Silvergate Bank, Silicon Valley Bank, Signature Bank and First Republic Bank collapsed like dominoes between March and April 2023. The United States Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) proceeded with a previous intervention in order to stop the transmission of the crisis to the regional banks and to the whole system in general.
They removed the FDIC’s $250,000 cap on insuring deposits at failed banks, and the Fed established the Term Funding Program to bail out all banks with liquidity problems to cover deposits. Interventions saved the banking system for a while, but they are proving to be little in the face of the true scale of the problem.
However, the problem has not been solved because it is systemic. When Signature Bank was liquidated and placed under FDIC control, New York Community Bank purchased $38.4 billion worth of Signature assets.
Less than a year later, Moody’s downgraded New York Community Bank to junk status and its share price fell 60%. This was accelerated by the Fed chairman’s statement at the Federal Open Market Committee’s January 31 press conference that the federal funds rate would likely not be cut until May 2024.
New York Community Bank sought to reassure markets and depositors by announcing that it was reducing its commercial real estate lending as well as liquidating assets and that it was not experiencing “deposit outflows from retail branches.” This last assurance is vague and says nothing about online withdrawals.
The systemic dimension of the problem
But New York Community Bank’s problems aren’t about a quirk—they’re inherent in how the system works. Regional banks in particular are heavily exposed to commercial real estate, a sector showing many signs of trouble.
Many businesses have abandoned office buildings as working from home has steadily become a more common regime during the Covid regime. The scenario is eerily reminiscent of the financial crisis of 2007-2008, in which banks and other financial institutions were unable to survive the massive collapse in the value of their mortgage-backed assets.
There are also similarities with the dot-com boom and bust of 2000. The bank failures of 2023 were partly triggered by the collapse of the cryptocurrency exchange FTX and the flight of deposits from tech startups. Tech companies sought liquidity when lending rates rose and pulled their money.
The manipulation of interest rates
The manipulation of interest rates has this effect and the distortions are evident on the asset and liability sides of bank balance sheets. Artificially low interest rates artificially inflate lending and the value of businesses, which boosts bank assets.
Businesses are willing to borrow at low interest rates to finance expenses such as paying employees and buying fixed assets with debt rather than using cash on deposit in banks.
However, when inflation becomes unacceptably high and the Fed is forced to raise interest rates, bank balance sheets suffer. On the asset side, they face increasing loan defaults and arrears.
On the liability side, businesses are withdrawing cash rather than borrowing at higher interest rates. Price inflation also encourages credit from cash because of its falling purchasing power.
Loan portfolios and deposits
At first glance, one might think that this should not be a problem because the balance sheets balance. If there is a corresponding decrease on both sides of the balance sheet, then all is well.
The problem is that the assets in the bank’s portfolio (loans) have a longer duration than the bank’s liabilities (deposits). In a crisis, depositors demand their cash “here and now”, but the bank does not have 100% cash deposits – instead it has illiquid loans that are collapsing in value.
Rescue programs
Government bailout programs are not the answer. When the Treasury, the Fed, and the FDIC work together to save the banking system with money printing, “lending of last resort,” lower interest rates, more regulation, changing rules, and changes in the nature of the dollar itself—all of which exacerbate the problem, increasing the cost of bank failures to citizens (who end up paying the price) and clouding the landscape as to the implications of the above for overall credit conditions.
When the biggest crisis finally arrives, the government intervenes even more, even though previous interventions caused the underlying problems in the first place.
The temptation of socialism
This spiral of interventionism in the monetary system inevitably leads to socialism – that is, absolute state control of the economy. All varieties of intervention in market phenomena not only fail to achieve the ends sought by their authors and advocates, but bring about a state of affairs which – in the estimation of their authors and advocates – is less desirable than the previous state of affairs things they were designed to change.
If one wants to correct their manifest inadequacy and stupidity by supplementing the first acts of intervention with more and more acts of the same kind, one must go further and further until the market economy is completely destroyed and socialism comes.
The distortion of competition
The interventionist spiral in money and banking has led to a struggle for survival among banks, as large banks – which are highly favored by the Fed – gobble up smaller banks.
However, what it only does is distort competition in a banking system already monopolized by the Fed. The trend is clear: eventually the Fed will remain the only bank!
It will probably have a handful of other “banks” that act as mere administrators of the Fed’s digital currency. The solution to the problem of the multi-year banking crisis is the removal of interventions.
If the problems are caused by artificial credit expansion, then we should abolish the agency that artificially expands credit and allows banks to do the same. Banks should not be protected by a lender of last resort or government-backed deposit insurance.
- No new money should be introduced into the economy through the banking system.
- Banks should not be given false credibility through government regulation.
- Allow insolvent banks to go bankrupt like any other failed business.
- To separate the function of money and the production of wealth in the economy from the state.
