With an increasingly dangerous war in Ukraine and the prospects of a widespread banking crisis, the world’s economy is set for trouble. What the world is now facing is not a repetition of the 2007- 2009 credit meltdown. But the issue now is fundamental. It calls into question the very essence of how banks and international trade can operate in a global environment: stability and trust.
Ironically, the event that exposed the structural fragility of the banking system for the second time in 15 years started in California’s Silicon Valley. The place, as we are reminded time and again by the cosmopolitan commentariat, is the epicenter of the post-industrial internet e-revolution: self-reliant, creative, and unimpeded by government rules.
That may be so, but it did not prevent a financial earthquake. Last March 9, in just a few hours, the favorite bank of geeks and internet billionaires of the New Economy, appropriately named Silicon Valley Bank (SVB) was wiped clean of funds and forced into bankruptcy by regulators. At the end of the day, $42 billion of deposits had left the bank.
There was more to come. While US regulators worked frantically over the weekend to devise an emergency rescue, the shockwave had already crossed the Atlantic.
In Europe unexpectedly the staid Deutsche Bank came under under fire. In Zurich the venerable Credit Suisse was forced into a shotgun marriage with UBS. In Asia, the irrational stampede did not spare even Singapore and Japan.
In London–still the second largest financial market after New York despite the self-inflicted damage caused by Brexit – Silicon Valley Bank suffered the ultimate indignity of seeing all its remaining UK assets bought by HSBC bank at the symbolic price of £1.
America’s regulators struggled to find a buyer for the rest of SVB. A similar fate fell also on Signature Bank, a mid-sized lender based in New York, specialising in banking services for technical start-ups.
In total, over $229 billion during March were wiped off the value of America’s banks in addition to the $620 billion of “unrecognized losses”. The strange adjective “unrecognized” needs an explanation. In the deregulated world of American finance only the very large banks are obliged by law to “mark to market” the whole stock of tradable bonds they own. The smaller ones instead are exempted. As a result, if a local bank, due to a sudden liquidity crisis, is forced to sell the bonds that it bought at a higher price, all of sudden the unrecognized losses become very real.
This is exactly what happened now. When the Fed raised interest rates at its sharpest rate in 40 years, bond prices held in portfolio by banks collapsed, triggering the investors’ panic and massive cash withdrawals that forced Silicon Valley Bank to sell bonds at a huge loss. Bankruptcy was the endgame.
That however, was not the end of the story. Only the end of the beginning in fact. Partly for political expediency, and partly for the objective difficulty of orchestrating a rescue plan and stopping a widespread 1929-style panic in a matter of hours, the US administration made an extraordinary decision.
The Federal guarantee, the regulator announced, will be extended in this case not only to small depositors up to $ 250,000, but to “all” clients of the failed banks the – including an unknown but presumably large number of multimillionaires.
Now, according to S&P Global, a specialist newsletter, over 95 percent of domestic deposits of Silicon Valley Bank, and 80 percent of those held by Signature, were “uninsured” up to December 2022. As a result, therefore, it appears that even the wealthy clients of bankrupt SVB and Signature Bank, with deposits of well over the Federal ceiling of $250,000, will not lose a cent. The Treasury will pay.
Sheila Bair, a former chair of Federal Deposit Insurance Corporation, the independent watchdog in charge of U. financial institutions, was frankly outraged by the huge “Moral Hazard.” Preventing systemic risks, she notes, was repeatedly used as a rationale for rescuing Wall Street during the 2002-2008 crisis. But the present case is different.
At $300 billion, she argues, the two banks represent a minuscule part of the US’s $23 trillion financial system. “Is that system really so fragile that it cannot absorb some haircut on these banks’ uninsured deposits?”, she rhetorically asks.
Martin Wolf, the FT chief commentator, is trenchant. “Banks are designed to fail. When they do, they scream for a state rescue. If the threatened costs are big enough, they will succeed. This is how, crisis by crisis, we have created a banking sector that is in theory private, but in practice a ward of the state. The result is a system that is essential to the functioning of the market economy but does not operate in accordance with its rules. This is a mess”.
