That there would be a meltdown in world banking was obvious to Danny Blanchflower and me as we worked on our submission to the Treasury Committee of the House of Commons, submitted last Friday.
As I have explained in an extract published this morning, if you push up interest rates so that the world's central banks could suck liquidity out of bank reserve accounts using quantitative tightening and simultaneously end the policy of quantitative easing only one outcome was ever going to be likely. We began writing some of this stuff late last year. The Committee then provided the hook on which to hang the publication. I admit the only thing we did not anticipate was the whole thing exploding this weekend or we would have got it out a week earlier.
Credit Suisse is the latest bank to fail. As they fall one after each other, to be bailed out in a fashion horribly reminiscent of the early autumn of 2008, the world should be waiting and watching to see what will happen next.
For the Swiss that is obvious: they are underwriting the losses in Credit Suisse on behalf of UBS. National pride and the currency are going to take a hit from that.
But if Credit Suisse could hide such obvious failings that immediate write-downs of its debt are required what other bank has similar issues hidden in its balance sheet? Again, there is a feeling horribly reminiscent of autumn 2008 this morning as the fear that no bank balance sheet can be relied upon is prevalent. And it does not matter much if those balance sheets are reliable: when KPMG signed off SVB's 2022 audit report without comment in February and PWC had already signed off Credit Suisse for 2022 without a going concern risk qualification, no one knows if any bank balance sheet can be relied on now. That is, once more, 2008 all over again.
No wonder the world's central banks have already opened a dollar credit line for the world's banks, just to keep them afloat.
But that is not enough. There needs to be a radical rethinking of central bank policy as another banking crisis emerges. This crisis was made by those central banks. Their policies and their failure to supervise created this outcome. As Danny and I said in the summary of our report:
We think QT and the associated policy of reducing or eliminating the APF is unnecessary because there is no evidence that UK or other financial markets have the capacity to absorb the sale of more than £800 billion of UK government gilts either now or in the future without:
- Significantly increasing in UK interest rates with all the harmful consequences already noted in this submission.
- Severely limiting the ability to sell new government bonds, which would result in the imposition of a period of prolonged UK government austerity, and which might also significantly reduce the capacity of the UK government to invest, damaging the infrastructure of the economy on which the private sector depends and also leaving the country at risk of breaching its net-zero obligations.
- Severely reducing the funds available within central bank reserve accounts held by the UK's commercial banks with the Bank of England upon which balances the smooth operation of the UK banking system is now almost wholly dependent.
- Creating a recessionary economic environment which might, because of prolonged austerity, high interest rates and potentially high inflation have the risk of becoming a depression.
- Creating substantial social stress and potential disorder within the UK.
This means that there is no identifiable reason for wishing to operate a policy of QT or to increase interest rates, which is the only identifiable reason for it, unless that is it is the desire of the government, Bank or England or both to:
- Reduce growth in the UK economy.
- Increase unemployment.
- Increase financial risk.
- Precipitate an economic crisis.
As a consequence of these observations and those in the submission that follows we recommend that:
- The APF be maintained at its current value, or be increased.
- That the current policy of the Bank of England to increase interest rates be reversed. Their current forecast is consistent both with cutting interest rates and/or reversing QT.
- That the policy of QT be abandoned.
- That a new QE programme of at least £50 billion a year for the next four years replace that QT policy.
We make these recommendations because unless they are adopted we fear that financial markets will be unable to finance the purchase of all the UK government bonds offered to them in the next few years without considerable increases in UK interest rates that will be profoundly harmful to the UK economy and the wellbeing of people in the country. The fragility of global financial markets in March 2023 is instructive.
As a result, in the interests of financial stability, economic growth, low inflation and stable government finances we believe that QT should be abandoned now.
Will the central banks change their policy now? We will know when the Bank of England reports this week. If rates go up, as many still think likely, then a cliff-edge policy is what they're going for. If they go for that I can say one thing with certainty and that is that we will go over that cliff.
Central banks have a choice now. They can service society or they can serve bankers. They cannot do both. What are they going to do?
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Your point about Central Bankers serving bankers is well made. It is why we need a broader pool of BoE monetary policy makers to include trade Unionists, Small business owners etc.. (and perhaps, even a Treasury Minister to allow better co-ordination between fiscal and monetary policy?).
I wrote elsewhere about the BoE needing to target yields rather than “put a number” on the amount of gilts it might buy or sell – particularly in such a fluid situation we see now.
Where I disagree with you is that this is “2008 all over again”. I am not involved as closely with markets today as I was….. but there have been a few -1987 (stock crash), mid 90s (S+L failures), 1997, (Asian credit crisis), 1998 (Russia and LTCM), 2001 (Dotcom crash) 2001, 2008 (Great Financial Crash), 2012 (Euro crisis). This one does not seem that bad – certainly nowhere near as 2008. Now, I accept there is a long way to go but so far so good.
(1) The credit exposure that banks have to each other is massively (and I really DO mean massively lower). Unsecured interbank lending is tiny, most trades are conducted through Central Counterparties etc.. I would venture to suggest that NO bank of any size would have significant uncollateralised exposure to CS. So, contagion risks are much diminished.
(2) Capital levels – real “loss absorbing capital” levels are much higher than 2008. This means that UBS could buy CS without state money being thrown in the pot…. with CS shareholders and sub-debt holders being (virtually) wiped out senior creditors (depositors, sen unsec bond holders etc.). We will see what the story is with SVB with regard to capital but this is not a “Lehman moment”.
Having said that, if Policy makers want to inflict the real economy with a severe recession due to high rates and austerity then any banking system will struggle… but I am not sure it is the banks’ fault that the Government/BoE are fools (or worse).
The real lesson of this crisis so far is how ‘flighty’ depositors are. This is due to better and faster information to “non-professional” players (ie depositors)…. and better technology that allows them to act quickly (ie. No queuing outside the branch to withdraw your money – just a click of the mouse). This needs to be addressed in LCR rules.
I accept the risk is different
But there is contagion – and wiping out AT1s charges where it is real, that is all
As fur flightiness, that is also present
But at the end of the day this is a central bank made crisis. They created the losses that are being hidden this time
“The real lesson of this crisis so far is how ‘flighty’ depositors are. This is due to better and faster information to ‘non-professional’ players (ie depositors)”.
One of the problems with the 2008 solution was precisely that the central banks (and government) served bankers (and dealers) first. Unlike the Pandemic the resources were not applied to ordinary people – the High Street (Main Street in the US), and it never reached the public, and it did not produce growth or do anything for living standards.
Not as bad 2008 (perhaps – but there is your problem, it is all digital yet we still do not know what is really happening)? We shall see; it isn’t much of a reccomendation for the system if that is the best can be said for it. At the same time you argue that there is no cost to the public purse, but even if not directly, are we to surmise the side effects, the indirect effects, the turbulence has no economic cost or consequences; not least to confidence? In addition are we saying that increasing liquidity in the global system has no opportunity costs for the central banks (and consequentially governments)?
The Swiss Central Bank threw £44Bn into the Credit Suisse pot, and I am not clear what happened to that public investment, after the UBS takeover. Does anyone know?
On the narrow question of “where did the £44bn go?” – well, it will be repaid almost immediately. It was a loan advanced against CS assets as collateral. UBS will have no need of it as the bulk of CS deposits will have fled to UBS.
On the broader issues, yes, I agree, it is a mess but banking is a fundamentally unstable business due to maturity transformation. We regulate to reduce the risks but they are always there and, if we wish credit to be available to the real economy, we have to accept there are always risks. We also regulate to minimise fall-out/contagion, protect the “innocent” and dish out punishment to the “guilty”.
I think some lessons were learnt in 2008, some have been forgotten too quickly, others are are being learnt as we speak.
I think this is the nub: “On the broader issues, yes, I agree, it is a mess but banking is a fundamentally unstable business due to maturity transformation.”
Yes, Minsky had to repeat it, because it is the bankers who are not listening, not the depositors. They never do. They will look for the loophole, and they will pay the most in fees for the best loophole advice. That is how it works – and always has. Bankers wish to encourage confidence; the problem is they do not achieve it by how they act, but how they choose to spin their PR, as a substitute for prudence. The central bankers then fall in line, in order to support faith in the system. What does this tell us about the system?
It is unstable, therefore it cannot safely left with commercial bankers in a system that gives them the regulatory freedom they currently possess. They can’t be trusted. This is not justabout 2008 (I am not falling for that deflection); that was fifteen years ago, things move on. The balance sheets are stronger, the liquidity more secure, the mortgage riskes reduced: however, that was to fight a problem fifteen years ago; ancient history, the loosest permissionless innovators and chancers will have moved on. I suspect High Street Banks should have a choice: public sector, or private, no investment banking, with regulators breathing all over them – perhaps ‘inside the tent’; or mutually funded.
Have they fixed the modern problem of the growth of complex derivatives, with exponential risks? I suspect not. Have the deriviative risks risen exponentially? I suspect they have. Do we have the regulations and solutions to fix a new derivative crisis, at scale? I have no idea. My problem is I doubt if the banking sector or the central bankers have the slightest idea either.
“Credit Suisse is the latest bank to fail. As they fall one after each other, to be bailed out in a fashion horribly reminiscent of the early autumn of 2008”
The book “After the Great Complacence” (Financial Crisis and the Politics of Reform” was published in 2011 and covers the events of 2008. It has the benefit of brevity (250 pages).
Chapter titles are useful & revealing: “Financial Innovation or Bricolage” (Chapter 2) and “Alternative Investment or Nomadic War Machine” (Chapter 3).
Key points; bankers work the angles (financial bricolage), the opportunity for reform was missed – chapter 8 “Reform? Hubristic Intervention or Effective Democracy”.
CBs will undoubtedly sort things out using the usual mix of sticking plasters and wrist slaps – a cursory consideration of the background of central bankers – e.g. Lagarde suggests that they are more interested in preserving the rights and privileges of the banking family to which they belong. It’s a bit like appointing as game keeper an ex-poacher who socialises and sympathises with his poaching mates.
Thus the reaction to current banking events is an example of socialism in action, helping those who have fallen on hard times through, e.g. financial bricolage combined with a failure to implement banking reform. Page 242 onwards is rather good & suggests little if nothing has changed either in the USA or the EU –with the failure of politicos to implement meaningful reform due to high-powered/well financed lobbying by banksters that want the party to continue.
As a long-time non-expert observer of Banking it seems to me that unless we are able to reinstate something like the Glass-Steagall act we are inexorably being sucked (suckered) into a financial black hole absorbing increasing multiples of the world’s wealth.
The only difference between an actual black hole and its financial equivalent being that an actual black hole takes a very long time to implode while our current financial system looks like it could go at any minute.
Thirty years ago the UK was stunned to discover that one of its oldest Merchant Banks was going bust with debts of £900 million. Now nobody bats an eyelid to wake up to American and Swiss banks being bailed out with £40, £50 or £90 billion.
A hundred fold increase but peanuts compared with the amounts of quantitative easing that now appear to be a basic requirement of a stable world economy.
If this was all being done to create a better, fairer, more civilised world there might be justification for the huge risk, but exactly the opposite is true.
What was Iceland’s experience after the 2008 crash. I’m sure we’ve all seen the memes about them not bailing out their banks, jailing the bankers, and the outcome being better. But what are the facts?
Banking is in meltdown, again. Will central bankers finally accept that their job is to serve society and not bankers?
In a word, No. They see their job as serving the interests of the Banking system and bankers.
They look after themselves. A little proof.
Silicon Valley Bank’s UK arm handed out over 15 million pounds ($18 million) in bonuses days after its rescue deal this week by HSBC, Sky News reported on Saturday.
https://www.reuters.com/business/finance/svb-uk-handed-out-over-15-mln-pounds-bonuses-days-after-hsbc-rescue-sky-news-2023-03-18/
They know where their bread is buttered and who is holding the knife.
Agreed
“if you push up interest rates so that the world’s central banks could suck liquidity out of bank reserve accounts using quantitative tightening and simultaneously end the policy of quantitative easing only one outcome was ever going to be likely. ”
So they pushed up interest rates, in the middle of an economic crisis. Even in the last few days we were still being told that ‘there is nothing to be seen here’. Move along, we have this minor problem under control.
Today? Following the waves rippling out from the SVB collapse (this is 2023, in a global, digital world), Credit Suisse has been acquired by its nemesis UBS, suddenly and overnight (after a failed £44Bn bail out by the Central Bank). Now the BBC is reporting: “In a statement the Bank of England, Bank of Japan, Bank of Canada, the European Central Bank, US Federal Reserve and Swiss National Bank launched the co-ordinated action to ‘enhance the provision of liquidity'”.
This is the Global world we have created, and that the bankers clearly do not understand.
It is always a matter of liquidity. There is a hierarchy of money, but perhaps the real truth is the commercial banks cannot be trusted to create money. In fact they create credit, and too often it is not high quality credit; because too often it is illiquid. Illiquid banks don’t work. I am astonished to find that in the world I am obliged to live in, I find myself writing that sentence. The test of experience in the modern world, meanwhile is that only the sovereign issuer can safely issue money, because it is the only money on which you can rely; and the proof of that is that it is the sovereign issuer that has to clean up the filthy mess made by the failure of banking “markets”. How many times are we going to have to go through this? How much treasure are we going to blow, before we acknowledge that the commercial banks cannot be trusted with the licence they possess?
When there is a crisis the money is always found. Always. The problem is this; it is political parties that select what crisis they support, and what they can safely ignore (for political or ideological reasons, typically). Typically the political parties feel safe in Britain with a large number of poor they can ignore, and large tracts of bleak, deprived areas, because they can still win elections by doing nothing in a tricked-up FPTP electoral system, and electoral constituency boundaries that typically favour the Conservative Party.
Allow me to imagine that Churchill is sitting in No.10 in 1940, newly appointed and trying to understand the predicament we are in, and how he is going to fight the war. Imagine that the advice, let us suppose is given by a neoliberal investment banker (just like a typical conservative minister today), who sits down to explain the problem; and tells Churchill the only thing he can realistically do is surrender, because we don’t have the budget; we have run out of money. If Churchill tries to go on fighting the national debt could be 250% by 1945 even if things go well, and that simply isn’t sustainable.
A neat idea: bankers will always advise surrendering to fascists
For clarfification of the 250%: it was Debt to GDP ratio in 1945. We are in a flap about a ratio of circa 100% (+/-5%), including circa £825Bn of QE (that should probably be cancelled on consolidation, if the Government had to produce a consolidated Balance Sheet); after a Pandemic, in the middle of a European War in which Britain is financially supporting Ukraine through defence equipment, and energy crisis, Brexit (with serious long-term adverse economic consequences for Britain) at scale; and a very serious cost of living crisis for ordinary people; as well as the demonstrable long-term now disappearenace of economic growth, investment and productivity improvements from the British economy – sustained over much of the last two decades.
The neoliberal case for debt reduction in an emergency is absurd; an insult to intelligence.
And yes, why should’nt Government be required to produce a consolidated balance sheet? That would put ‘the cat among the pigeons’.
Don’t leave the bankers and economists to do the accounts. None of them understand double-entry. And there, I rest my case.
🙂
As soon as there is doubt about banks having enough money to deal with above average withdrawals then jtters and then panic sets in and we weill have Lehman/Northern Rock all over again.
What we seem to be having, from reading around, is capital flight from small banks into big brand banks, belief in them continuing for whatever reason. I note, for instance, the value of Bitcoin has hardly lifted at all, and usually you might have expected it to when people were fleeing banks. It makes me wonder if the point of this entire exercise (ie the central banks raising interest rates despite consequences being wildly antisocial and it doing nothing to stop inflation) is herding depositors from small banks in to the welcoming jaws of big ones, a consolidation of power within the system, a move towards corporate oligarchy, if you will. If so, what would the next move be? I’m guessing we’ll see the West’s biggest banks teeter-tottering and bail-ins being implemented to save them (the legislation exists), leaving the bank accounts of the greater part of the population gouged and empty while the banks sail on unperturbed. I am of course aware of grand statements from govts about bank deposits being guaranteed by said govts but look at what that actually means in practice – the guaranteeing part of the UK govt. for example was turned from a simple department (ie of the Treasury or the BofE, can’t remember which now) into a ltd company a few years back. Ltd companies, of course, can come and go, leaving no liabilities behind them. What if, when push come to shove, it goes and the so-called gtee proves worthless? I mean, if it’s the banks and govt doing this between them, who you gonna call? Serfdom could be just around the corner for millions. I really wouldn’t be surprised. These are the times.
This is what Danny and I fear and is one of the contagions we describe
Without deposit guarantees this could be as bad as Savings & Loans
And notably, we lack a Bill Black or anyone even approximating his calibre in authority, offering a clown show instead.
The contagion we saw in 2008 will not materialise with the Credit Suisse situation. The Alt1 holders being wiped out (ahead of ordinary shareholders) is something peculiar to Swiss Banking and absolutely does not apply to the EU,US or the UK. The fear this will be widespread is completely off the mark.
It is all here .. https://www.credit-suisse.com/content/pwp/legalgates/about-us/capital-instruments-disclaimer.html/about-us/en/investor-relations/debt-investors/bonds-securities/capital-instruments.html?t=397_0.34470471785666357
If you look at the covenants of the capital structure of Banks outside Swiss jurisdiction then you can see they are quite different and are are contingent capital based on the performance of the business not the whim of the regulator.
You know AT1s are common?
Of course, they are on the balance sheet of all banks . My point is that they are not all the same and the vast majority are contingent capital i.e they turn into equity on the performance of the business and can not be swiped out on the whim of the regulator. To understand this requires the reading of the covenant deeds. Many are making the false assumption that all Alt1 are the same.
Very few are priced for the current risk
Your bizarre assumption is that there is no extra risk premium in banking now when it has just gone through the roof
Until now, most of us classed AT1s, (along with CoCos, other sub debt etc) as “basically all the same”….. but the devil is in the detail and it varies bond by bond (let alone bank by bank and country by country).
That these AT1s were wiped out completely will get everyone reaching for the prospectus of what they own….. but, to be frank, AT1 holders arguing with Common Equity holders over where they are in the pecking order is fairly irrelevant. AT1 wipeout is not systemically problematic – they will reprice to reflect a realistic price for the embedded equity put option they contain. That is probably a good thing as banks will either reduce the risks that they run or hold more capital in order to avoid issuing these expensive instruments.
Bit what cannot be denied is that the risk premium has risen, maybe considerably, and that is the real issue
That and the fact that we now know that ban k balance sheets cannot be relied on again
“that there is no extra risk premium in banking now when it has just gone through the roof”
Where did I say that? I said not all AT1s are the same as those issued by Credit Suisse. The error many are making is to believe here that AT1 bonds are the same thing all over the world. They’re not. Every jurisdiction has a different tweak. It is worth taking a look at the Credit Suisse prospectus.
“A ‘viability event’ will occur if either:
(a) …
(b) …CSG has received an irrevocable commitment of extraordinary support from the Public Sector…without which, in the determination of the Regulator, CSG would have…unable to carry on its business…” There is not a single a mention in the 212 page prospectus about equity needing to be wiped out first.
I absolutely guarantee this wording will not be in the vast majority of issuance in the EU, the UK or the US. To understand the risk the covenant deeds have to be read and properly understood. Of course many who owned CS At1 securities and the many people commenting about whats happening obviously haven’t read the covenant deeds either.
Why don’t you look up and see the tsunami sweeping your way?
You are behaving very much like a banker
“You are behaving very much like a banker”
Haha i’m certainly not a banker i have worked in industry all my life. I am
also a private investor who likes to do their homework.
So, a micro perspective on a macro issue
“So, a micro perspective on a macro issue”
I’d like to think both..what I try to avoid is making sweeping generalisations or relying on paper talk. Even the FT misrepresented the true situation in its early articles on the takeover.
Wow
Publish your cv, guru
Or don’t call again
Blair,
Tell me I’m wrong, but somehow I don’t think this is how contingent convertibles were supoosed to work; £17Bn written off in one jursidiction, and I undertand other jursidictions apparently now changing their tune on following the precedent. Globalisation, eh?
“The fear this will be widespread is completely off the mark.”
Well, the irony is – CoCo Bonds were supposed to be part of the post-Crash reinforcement of banking capital. The Washington Post said this: “The decision to ignore market convention — that shareholders are the first to take a hit before AT1 bonds face losses — could prove to be a huge blow to the $275 billion AT1 market and raises serious doubts about the prospects for other lenders’ CoCos. …. ….. The huge uncertainty is likely to weigh on lenders’ bond prices right across the ratings spectrum.”
Spot on John
As Danny and I say, this changes the risk premium, significantly
Right now it wrecks the AT1 market
Existing AT1 bonds (about USD 200+bn at par face value) are still doing their job and providing “loss absorbing capital” for the banks that have previously issued them – where they trade in the secondary market is unimportant with regard to whether a bank is meeting (or otherwise) its capital requirements.
Clearly, owners of these bonds are not happy – it appears that they under priced the risk (which was clearly stated) and the owners of CS AT1 are crying foul over the fact that they got zero while share holders got something…. but they are complaining about whether they should have got 5 cents on the dollar or zero (not 100). In 2008 subordinated bond holders were bailed out at par (which was wrong) so AT1s are doing the job they were supposed to – except that 17bn was insufficient to save CS from the massive outflows. However, it did permit UBS to step up and buy CS as a “going concern” that saved a liquidation.
With the AT1 secondary market in disarray new issuance is impossible so banks that raise new capital will have to do it through selling common equity…. or reduce risk.
So, the fate of CS AT1 bond holders is fairly insignificant in this affair although they have managed to make a lot of noise.
Noise = risk premium, and that is what matters
“Noise = risk premium, and that is what matters”
Hmmm – yes and no.
If you need to raise capital in this environment then you are toast (as CS found out). If you are a big bank it offers opportunity (as UBS has found out) and cheap funding (as JPM is finding out).
In between there are lots of banks and depositors that don’t know if they are “CS or UBS/JPM” and they are desperate to stay liquid…. and this is having a negative impact on the provision of credit to the real economy.
It is THIS risk premium that matters…
…and markets now believe that the Fed will respond by cutting rates which may partially offset this effect. I don’t really care what happens to AT1 investors or equity investors and the risk premia they face…. that is what investing is all about.
We both agree that high rates by BoE and Fed are wrong and that they are killing the economy….. and banking crises nearly always have their roots in problem credit quality in the real economy/housing. The question is whether the approaching recession (and there will be one) will cause a ‘crisis’ or just ‘serious pain’ to be absorbed by existing shareholders and AT1 holders. Give or take the demise of a few foolish player, I expect the system to remain in tact.
I think you and I are now reconciled
It is the risk premium you identify that DSanny and I were targeting yesterday
I am happier where this discussion ended, than where it began. I bow to the detailed knowledge of process (and it is invaluable that we have the resource in Clive to explain the detail so trenchantly), but process is not causation and my concern was always where this was going, what substantively the turmoil actually represented, and where it ends.
Here is where I found what I was looking for, because it is always a matter of confidence, trust and liquidity:
“In between there are lots of banks and depositors that don’t know if they are “CS or UBS/JPM” and they are desperate to stay liquid…. and this is having a negative impact on the provision of credit to the real economy”.
There, it seems to me is the problem, neatly expressed. It is not a statement of a solution achieved.
Anyhoo… ‘unrealised losses’, a phrase I’m seeing used over and again in connection with currently suspect banks is another phrase which could usefully be added to the glossary.
Indeed
[…] Cross-posted from Tax Research UK […]
Oh wow. I read this blog every day but much of it goes over my head as I’m not financially literate at least in issues like this. My question is should we be buying gold or not? Even if it’s only 2 or 3 ounces which is about as much as I can afford.
It has never occurred to me to do so
Your m9ney is safe if you gave £85,000 or less in a U.K. bank account
And give. You will not actually physically possess the gold where is the security in that?
Thank you
If you read Mattei “The Capital Order” the fate of the economy is secondary to the fate of the elite and capitalism itself.
Somebody has to pay and a crisis covers up that it is going to be us.
It should come as no surprise that a lot of assets on the books of dodgy private banks are worthless. Nor that regulators cover this up.
The issue is what comes next?
“Will central bankers finally accept that their job is to serve society…………….”
No. Central bankers will always consider their job to be what Government tells them that it is. The problem lies with Governments for giving CBs too much responsibility for macroeconomic regulation.
Monetary policy adjustments may be necessary from time to time but these should be secondary to those of fiscal policy. Furthermore, both should be controlled coherently instead of a change in one being fought against by a change in another.