Vladimir Tregubov 2008 again? On how the Fed’s monetary policy again poses a threat to global financial markets 04/07/2023, 13:48

The pages of foreign and domestic business publications are full of headlines about a possible financial crisis in the 2008 model. The bankruptcy of Silicon Valley Bank was the beginning of a whole chain of disturbing events, not only in the financial dome of the United States, but also in Europe. Well-known American financier Robert Kiyosaki, who predicted the bankruptcy of investment bank Lehman Brothers in 2008, argued that Credit Swiss, one of the oldest banks in Switzerland, should be expected to go bankrupt after the collapse of the SVB. And then, as both American and European banks are linked by cross ownership of stocks, bonds and various financial derivatives, it is quite possible that the crisis will develop due to the “domino effect”. The failure of a few key banks could lead to a systemic crisis in the global banking industry.

Not only them, but regulators in European countries and the US Federal Reserve remember how Greece prepared to default on government bonds in 2011. Given that the debts of a small European country are held on their balance sheets by leading European banks, the ECB, IMF and European Financial Stability Fund have given Greece an unprecedented €360 billion loan. At that time, gold rose from $1,300 to $1,940 an ounce in just a few weeks.

In the fight against rising inflation, the increase in interest rates first by the Central Bank, then by the European Central Bank and the national regulator of the confederation, caused a decrease in the prices of the bonds held by the banks in their balance sheets. The latter pondered the fate of their savings, since they were bought with money collected in the form of deposits from the population and companies. So called. “Deposit raids” – a large and hasty request by bank customers to withdraw their money even if there is a loss of interest.

If anyone remembers 1998, Russian depositors also spent a lot of effort, time and nerves to return at least some of their savings. The problem is that no bank in the world can quickly return their customers’ money, because they are invested in some kind of asset – bonds, loans, etc. The banking business thus relies on a fractional reserve system. If you’ve been so raided, you’re left with nothing but selling assets at deep discounts, especially since the discount on bonds has already become significant. Or, as a last resort, seek help from the lender – the Central Bank, if he can and wants to do it. Otherwise, bankruptcy ensues and can often be of a systemic nature: banks lend to each other in the interbank market, enter into REPOs and swap agreements with each other, and a loss of liquidity causes the collapse. from dozens of banks

And that’s what happened in 2008: many banks found themselves committed to a system of mutual commitments—in this case, issuing insurance or credit default swaps (CDS) to mortgage-backed bondholders. Back then, bankers and investors alike had the misconception that real estate would always appreciate.

The result of such delusions is known – the global financial crisis. The US itself created the conditions for the crisis: fluctuating interest rates, which fell to 0-0.25% after the dot-com crisis in 2001, subsequently rose, undermining borrowers’ ability to make more expensive loans. . Add to this the Fed’s weak control over the issuance of so-called mortgage-backed bonds, but in reality – just debt. In fact, loans were issued for loans as if the property had been sold several times to different buyers. And famous US rating agencies gave them investment grade ratings. Thus, the pension funds of Europe and Japan, who believed that they had acquired the most reliable assets, were left speechless!

In the United States, 25 banks went bankrupt in 2008, and another 140 credit institutions went bankrupt the following year. Now the number of bankruptcies alone is also on the rise – first SVB, then Signature Bank, First Republic Bank, already taking a deep breath, taking $30 billion from 11 of the largest banks in the country to pay depositors. According to experts, the collapse could surpass 186 US banks, and this is not the limit.

While the scale of depositor-run banks is much smaller than in 2008, the pace of this process has long outstripped the outflow of funds at the start of the COVID-19 pandemic. Since the bankruptcy of the SVB, regional banks have already lost more than a trillion dollars in depositors’ funds.

Meanwhile, the concerns of bank customers spread to Europe. Credit Swiss, one of Switzerland’s oldest banks, also went bankrupt. Concerns about the stability of the banking system in any country known for its rock-solid banks are spreading fast these days.

The Swiss National Bank was unable or unwilling to bail out Credit Swiss and offered the credit institutions to buy it with all its debts. There were few applications, but the largest bank holding UBS bought the troubled bank. Shares of UBS and other banks around the world began to fall, turning from a defensive asset to a toxic asset. Investors are also starting to get rid of the Swiss franc, which has traditionally acted as an asset haven. Meanwhile, during both the 2008 crisis and the pandemic, the franc strengthened against the US dollar and other currencies, fully justifying this role.

But amid panic from bank depositors and other investors, gold soared above $2,030 an ounce in early April. It looks like the price of the yellow metal could rewrite all-time highs as gold remains the only safe-haven asset. The price of gold has always been an indicator that investors fear.

Demand for the US currency and cheaper US government bonds has also increased. Between March 15 and 22 alone, European central banks sold $76 billion in US government bonds to banks, breaking record sales since March 2014. The US dollar was sold by central banks for $60 billion through a special FIMA mechanism. According to Bloomberg, even at the peak of the pandemic, this figure did not exceed one and a half billion.

On March 24, as the situation began to spiral out of the control of the Fed and the Treasury, all US financial authorities convened for a meeting to develop emergency measures to stabilize financial markets. Treasury Secretary Janet Yellen said there was a “high probability” of large withdrawals from US bank accounts. And although experts say the US banking system is safe, at least $2 trillion more is needed and 50 more banks in the country could go bankrupt.

The financial authorities of the USA, Europe, Canada, Japan and other countries were caught between two fires. On the one hand, they need to combat record inflation, and for this they need to reduce the money supply in the economy: they need to raise interest rates, sterilize cash liquidity by selling securities on their balance sheets to banks. Also, inflation in the US is practically not falling – in March, the consumer price index in February fell to only 6.0%, compared to 6.4% in January. Although this is mainly due to low fuel prices, including oil and gas and gasoline. Excluding these, core inflation remained almost unchanged at 5.5%, compared to 5.6% a month ago. In response, Fed Chairman Jerome Powell announced a 25 basis point increase in the federal funds rate.

On the other hand, the increase in interest rates causes a decrease in the market value of bonds, which constitute a significant part of the assets of credit institutions. And in the case of mass withdrawals from banks, an attempt to stabilize the situation in the banking market and continue raising interest rates, as the US Federal Reserve did at its March meeting, is more and more like trying to put in gas. on fire. This stance cost the British Prime Minister Liz Truss, who in 2022 almost bankrupted the entire pension fund system of the country by following the monetary policy of the US Federal Reserve, with a sense of duty.

I’ve written more than once about its flaws – the desire to stop any imbalance, a structural problem by pumping money into the economy, lowering interest rates and increasing the money supply will only lead to another financial bubble. But then the vicious circle starts again – inflation, which central banks begin to fight by reducing the money supply and raising rates. As a result, the world is facing another financial and economic crisis.

Is it perhaps worth reconsidering the principles of monetarism and realizing that running the economy and the financial sector is also not blindly following the occasionally yellowing guidelines for central bankers? This is the art of finding balance if the system suddenly becomes unstable. Or is it worth preparing for the next crisis? After all, gold only grew in March – early April by an unprecedented amount – $180 per tr. self.

The author expresses his personal opinion, which may not coincide with the editors’ position.