The era of easy and low cost borrowing and abundant liquidity is long gone, and the policy of ever-higher interest rates has spread throughout the world.
The sharpest jump in the cost of money in recent decades is causing great concern in the markets, thus maintaining a not-so-reassuring level of uncertainty about the future.
The collapse of Silicon Valley Bank in early March after heavy losses on its bond portfolio due to rising interest rates was a wake-up call to markets that monetary tightening is likely to have negative consequences. Since the end of 2021, major advanced economies, including the United States, the Eurozone and Australia, have collectively raised interest rates by nearly 3,300 basis points.
Of course, not everyone agrees with the tightening of monetary policy. “Even in the ECB, the supposedly complete unanimity is inaccurate. The fight between hawks and doves continues, even in the midst of economic turmoil”, European sources emphasize to “The Liberal Globe”. Some disagreed, as can be seen from the minutes of the ECB meeting: it will soon be necessary for the “ECB to avoid being too harsh” and “the risk of going too far must be taken into account as well as the risk of backing down”.
Markets are already feeling the effects and the epochal change in monetary policy could hit stock markets and economies in at least five areas:
- The banks
Banks remain high on the list of concerns after the collapse of SVB, as well as the forced merger of Credit Suisse with UBS, which sent industry-wide into turmoil. Investors are now trying to assess which other institutions are at risk of unrealized losses on government bonds, whose prices have fallen sharply as interest rates rise. Bank shares in Japan, Europe and the US are still well below levels seen just before the SVB crash.
- Tech giants under pressure
The collapse of SVB showed that stress in the technology sector can also quickly spread throughout the economy. Tech companies including Alphabet, Amazon and Meta are announcing massive layoffs after years of record hiring. Investors are wary, as an earthquake in this important American industry will cause aftershocks in Europe and beyond.
- Increased bankruptcy rates
Rising interest rates pose a threat to many companies, which must pay more to refinance maturing debt. S&P expects default rates in the US and Europe to reach 3.75% and 3.25% respectively by September, more than double the 1.6% and 1.4% in September 2022. The pessimistic forecasts for 6.0% and 5.5% respectively, not so slim, warns S&P. Companies are more leveraged now than they were during the Great Depression, and this cycle could ultimately be more focused on corporate bankruptcies.
- The Cryptocurrencies of “Chaos”
The “king” of cryptocurrencies, Bitcoin, has unexpectedly benefited from the wider market turmoil, and its value has increased by around 40% in just 10 days. The gains on expectations that interest rate hikes were nearing their peak. However, there are reasons many investors are cautious about cryptocurrencies: the collapse of several high-profile digital currency companies last year left cryptocurrency customers with huge losses, while US authorities have increasingly put the industry’s biggest crypto players under the microscope.
- The real estate market
The rise in interest rates operates with a time lag, meaning that the impact on interest rate-sensitive housing markets has yet to be fully felt. A distressed debt index compiled by law firm Weil Gotshal & Manges showed that the property sector remains the most troubled sector in Europe and the UK.
The concern is that commercial real estate could be the next loser if the global banking problems trigger a wider credit crunch in the sector, which was already under pressure. Trust Economics reported that US commercial real estate (CRE) prices have fallen 4-5% from their peak in mid-2022 and expects a further decline of 18-20%.
The industry’s reliance on lending from small and medium-sized banks—which provide about 70% of outstanding CRE loans—is worrisome as these banks face pressures and withdrawals of deposits.
“Useless” Fifteen whole years of reforms and controls
Fifteen years of reforms and controls after the Great Crash of 2008 failed to prevent the bankruptcy of Silicon Valley Bank, Signature Bank and the forced takeover of Credit Suisse, but also to shake up Deutsche Bank and the stock markets again.
The 2008 crisis was caused by bad loans: Mortgages were given to poor people who couldn’t afford them. And greedy investment bankers cut and rolled those mortgages into bonds, calculated their default risk, and quickly sold them to all corners of the financial system, making billions in profits.
Fifteen years after Lehman Brothers, bankers, investors and politicians around the world had to be terrified again – even though they had sworn to themselves and the voters that this would never happen again.
After all, a lot has happened since then: today’s financial institutions have larger capital reserves than they did then. But markets and regulators were once again caught up in the new turmoil. But that’s not just because they’ve turned a blind eye to the problems they helped create for too long. But also because this crisis is completely different from the previous one.
This time, the driving force behind the threatened crash was not poor subprime customers, that is, customers with limited credit. But relatively wealthy superprime customers. They don’t have too little money, they have too much and they want more. It’s no wonder that along with Silicon Valley Bank—where many startups amassed billions—Credit Suisse was hit the hardest. Because he managed the money of the super rich.
The smaller banks had the problem
Global financial giants such as JPMorgan, BNP Paribas or Deutsche Bank are still too big to fail. However, today the greatest risk is represented by small and medium-sized financial institutions. This time we could say: The banks were too small not to fail.
The growing uncertainty among savers is so great that they have apparently already started moving their money from small to big banks like Citigroup and Co. In the week after the Silicon Valley Bank crash, the 25 largest US banks made $120 billion in deposits, according to the Federal Reserve Bank – all smaller banks lost $108 billion in deposits. It was the biggest weekly deposit collapse ever. The big fish eats the small fish!
And this is mainly due to the cause of the crisis: the explosion of interest rates caused by central banks, threatens the smaller ones because savers suddenly withdraw their deposits in search of higher returns. And at the same time government bonds and real estate securities, into which banks have poured trillions for years, are suddenly worth much less. To pay depositors who leave, they must liquidate government bonds at heavy losses.
Bad fund managers
Bad portfolio managers and their investment strategies triggered the new crisis. Due to the policy of zero interest rates for years, they were swimming in investors’ money. And they underestimated that things could get tight when the cash register suddenly stops having money and too many customers turn their backs on a bank.
Mid-sized regional banks in particular are at risk from this vicious cycle, as the bailout of First Republic in San Francisco shows. Because smaller banks are hit harder by the exodus of big customers than the financial giants, who have millions of customers with billions in their accounts.
Stricter rules
The Biden administration and the Fed apparently want to introduce tighter risk regulations for mid-sized banks this week.
The problem is likely to worsen in the future as interest rates are likely to remain high in the medium term. And apparently, more and more bank customers will realize that their money is much better invested elsewhere than in interest-free checking accounts.
In other words, it is a banking crisis in slow motion! In 2008, losses from bad loans from the real estate market in the United States and investor fear destroyed confidence in the financial system around the world within days. Banks stopped lending money to each other, the financial system froze and stock markets crashed.
This time there is nothing to see from this disastrous transmission result. The crisis is not spreading like wildfire, but like a smoldering underground fire – because it is not about credit risks, but interest rate risks. The fact that there is no panic is perhaps less impressive, but no less dangerous. Because the causes of this fire cannot be extinguished by fire sales or rescue funds as they were 15 years ago.
History shows that the damage can be great in the long run: In the 1980s, the Fed rushed to raise interest rates to fight inflation. Many small regional banks in the US were caught in the same interest rate crisis as today. Thousands ended up bankrupt or had to be bailed out. The crisis lasted more than 10 years, until the mid-1990s – and ended with a debt crisis in American households and a deep recession. So it may be a long time before the fire that engulfed Silicon Valley Bank and Credit Suisse rekindles. But it is not completely extinguished. Smoldering…
