The Economy

Opinion | The U.S. Needs Economic Regime Change

I'd take what he wrote -- and unfortunately, people Kevin Warsh have been ignored and were even being painted as extremists for years -- and add to it that we shouldn't HAVE a central bank trying to price fix the debt markets (to all of our detriment), let alone ones as bad as what the world has. It's like expecting children to manage a candy store and then wondering why things went wrong. The debt markets are the most important markets to capitalism. They determine the price of money. Free markets -- buyers and sellers transacting freely based on what THEY see as the incentives, are a natural regulator of the excesses that central banks cause in the name of a free lunch. ... which then ends up costing us all way more when the piper comes calling. It's time to end the madness.

History will give a full accounting of the grave errors committed in recent years in economic policy. A central lesson is already clear: Nothing is as expensive as free money.

The costs of the Federal Reserve’s zero-interest policy are multiplying: The misallocation of capital—goosing the price of the riskiest and least-productive of assets—set the conditions for boom and bust. The financing of the “big state” set the country on an unsustainable fiscal trajectory. The extraordinarily loose financial conditions created herd behavior among market participants and firms and complacency among policy makers, including regulators. The surge in inflation substantially raised the cost of living for citizens and undermined business planning.

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First, the Fed, Treasury and FDIC should come to terms with—and agreement on—the breadth of the problem. It’s not about a few troubled banks and an irrational run by panicky depositors. Weekend fire-fighting only buys time. The liquidity-induced holiday from economic history has ended. They should be prepared for a pullback of everything everywhere all at once.

 

Really good questions.

1) There isn't a bank in the world that isn't sitting on a bond portfolio that marked to market has huge losses. Interest rates were being kept artificially suppressed at zero (negative in Europe) for about a decade. The only way for a bank to eek out positive net interest margins (make money) was to extend duration in their portfolios (which should be comprised of safe investments -- things like treasury notes and bonds, backed by the U.S. government). ... so everyone loaded up on longer-dated treasuries. It wasn't a problem. ... as long as rates were being artificially suppressed. Then inflation took off and the fantasy of zero percent interest rates ended, and to deal with the inflation, central banks raised their overnight rates (and the Fed let some of the debt roll off its balance sheet). And that created losses for the bonds in those banks' portfolios.

So YES. ... you had that exactly right. Everyone has been scouring those banks' balance sheets like sharks looking for blood in the water. It's not a domino effect. The banking system really is weak. It's not just the U.S. It's global. It's concentated in the regional banks in the U.S. (our large banks are more diversified, so more insulated), but everyone is vulnerable inluding the big banks.

2) Yes, they stress test banks. But the stress tests are silly, because the Federal Reserve (which caused what is happening) creates the conditions of the stress tests. So two things are at work:
a) Silicon Valley Bank, for example, wasn't stress tested anyhow the way that say Citibank or JP Morgan Chase is. It's based on size, and supposedly how too big to fail you are. and
b) The Federal Reserve is still the regulatory authority that was supposed to be on top of all of those regional banks, and it never considered the duration risk problems we are now having in the wake of interest rates rising. Even though they were the ones suppressing yields! You had banking examiners looking at these banks' balance sheets and they simply assumed that the artificial environment they had created could/would stay that way forever and we could exponentially just create more and more credit forever. ... so they were just looking at the credit quality of the bonds they owned, not the valuations the bonds would have had without the prices being artificially lifted by Fed policy. I know I keep saying this. ... but it's the same as putting the arsonist in charge of preventing fires. They blew a bond bubble that forced banks to buy bonds at insanely artificially high prices. Butthen when inflation (which is a consquence of all of the money creation that is their tool to suppress yields) finally forced the Fed to feel like it had to deflate the bubble they were causing (and they have barely done this; they have gone at it gingerly), and the prices of the treasuries and mortgage-backed securities those banks owned came down (creating massive losses), the Fed (and its bank examiners) were completely taken by surprise.

What is happening was always an inevitability. It was a matter of when, not if, and the longer they created the distortions to keep credit growing the way it was, the greater the price there was going to be to pay.

 

I should add. ... what is going on with Credit Suisse, is that problem on steroids. ... in the case of the regional banks here, their portfolios are not crazy. They largely own treasuries and mortgage-backed securities. Credit Suisse (and I am a little surprised we didn't hear about Deutsche Bank first, because from what I know it's an even worse situation) has a flat-out toxic portfolio. The problems with those banks date from before the financial crisis in 2007. They propped up the toxicity and grew it in the process. I don't know the degree of it, but we could be talking about trillions of dollars leveraged bets that were being fueled by the negative rates that was forcing bigger and bigger piles of money into the banking system and fueling wild speculation -- leveraged loans, mostly. It's different because the leverage makes it even more dangerous. ... enough to take down the global financial system. But it's similar in that it was somewhat manageable as long as real interest rates are negative, and the minute that fantasy began to end. ... things started to blow up.

 

Shares of First Republic Bank just halted (stock price sold off more than 20 percent in minutes). ... Also reports that JP Morgan led by Jamie Dimon is talking to other banks to turn the $30 billion in deposits those banks thought would get the job done last week into a capital infusion. This is all much worse than people realize.

 

The stock opened again, dropped, and they immediately halted trading again. I have no idea what that bank is worth, but they really badly want to make a stand here, because if this bank goes down (and the market is saying $30 billion in deposits last week from the big banks is NOT enough), there are others right behind it.

 

1) How does Martin Gruenberg know that? He was pulling made up numbers out of his sphincter that the FDIC had never "reported" before.
2) Even if you believe $620 billion. ... that was at the end of 2022. Since then, the Fed has hiked another 50 basis points (and still counting, because they haven't officially pivoted yet and they even announce another rate decision on Wednesday, where there is a chance they will hike 25 basis points because they have a credibility problem now) and the efects of the previous 400 basis points are STILL filtering through. It's true that yields on the 30-year have come down a bit recently, on the assumption that the Fed is GOING TO reverse course, as well as on a flight to perceived safety. ... so maybe the worst of it is done for those banks on the prices of bonds they own coming down. But the problem isn't so much how much the bonds are worth on paper with where interest rates are today, it's how much they would be worth without the Fed still suppressing yields and artificially driving the prices of those bonds higher. And that is way, way, way bigger than $620 billion for the aggregate of all the banks' balance sheets in the U.S. It could be multi-trillions of dollars without the Fed creating its distortions.