Higher rates and liquidity shortage
If one imagines a huge dam, the water in the agitated lake is typically completely calm, but one can still imagine the destructive forces that will be unleashed if the dam breaks. If you are below the dam in the gorge or the valley, the impression becomes even more monumental.
In the same place, one finds fear that the water will suddenly begin to trickle forward through a small hole in the dam. If one does nothing, the hole will undoubtedly grow dangerously large, and therefore, the famous solution of sticking a finger in the hole might be the way to go. If there are more holes, it can hold as long as there are enough fingers. Right now, that picture is very reminiscent of what is going on in the banking sector in some countries, but maybe it’s just a few cracks in Switzerland and the US – or should all the world’s investors fear that the dam will break completely?
I fully understand that this risk is being discussed. There is no doubt that the significant interest rate changes last year – in whole or in part – are behind the problems for the banks that have been closed or forced to merge within a short time.
Therefore, speculation inevitably arises as to whether more banks are suffering from the “interest rate risk disease”. Consider how the European Central Bank has pumped large amounts of liquidity into the financial system at zero percent in interest so European banks could buy up Southern European government bonds with long maturities and weak creditworthiness – basically, the same thing that SVB in California tried to do.
A casino like bet
Allow me to start in the most conservative stronghold for money: Switzerland. I don’t think I’m giving much away by mentioning that many in the financial market over the last 20 years have noticed the several speculative and marginal businesses that the major Swiss bank Credit Suisse was involved in. It’s almost given that at a time of extreme volatility in the financial markets, a bank or two would fail when they are so stressed all the time.
It is always easier to be wise about other people’s companies than one’s own store; the experience with SVB adds to this in retrospect. One thing is how the company culture has been handled at SVB and where the commercial focus has been. Based on a number of serious media reports, it has been made clear that there was also a direct parallel between the increase in interest rate speculation and the increase in the salary level for the bank’s management.
The bank had a significant deposit surplus, which yielded zero percent in return. It was decided to place this liquidity in bonds, so an additional income could be created via the higher yield from the bonds. This went well for a long period, and every time the bank needed to increase earnings, the bond portfolio was moved further out on the yield curve to increase the yield return. It also meant that, at the same time, the interest rate risk was increased. So, when long-term interest rates in the US suddenly rose quickly and violently, the bond portfolio ended up showing such a large loss that SVB tilted.
A few other niche and regional banks have gotten into trouble in the US in a similar way, but in SVB’s case, I think it is quite clear that they tried to increase the bank’s earnings through pure speculation which turned out to look like bets in a casino.
The dam still holds
As it is all about banks in Europe and the US, I can’t see the justification for calling it a global banking crisis. There is no systemic similarity between the banks in question apart from the fact that the respective managements have pushed the banks into unacceptable risks. Furthermore, the banking sector in Asia is doing quite well, and therefore, I do not see the global aspect in the challenges either. If one finally wants to compare the global financial crisis in 2008 to 2009, then I would rather look at the differences – back then, it really was a global crisis, and it was bitterly hard.
Right now, the situation is quite different, and that is why I am currently not worried about a global banking crisis, or to put it another way, the dam is not collapsing. But this does not mean that the credit market is risk-free again. The US central bank, in particular, will continue to provoke a reaction in the American economy so inflation comes down to a controlled area again. The central bank obviously has raised interest rates. I also expect that, in a number of economies, there will be an increasing shortage of liquidity. I could well imagine this situation lasting until mid-2024, which will be a nuisance, not least for commercial companies.
One open question that I continue to pay particular attention to is how much the US real estate market will be affected by the monetary tightening. Right now, house prices are staying at a stable level (graph one), which is important in relation to whether the concern about a banking crisis in the US increases further.
It seems that it is only the construction activity that is slowing down (graph two), so I therefore also continue to expect that the IT sector and the construction sector will be the two major sectors to drag down activity in the US. With this, I still have the same assessment as before – that the dam holds, the glass is more than half full, and the US will experience a recession in certain sectors – but overall, the country will be free of a recession.
