The collapse of a Silicon Valley bank could spark the next financial crash – but we can’t bail out failed bankers again

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Silicon Valley Bank Headquarters in Santa Clara, California – Phillip Pacheco

Depositors are unable to withdraw their money. Payroll may not be available next weekend. and smaller companies, especially those in fast-growing technology industries, May face closure as soon as their property are frozen. There will be considerable nervousness when financial markets open on Monday morning following the collapse of Silicon Valley Bank in the United States and the Bank of England’s decision to take control of its London branch.

In reality, it is more than reasonable. There is real risk in running a full blown bank. Central banks will have to act swiftly and decisively to prevent the situation from spiraling out of control. and yet they need Learn the Lessons of 2008 and 2009, Last time the financial system was in so much trouble. Depositors should be protected. But bondholders and shareholders should be left to fend for themselves. And, crucially, there should be no return to the easy money of the last decade. Otherwise we will learn nothing from the crash of 2008 and 2009 – and risk repeating all the mistakes of the past.

If anyone thought we could get out of near-zero interest rates, unlimited amounts of printed money, and double-digit inflation for more than ten years without pain, they’ve been in for a rude awakening. Over the weekend, a Silicon Valley bank was forced to close after a very old-fashioned bank run. Amid panic about losses on their bond holdings, customers, in this case mostly tech companies, rushed to get their money out.

Once started, it is almost impossible to stop. By Saturday morning, the US regulator, the Federal Deposit Insurance Corporation, had taken control. Anyone with cash in the bank will be able to withdraw up to $250,000. On this side of the Atlantic, the London branch of SVB would be forced into bankruptcy. Depositors will be protected up to £85,000, with the rest being recouped, if possible, by selling assets.

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There will be movement in the markets When they open on Monday morning, and well. This is the worst bank failure since 2008, and we all know what happened then. Equally worrying is that it follows a string of ‘crashes’ in the financial system.

In the crypto space, always likely to be the riskiest place, digital bank Silvergate ran into trouble last week, and of course, it’s only been a few months since the spectacular crash of exchange FTX. Similarly, last autumn in the UK, the LDI crisis erupted in the wake of a disastrous mini-budget, threatening huge losses among pension funds, and prompting the Bank of England to step in to keep them afloat with emergency liquidity. forced (and, as it happens, taking down the government of the unfortunate Liz Truss as collateral damage).

Each collapse can be explained on its own. But they all have the same formula. In the background, central banks, led by the Federal Reserve, are rapidly raising interest rates, and unwinding, and in some cases the opposite, quantitative easing. The era of easy money was coming to an end. Result? Fall in bond prices. It overtook SVB, which saw huge losses in its portfolio. This caught up with LDI to pension funds who believed bond yields would never rise. And the withdrawal of liquidity, and the return of real yields on real assets like Treasury bills, drove down the price of volatile options like bitcoin, causing a crisis on FTX. The circumstances were varied. Yet in each case, a tightening of monetary policy was the root cause.

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Will it spread? That will be the big question everyone will be asking on Monday, and for the rest of the week. The answer will depend on how quickly, and decisively, central bankers move to calm nerves, and to show that they have learned lessons from the last major crash. Seriously, it’s not going to be easy.

In the past, there would have been an easier way. The Fed, the Bank of England and the European Central Bank could announce an emergency cut in interest rates and pump a few hundred billion of additional liquidity into the system. That’s what Fed Chairman Ben Bernanke, or indeed Alan Greenspan, would have done at the time of the last crash. Bond prices will go up, and banks will have extra cash and that will fix the problem. This time, when inflation is already spiraling out of control, it is absolutely impossible. Cutting rates and printing more money now would guarantee hyperinflation, with dire consequences for every developed economy.

Instead, they really only have one option. Depositors must be protected, and if necessary with public money. If you have money in the bank you should be able to withdraw it. Nothing guarantees a full blown collapse in trust in every form of financial institution, and very quickly in fiat currencies as well. But unlike in 2008 and 2009, the banks themselves must be shut down. If bondholders and shareholders lose their shirts, that’s just bad luck. We cannot go back to bail out failed bankers. More importantly, we cannot easily return money on paper because of loopholes in the system. A decade was enough.

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This is going to be a high-wire act that will require an enormous amount of skill to pull off. The Fed is fortunate to have the vastly experienced Jerome Powell in charge, and is well into his second term, and if anyone can convince the markets he can. Less fortunate is the hapless Joe Biden in the White House. If someone can mess with it, he will.

Similarly, Rishi Sunak in London, with a banking background, will be well aware of the risks that have to be managed, but Andrew Bailey has been useless as governor of the Bank of England, and could easily fail this test. Are. Can policymakers restore confidence in the markets, prevent bank runs, and keep inflation at the same time? just possibly. But as the Duke of Wellington can remark, it will be a matter of a very close run – and nobody will count on success just yet.