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What does the financial crisis smell like?

More than 10 years have passed but the economists and financiers all around the world are arguing about whether the global banking system has recovered from the disaster of 2007-09. The new issue and the new cover of The Economist magazine clearly makes it clear to us that banks are still the state of the largest financial institutions in the United States are still capable of causing panic. At the beginning of March 2023, $42 billion of deposits were “destroyed” in just one day after Silicon Valley Bank, in fact, became bankrupt. Regulators from Wall Street are trying to find a solution that can keep the entire US banking system out of control while ordinary depositors are wondering if their money is safe. This is told by a new issue of the magazine, whose forecasts we have already considered in previous articles.

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What does the financial crisis smell like?

Yes, investors are terrified. The capitalization of American banks in March of this year decreased by 17%, to $ 229 billion, which represents the largest drop in the last 20 years. Treasury bond yields have also fallen. Financial markets expect that bank stock prices in Europe and Japan will continue to fall in the near future. The shares of Credit Suisse bank have fallen by 24% since March 15, and already on March 16 it asked for help in providing additional tranches to the Central Bank of Switzerland. 14 years after the financial crisis, businesses are again having doubts about the reliability of banks and that regulators are not coping with their responsibilities.

At the end of 2022, the amount of unrecognized losses in the American banking system amounted to an absolutely fantastic amount – $ 620 billion. And although some banks have managed to stay away from the abyss, the situation may become more dangerous as interest rates rise.

The global financial crisis of 2007-09 was caused by irresponsible lending and the collapse of the real estate market. In response, new rules were introduced aimed at curbing credit risk and providing reliable depositors with buyers. Government bonds have become a popular choice for banks, since no other lender can compare with Uncle Sam in reliability, and treasury bonds could easily be sold during the crisis.
For a long time, few people have thought about the possible negative consequences for banks in the event of a change in the global economic climate or a decrease in the value of long-term bonds. This sensitivity only intensified after the COVID-19 pandemic, when bank deposits increased and the Federal Reserve implemented stimulus programs to inject money into the US economy. Some banks used deposits to buy long-term bonds and mortgage-backed securities backed by the state. Obviously, all banks, regardless of their size, suffer from one problem: when a crisis comes, customers who were loyal to the bank can transfer their money to another place. This requires the bank to sell assets to cover the outflow of deposits. And if this happens, the bank’s losses become noticeable even to those who are not an expert in the field of global finance.

Over the weekend, the Fed took steps to avoid a potentially dangerous situation. Starting from March 12, the Fed is ready to provide loans secured by bank bonds. Previously, it limited the value of collateral, but now it will provide loans equal to the nominal value of the bonds. Their value may exceed the current market value by more than 50%. Yes, the Fed is doing the right thing by offering loans with reliable collateral to stop the outflow of money from banks. However, you have to pay for these easy conditions. Arguing that the Fed will take responsibility for the volatility of interest rates in a crisis, it pushes banks to rash actions. The program is designed for only one year, but even after this period, banks trying to attract deposits will still strive for higher returns, taking on excessive risks. Some clients who know that the Fed has previously intervened will have little reason to distinguish between good and bad risks.
What does such a solution smell like? Obviously, nothing good! And the cover of the new The Economist magazine clearly tells us about this!

Regulators around the world should take steps to recognize the risks associated with higher interest rates. Banks with unrealized losses are more vulnerable to bankruptcy in difficult times, even if this does not affect capital requirements. As a result, they need to conduct stress testing to assess the effect of the bank’s bond portfolios on the market when rates continue to rise. The creators of such a policy should also assess whether the system has enough capital for this purpose.
But the safety of customers and taxpayers is above all. People in Silicon Valley, Europe and Switzerland are experiencing anxiety and cannot forget the fear they experienced in 2008-2009, even though many of them still believe that the old unsafe times are long gone.

It is obvious that the times when the world economy will have to find a way out of another crisis are already close. This means that we will all have to make choices and look for new ways to maintain financial stability.

What does the financial crisis smell like?

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