significant bank collapse in under two months. Either there is some sort of odd conspiracy playing out, as you suggest, or the world is sleep walking into a financial crisis.

Nik Jewell
Nik Jewell
29 days ago
Reply to  J Bryant

As I understand it, there are two tensions with CBDCs. There is the obvious one concerning social credit systems and the control of individual behaviour. The other issue concerns the banks. At the moment, banks can create money by lending it, a power they are going to lose in the future. There are too many banks, particularly in the US, and only a few banks can realistically be involved in managing CBDCs (the first C being ‘central’). Ergo, the small banks have to go.
At the same time, the fiat money system is going to collapse very soon. It could be next month, in six months, or a year or two, but it is terminal now. The CBDCs are not ready yet to roll out globally. We are in uncharted territory here, and my guess is that things are not quite going to ‘plan’ so everything has to be propped up for a bit longer, carefully trying to balance inflation with printing money to keep things afloat.
I believe the banking sector is aware that they may become obsolete, hence the sops being offered that (initially at least) that the amount of money that can be held in CBDCs will be limited to keep them onside, for a time at least.
That’s my very speculative take anyway, but I’m not a banker or economist, I’m not privy to the mind of Agustín Carstens, and thus it could all be total nonsense.

polidori redux
polidori redux
29 days ago
Reply to  Nik Jewell

I believe that every fiat money system in the world has eventually collapsed. Governments always fall to the temptation to print money.

Rocky Martiano
Rocky Martiano
28 days ago
Reply to  Nik Jewell

CBDCs are simply a digital form of fiat money. They are centrally controlled, there is no limit on the creation of new ‘units’ (unlike Bitcoin) and so governments will use them in the same way as they use their fiat currencies i.e. to inflate away their debts and fund their incontinent spending programmes. Plus the added bonus for them of visibility over every single transaction in the system and programmed control over how each unit can be spent. Didn’t pay your ‘fair share’ of tax? Your units are suspended. Expressed a controversial opinion on Unherd? Your units are suspended.
Welcome to another dystopian export from China – the social credit system.

Carl Horowitz
Carl Horowitz
28 days ago
Reply to  J Bryant

Watch CNBC sometime. There has been a ton of reporting on this.

Charles Griffin
Charles Griffin
28 days ago
Reply to  J Bryant

Isn’t it obvious? There’s a Democrat in the White House, shhh, all is well.

Susan Grabston
Susan Grabston
29 days ago

Just listened to Sir Paul Tucker on this topic. Back in 2019 the Fed stopped work on a project specifically looking at how they wd backstop a regional bank failure. At the time Tucker was leading an international systemic risk body. All the big names of a previous generation (Volcker, Trichet, Turner, etc) wrote to the Fed advising them against the “down tools”. Same with UK LDIs – BofE lifted the stone in 2019 and decided to put it back down. We are led by idiots. Sadly their poor decisions since 2009 will drive us into a more centralised, digital solution to “reset” the unsalvagable mess we are in. Ho hum.

Barry Hynes
Barry Hynes
25 days ago
Reply to  Susan Grabston

Are they idiots? I find it hard to believe they are. Regardless of my views on his politics Mark Carney, Governor of Bank of Canada 2008-13 (and later Bank of England) steered Canada through the 2008 crisis by leading our greedy banks with a firm hand. His intelligent financial leadership has been dismissed. This “crisis” is part of the plan.

Nicky Samengo-Turner
Nicky Samengo-Turner
28 days ago

if an individual was allowed by his bank to be credit assessed the same way as a bank, and count that owed to him as assets, and borrow 3x + his revenue unsecured, the banks would have many more bust customers!!!!

Joe Black, Sr.
Joe Black, Sr.
28 days ago

No, the bailouts won’t prevent a financial crisis, more than likely they will create one by using our tax dollars to fund companies’ bad business practices and management. What’s the incentive now if they know they will be bailed out and regulators aren’t looking at your operation? The Feds knew about the SVB a year ago and did nothing. A relative of mine actually looked at buying the debt, or some of it, and they said the stuff that they were doing was crazy. No one that seriously bought debt wanted it., thus, the closing and bailout.