No panic---yet

The Atlantic Daily

From the Atlantic Daily:

 

On Sunday, one of the world’s biggest banks, Credit Suisse, narrowly escaped annihilation when it was bought by an even bigger Swiss bank, UBS Group, in a government-brokered deal. 

The hasty move did the job of averting the “too big to fail” lender’s, well, failure. But in the aftermath of the insolvency panic that triggered the falls of Silicon Valley Bank and Signature Bank in the U.S.—not to mention the current precarious standing of First Republic—it’s fair to say that the world’s financial institutions, and their customers, are spooked.

Shaky confidence in global financial markets could spell further trouble, potentially setting off a massive cascade of bank runs that destabilizes the entire system. Right now, that possibility is not off the table. But is it a crisis?

“I would say no,” Arthur Dong, an economics professor at Georgetown University, says. But we’ve gotten a preview of what could happen next, he told me.

In short: After years of very low interest rates, the decision in the U.S. and elsewhere to begin raising interest rates in order to curb inflation led to lowered asset value. That, in turn, led to depositors’ whisperings of relocating their holdings and not-totally-unwarranted fears of bank insolvency. 

For SVB, and other lenders that similarly serve a narrow band of customers (who are likelier than a more diverse pool to react in unison to market shifts), these conditions can add up to a major stress test of client confidence. 

And as SVB has shown, bank failures don’t exactly alleviate wider anxieties—even if federal governments and regulators step in to protect customers’ holdings, as was the case for SVB.

Dong acknowledged that, although the sagas of SVB, Credit Suisse, et al., have certainly created “shock waves through the financial markets” (and inspired worry in the average consumer about whether their deposits are safe), the present climate of economic uncertainty is probably more aptly viewed as a momentary shake-up than an existential disaster. “There are other institutions out there that might be imperiled, in the way that SVB was imperiled, but I don’t think it’s a global crisis,” Dong explained.

But although it isn’t a full-blown crisis, it might be a “mini-crisis,” suggests Paul Kupiec, a senior fellow at the American Enterprise Institute. “Could it get worse? Yes. Could it be just a bump in the road that goes away? Yes.”

Kupiec says that if the Fed continues to raise interest rates, many institutions’ mark-to-market losses will get worse. More people might be moved to pull out their deposits, which could have far-reaching consequences—especially if multiple banks find themselves in a position of needing to replace those deposits (that they’d collected minimal interest on for a long time in the first place) with Federal Reserve loans whose target rate range is already 4.5 to 4.75 percent, and projected to climb higher.

“We’re not totally out of the woods,” Kupiec told me. “We might avert a panic. There’s going to be some pain going forward, though.”

“This is what happens in this type of environment with higher degrees of volatility, as well as very rapid interest-rate increases around the world,” Dong noted. “And it will very quickly expose the weaknesses of banks that were not necessarily in a state of failure, whose balance sheets were kind of creaky to begin with."

“As the tide goes out, you kind of see who’s swimming there naked,” Dong added with a chuckle, borrowing a well-known aphorism from the investor Warren Buffett. “I think that’s more of the issue here, rather than a widespread or global financial contagion like we saw in 2008.”

For now, we can expect more damage control. Earlier today, Treasury Secretary Janet Yellen told a conference of American bankers that she was willing to protect depositors at smaller U.S. banks in the event of future bank runs, if necessary.

We can’t know what will happen next. But the picture of what’s happened up to this point, and how to read it, is coming into focus. As my colleague Annie Lowrey wrote last week on the SVB collapse and bailout:

There’s no success story here. The complexity of financial regulations and the dullness of balance-sheet minutiae should not lull any American into misunderstanding what has happened. Nor should the lack of a broad meltdown make anyone feel confident. The bank failed. The government failed. Once again, the American people are propping up a financial system incapable of rendering itself safe.