We are approaching the tipping point where the US economy and banking system either slide back over the edge and back to safety or fall off a cliff into a full banking crisis.
The Federal Reserve could solve this in one step: cut interest rates at its meeting this week.
Yet the chances of the Fed taking this step are slim. While most forecasts now have the US central bank holding off on rate hikes, a pause is not enough.
Cutting rates releases an economic pressure valve. Although this step will be temporary, the relief is necessary for the health of the financial markets and the banking system.
Yes, the Fed wants to rein in inflation and, no, rate cuts on that front won’t help, but someone needs to tell Fed Chair Jerome Powell that this is not a “kill at all costs” mission, because None of us can pay the price we paid in striving for the stability of the banking system.
squeeze and bleed
Most of the coverage so far of the collapse of Silicon Valley bank SIVB,
Silvergate Bank SI,
and Signature Bank SBNY,
— and instability in First Republic Bank FRC,
and others – have focused on how these banks fought their way into trouble. It hasn’t been hard on the crisis these businesses faced.
Bryce Doty, senior portfolio manager at Sitt Investment Associates, said an issue many experts are telling me is being ignored: “Most banks are insolvent right now.”
It sounds awful, but it’s more about regulatory rules and interest rates than a complete inability to pay back all the debt.
Reading: From the sudden collapse of SVB to the collapse of Credit Suisse: 8 charts showing the turmoil in the financial markets
To bring this home, consider if you took out a long-term fixed-rate mortgage on a home about 10 years ago, when the average mortgage rate was about 3.6%. It was almost twice the rate of the 10-year Treasury TMUBMUSD10Y,
At the time, that meant that an institution would rather buy your debt than settle for a secured Treasury bond.
Nowadays you’re still paying 3.6% on the mortgage, but that’s about what a 10-year Treasury pays. As a result, the value of your mortgage on your lender’s books is lower now than it was a decade ago. In the world of banking, such occurrences are not a problem as long as the paper does not have to be “marked to market” such that it is being sold today.
Federal regulations allow banks to plan to hold a portion of their assets until maturity, allowing them to ride out temporary paper losses because hold-forever securities are not marked to market (purchased on the books). staying at their cost on the go). This gives banks the flexibility needed but can create “not a problem until it’s not a problem” diversity issues, only to be noticed if you’re looking especially carefully.
Where the 2008 financial crisis was caused by default losses by banks, the current problem with the system is not about waste paper (at least not yet). This time, the rates went up so fast that it caused paper losses.
, The Fed should have seen this coming.,
The Bloomberg US Aggregate Bond Index fell 13% last year; Its worst year before that was a 3% loss in 1994. Since 1976, the index has been down in only five calendar years — including the past two.
The Fed should have seen this coming; Its own balance sheet holds bonds worth about $9 trillion, losing north of 10% of their value during rate hikes. “The Fed kept rates so low and then raised them so fast that no [financial institution] Could possibly readjust your bond portfolio to avoid losses,” Doty said in an interview on the My Money Life with Chuck Jaffe podcast.
Off-air, Doty speculated that if the Fed cut interest rates by 100 basis points — one percentage point — “it would eliminate half [the banking industry’s] Subliminal damage in one fell swoop. This would be the easiest and most short-lived banking crisis in history.
Furthermore, it would ensure no “transition” from the blasted banks; Keep in mind that it was the banks that came to First Republic’s rescue this week, planting the seeds for one bank’s mark-to-market problems to become the next institution’s default loss.
That’s how you turn a problem into a disaster. If the Fed raises rates too high without allowing time for relief, it dramatically increases the likelihood of a liquidity crunch and a debt crisis.
Hello Mandi, your table is ready.
Reading: ‘We need to stop this now.’ First Republic Support Is Spreading Financial Transition, Says Bill Ackman.
Jurien Timmer, director of global macro at Fidelity Investments, said in a recent interview on my show that he can’t see the Fed losing, noting that no one wants to be the next Arthur Burns, the infamous Fed chairman during the Great Inflation of the 1970s. In the decade of
Timmer said: “They are committed to never repeating the mistakes they made in the 70s to keep policy loose for too long, letting the inflation genie out of the bottle.”
But this isn’t the 1970s, and anyone who thought the Fed was too soft on inflation – which is why it’s taking a hard stance today – should consider that perhaps the central bank backed down because higher rates were a sign of wider systemic problems. was causing.
The Fed needs to solve problems, not contribute to them. If it means living with high inflation for a long time, it is still a better option for the country than letting a global banking problem turn into a global liquidity crisis and a hard landing for the economy.
A cut doesn’t end the war on inflation, it just pauses the fight to strengthen and secure its fighting position. Sometimes, the best way to move forward is to start with a rocking step backwards. Let’s hope the Fed has the courage to do so.
Reading: What it may take to calm banking-sector jitters: Time, plus a Fed rate hike.
More: The first republic was saved by rivals. The Silicon Valley bank was abandoned by his friends.