The Economy

This isn't over and these aren't "one offs."

With interest rates not being suppressed. ... the malinvestment that mispricing of money caused is going to cause a crisis. The next things up are commercial property mortgages. Zero interest rates blew a huge bubble there, and there are a bunch of banks that are exposed.

The only thing that can hold off that financial crisis is for our monetary mandarins to reverse course and price fix rates back down to zero. ... The problem with doing that is the sticky, persistent consumer price inflation they let out of the bottle with their arrogance. ... along with their cluelessness.

There is no way out for them. As I have said for a long time, they are backed against a wall. If they keep hiking rates (and the market is predicting another 25 basis points on Wednesday) to ostensibly try to address inflation. ... you are going to see banks start failing for all kinds of reasons related to their decade plus-long interest rate distortion. If they don't, we are going to start to look more and more like Venezuela or Zimbabwe. If they do half-assed measures, slowing the economy a little and not doing enough to address the monetary inflation they caused, we are going to die a slow stagflationary death -- what is already in motion.

Ultimately, if their past is prelude to the future, they will choose the typical cowardly action of trying to avoid the blame of a financial crisis, and they will start expanding their balance sheet again and they will suppress rates back down again. And the tax we will all pay will be an inflationary tax that destroys the poorest people. They will do that, in large part, because the interest on the massive Federal debt they have monetized and allowed to run up is now running close to a trillion dollars a year. We can't afford normalized interest rates with the government debt mess we have whistled past the graveyard to saddle ourselves with.

At the bank level? The nonsenses that three large bank failures in less than 3 months were all one offs is absurd. And it's infuriating that they will pass it off as simple "greed" or "mismanagement," rather than pointing the finger where it mostly belongs. They have had a policy to rob savers to reward debtors by suppressing interest rates. That made it impossible for banks to take deposits and then loan them to earn a net interest margin. So they were forced to try to make up the yields they were being robbed of in any way they could. You are now getting a sampling of how they did that.

In SVB's case, they extended duration of bonds they bought with their deposits to earn a tiny bit more yield. That was fine. ... until the Fed started to raise rates (after 13 years!) because inflation forced their hand. It put those longer dated bonds under water.

In the case of First Republic, they were writing mortgages for uber wealthy people, and in order to attract the business, they had to offer better and better terms. So they were multi-decade long jumbo mortgages that for the first 10 years didn't require any repayment of the principle. When rates rose. ... those mortgages sunk in value.

When banks fail in a unmanipulated environment. ... it has ALWAYS been because of credit risk. What is different now is that these are interest rate risk problems. Everyone was herded into taking long duration risks by the Federal Reserve. And now the scheme the Fed was using to force that behavior is being reversed, and . ... you are seeing the consequences. You have huge mortgage and loan portfolios that are under water. And it's not limited to a few banks.

Marked to market there are HUNDREDS of banks that are really insolvent right now if depositers start pulling their assets.

 

One other thing. ... and this is a little arcane, but not really because it is so important, but people won't understand it.

The Fed has used endless schemes to manipulate the rates markets. In the early 2010s under Ben Bernanke and then Janet Yellen, they wanted to pin their overnight lending rate near zero (make money free), but they were trying to prevent rates from going negative.

They started using reverse repo operations to do it. I can explain if anyone cares, but the part that is important is that it set a floor under interest rates. They did this so that if rates dropped lower than they wanted, they knew that banks would borrow from them on a short-term basis instead to get the slightly higher yield. They made the availability of that money unlimited (why not, they can create money out of thin air?).

They have kept those operations in effect (mostly out of arrogance. ... acting like they can design something they can't really control) . ... even as they started raising rates.

What is happening right now. ... The Fed spurred runaway inflation, particularly because of how much money they essentially printed during the pandemic to monetize all the debt politicians were idiotically running up. In response, they felt forced to raise interest rates. And that sparked bank runs. People can finally earn some positive yield for the first time in more than a decade. Their banks are still paying next to nothing (in part because they are underwater on their loans and bond portfolios because the Fed raised rates). ... but people can buy a money market fund that might be yielding 4.5 percent and feel it is perfectly safe. ... because those money markets are investing in risk-free high-yielding reverse repos courtesy of the Fed! It's how their "solutions" are always the problems.

This is what happens when you have a price czar fixing prices in a market (in this case the debt market) rather than letting buyers and sellers -- supply and demand -- finding levels via price discovery. The distortions might look like they have given something for nothing at first. ... until the actual price comes due.

 

They reported earnings last week. It put a spotlight on a large financial hole they were sitting on. Which is why things came to a head.

The FDIC has been on top of it, but rather than react, their main purpose is to keep people from panicking. They were kind of hoping for a sale to happen before they were forced to put the bank in receivership.

The first move was actually pretty funny -- in its nerve. A handful of large banks (at the behest of the FDIC) had deposited $30 billion in First Republic to try to sure up confidence a few weeks ago. ... and First Republic went back to those banks, but instead of doing it with hat in hand their pitch was: We are going to get put into receivership unless you bail us out, so we want you to buy tens of billions of dollars of underwater mortgages for way more than they are worth. If you don't do it, you run the risk of losing the money you already gave us AND the FDIC (which has to keep 1 percent or something like that of total deposits on hand) is going to raise fees on you that will cost you even more than if you just buy our underwater mortgages.

That extortion gambit didn't work. Which is why you ended up with the bank being taken over and a couple of banks bidding on the good assets the bank had (with JP Morgan getting the sweetheart deal). The rest of us will be forced to pay for the mark down of the bad assets because. ... we must socialize every cost and hide that cost from everyone in ways that create even bigger costs down the line.

The bad part is that with Signature, SVB and now this. ... the FDIC is setting the precedent that NOTHING will fail. No depositer will lose a penny. But you have probably $17 or $18 trillion worth of deposits, and the FDIC literally has between $100 and $200 billion insuring that implict guarantee.

They are running a confidence game that they are praying actually keeps people confident enough. But the Fed is working at a crosscurrent to that as it keeps letting interest rates rise (to ostensibly deal with inflation), which is going to put more and more pressure on banks with duration risk problems. Things are way more perilous right now than most people realize.