Janet Yellen has talked about the US government offering a 100% Federal government guarantee to all depositors in smaller US banks, of which there are plenty. And now she she denied that this is being considered in a move that sent shares in such banks down yesterday, which is why I very strongly suspect that this guarantee will happen.
You cannot muse on this issue when in Yellen's position as US Treasury Secretary and then say you have changed your mind and not expect a run on the banks in question. Thinking out loud and then saying you did not mean it is not an option in her position. So my guess is that it is going to happen.
Yellen's motivation is obvious. She wants to make sure money stays in smaller banks. Without a guarantee she knows it is going to flow, pretty rapidly, from such banks to JP Morgan Chase, the Bank of America and the like. If she wants to save the small banking sector she has no choice but offer this guarantee.
But then let's think about what happens next. Doing so, settle in for quite a ride.
First, Yellen cannot offer this guarantee for those in smaller banks without doing so for larger banks as well. That's because unless she does offer that guarantee to larger bank depositors they are going to be moving their funds to small banks. If Credit Suisse can fail despite passing all bank solvency tests depositors are not in the mood to trust anyone now. So, by musing out loud Yellen has in effect opened the door to a 100% deposit guaranteed US banking system. That's the end of US banking as we have known it.
But, before considering that now think about the situation of a large company in the UK not enjoying such a guarantee. How long will it before it shifts its funds out of sterling and into a US bank to get a deposit guarantee? And then ask the same of will German, French, Spanish and other companies. They will do the same.
Of course, it could be argued that they can use repo to simulate a government guarantee on funds deposited but if by holding funds in dollars you can have the real thing why not take it? I think I can guarantee those flows to the dollar. Five central banks have even created a credit line to enable them at present. The result is obvious. One after the other the governments of countries are going to have to succumb and offer 100% bank deposit guarantees. How long will this take? It is hard to know, but maybe only weeks.
Then just think this through. First, if all bank deposits are 100% guaranteed the whole repo market ceases to have a purpose. That wipes out a whole banking sector, and that would be inevitable. Repo only exists because there is no deposit guarantee for large companies.
Ending repo also removes one way in which the government can influence short term interest rates: effectively one of its so-called ‘open market operations' arrangements that are used to communicate bank base rates into the market evaporates, overnight.
But then so too does something else disappear, which is the reason to buy gilts (or in the US, Treasuries). Government bonds are, after all, just 100% secure fixed-term deposit accounts with the government. You can describe them in any other fancy way you like, but the previous sentence tells you all you need to know, excepting the fact that these deposit accounts are arranged so that they can be traded between those wanting to own them. Now offer 100% guaranteed deposits and who would wants a gilt or US Treasury bond? You could then get all the security you want by putting the money on deposit instead, and quite probably with a break clause. So that basically eliminates the government bond markets, and the supposed funding mechanism that it provides to governments.
This is not the end of the consequences though. As is now universally acknowledged by central banks, bank deposits are only created by lending. And if those deposits only exist as a bank liability (which is what they are on a bank balance sheet) because there is a matching bank asset, which is a sum advanced as a loan to customer, now ask a simple question. That question is whether it is credible to expect a government to guarantee deposits and have no interest in the quality of the loans creating those deposits? It seems very unlikely that this would remain the case for long: the risk of moral hazard would otherwise be off the scale. So loan regulation has to follow from 100% deposit guarantees: it makes no sense to regulate only one side of the transaction.
But in that case what is the remaining role of the private sector bank? Its capital has ceased to have consequence because it has been replaced by a government guarantee. Its depositors need have no faith in it. They are only concerned with the government guarantee. Its lending will be regulated. Some of its capacity to speculate will have been removed. Its agency with regard to interest rates may well have been curtailed. All that there would be left for it to do would be investment banking, and it would be easy to see how a new Glass Steagall Act,splitting investment banking from deposit taking, could be enacted to ensure that this division, harmfully abandoned by President Clinton, could be recreated.
No wonder that Janet Yellen has hesitated in that case. Perhaps no wonder too that she has realised the danger of her speculation, which she uttered rather too loudly to ever deny. A 100% deposit guarantee might save small banks but at the same time it would completely change the entire model of banking as we know it. It would simultaneously change the way in which governments pretend that they are financed through borrowing. What would undoubtedly be brought forward is the era of central bank deposits probably through central bank digital accounts.
Maybe Yellen has realised this. Maybe she has realised that this change is inevitable. I think it probably is. Or, unless it is recognised as necessary banking will continue to operate on the basis of the pretense that there is not a 100% deposit guarantee when in reality we all know that there is, because no bank depositor is ever going to be abandoned: the political cost of doing so is too high.
Banking is at a massive crossroads. It is time that we talked about what comes next.
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If the deposit guarantee is only called upon once a bank’s own capital has been exhausted to discharge some of the total liabilities then aren’t there still consequences for the bank?
Sure – there are no private sector banks left in a systemic meltdown
I agree.
Greed, malpractice, short-termism, poor management have all broken the system to the point (and this is the only benefit) the the source of all money and the state’s sovereign role in its creation has been reified – again!
The problem remains however public perception of the problem – there cannot be a ‘revolution’ until the public understand what has happened.
It seems to me though that in the U.S. as in the UK it is the politicians who are getting in the way.
They’ve been bought.
“So, by musing out loud Yellen has in effect opened the door to a 100% deposit guaranteed US banking system. That’s the end of US banking as we have known it.”
As you say, half way to reasserting the division between investment and deposit taking High Street banking. The point here is that in the UK the Government is already guaranteeing small depositors 100% up to £85,000; so ‘de facto’ we are already quite far down the road of asserting the split. Moving forward, I am not sure what value the joint-stock bank adds to High Street banking. Perhaps High Street banking should be largely made up of mutual funded (still private sector) or public sector banks. The small businessman would still be able to take the opportunity to tap into the investment banking market; but I would suggest the existing banking system has not served small business well; especially innovative new businesses. The track record is poor of the current banking system supporting new, innovative industry. TBTF following the 2007 Crash merely reinforced a banking ‘rip-off’ culture; it merely did so with a slightly stronger balance sheet, an slightly tighter regulatory regime (but that wouldn’t have been difficult given the irresopnsibility that had gone before ever since Thatcher and Big Bang).
The cat appears to be getting out of the bag there. I don’t suppose most people would care, having less than £85k in any one bank account. It is faintly ridiculous that if I have £170k , the only way I can get 100% backing is to deposit this in two separate banks, what is the point of that? The government is still willing to cover the entire amount.
At the end of the day, in a 100 % deposit guarantee world,the entire government guarantee is unlikely to be used since we can only move money to another bank,where it will be still covered. Unless I take it all out and put it under my mattress.
We just want a functioning payment system and a safe storage of our money. That is all we need from banks. You may need a loan, and that is a different function for a bank. You may be willing to allow some of your savings and agree to let the bank use it,at a rate of interest commensurate with the risk. Of course this changes a fundamental issue about money, you would actually own your own money,whereas currently banks own your money. I think that fair enough, but noone should be guaranteeing my money in the event of me agreeing to lend mine on. Maybe a brutal reductionist view, but banking and finance has become way too complex to the benefit of a few and no apparent improved return for wider society.
“if I have £170k , the only way I can get 100% backing is to deposit this in two separate banks, ” We might as well be precise here and point out that the two banks in question would need to be seperately licensed for the govt gtee to apply.
If large UK companies shift their deposits to the secure Fed-backed US banks into dollars, the exchange rate of the £ will drop, and as energy trading is done in dollars this will put extra stress on the UK economy and inflation will not lower to the extent that is presently predicted.
I am not sure that Janet Yellen ever spoke about a “blanket guarantee”… but I agree, the ambiguity (intentional or otherwise) has unsettled markets.
I don’t think a full guarantee is likely…. but for the purposes of discussion let’s assume there IS – where does it lead?
First, you are right that any attempt to put a full guarantee on small banks will lead to a guarantee on all banks; it would be weird if systemically important banks were not guaranteed when less important banks were.
Second, you suggest this will “leak” overseas. I think this unlikely as it would be politically impossible to offer guarantees to all the world’s depositors. It would most likely apply to US citizens/companies in USD only. Besides, it is quite a hassle for a UK firm to manage the FX risks and I wonder whether they would really bother. You note that CBs are getting USD “credit” from the Fed but it is a Cross Currency Swap rather than credit and this gets very complicated… suffice to say that this market has been “taking the strain” of the banking crisis and a deposit guarantee would almost certainly help it to return to some normality.
Could the rest of the world run their systems without a guarantee? Quite possibly but they would probably guarantee.
Why? “Back in the day” before Basel Accords, US banks went bust on a regular basis with FDIC busy virtually every weekend shutting a bank; European (inc. UK) and Japanese banks had an implicit state guarantee with “failure” meaning a state bailout. And it was this that drove the US to demand a “level playing field” with respect to capital adequacy. In the 80s we feared that (effectively state guaranteed, lowly capitalised) Japanese banks would take over the world and the US did not like it. It was the US that wanted to impose “market discipline” on banks…. So, if they do an about turn the rest of the world will follow.
If we move to globally guaranteed deposits, what about repo? There would still be a very important role for repo and government bonds. First, government bonds offer duration and liquidity, second, government bond traders would still need it to cover short positions and third, not all gilt traders are banks and they would need to trade repo. Central banks might still operate in the repo market but even if not it could simply borrow/lend unsecured to banks in order to control interest rates.
With no discipline from depositors could banks become (more) reckless? Possibly…. and the regulators would have to up their game. But you are right, it would lead to a state take over of credit provision….. with all the pitfalls that involves.
So, for all these reasons there will no permanent blanket guarantee. So, how about…..?
1. A temporary guarantee lasting 6 months, perhaps a year – enough time for banks to sort themselves out. I do ask myself what a “non systemically important”, regional bank is doing having deposits of $200bn (double a year or so earlier)… and I would expect to see balance shrinkage that would return these institutions to the purpose they were intended (cue “It’s a Wonderful Life”).
2. Increase the FDIC cover to $5mm (still funded by a levy on banks). (It is unchanged at $250k since the early 80s).
3. Sort out Federal/State regulatory relations.
4. Update LCR rules to be more reflective of actual depositor behaviour… and apply them universally.
5. We need a modern “Glass Steagall” that makes clear which institutions are “safe” and which are “speculative”.
A magic bullet? No. A step in the right direction? I would like to think so.
I do not agree on repo, and would need persuasion rather than assertion
And a six month guarantee would be as impossible to reverse as Yellen’s current comments are
We now know the guarantee does really exist already everywhere
What we need to discuss is what it means
And what pretending it does not exist means
I will try to persuade on Repo……
Repo is a loan with gilts acting as collateral. If all the participants in the repo market were “Government Guaranteed” then you might have a point… but they are not. Other non-bank institutions use the repo market – are you planning to guarantee everyone?
Also, repo market is used to borrow bonds (the “specials” market). Dealers who are taken short of a particular gilt in the course of their market making business need to borrow those bonds in order to deliver as contracted…. and cash moves in the other direction. You could (just about) have a bond borrow system with no movement of cash….. but only if ALL participants are Guaranteed (and there are lots of them).
So, diminished importance… but still essential to the smooth running of the gilt market.
I agree entirely that we need to know “where we stand” with respect to guarantees – explicit or implicit. My thinking behind the 6 month to 1 year guarantee is to allow banks and depositors time to adjust their business/behaviour to the new regime….. a regime that would allow banks to fail with depositors guaranteed only up to the FDIC limit…. with any amount above that having a super senior claim on the assets upon liquidation.
My assumption is a 100% deposit guarantee
Why will there even be gilts?
100% deposit guarantees for banks? Any bank? Who would the UK public underwriting? What about a bank like Standard Chartered Bank or HSBC – a UK bank that does most of its business overseas? What about foreign banks operating in the UK? What currencies? I really think we need a cap on the liability.
Also, not everyone is a bank. If I deal with a non bank counterparty (customer) then I might want collateral.
Gilts offer fixed rate long dated assets that are liquid – bank deposits don’t do that. (Even if banks offered 50 year deposits they would not be liquid.)
Gilts offer ways to drain/add cash from/to the system (important for inflation control)
Gilts offer a benchmark, risk free rate that allows smoother running of non- risk free borrowers.
Why would you want to get rid of gilts? What does it achieve?
Why not 100% for all deposits in all banks
That is what happened at Northern Rock
It is what happened at SVB, and CS, in effect
When the credibility of your currency is at risk that is what governments now do, de facto
It is what Ireland did in 2008
Gilts would go because they would have no meaning or purpose, excepting maybe to a pension fund
But even then, I am not sure
Why not a 100% guarantee?
It seems you are trying to solve the problem “banks are too risky” by permitting greater risk taking. Any bank lending to any client will always be able to raise deposits by bidding up to attract them… and unless you think we can suddenly make the regulators better at their job it will be a disaster.
Controlling risk in banks requires regulation and market discipline. The “full guarantee” the Fed is talking about (which is not full) is required because the deposit guarantee limit being too low, a crazy interest rate policy and lax regulation enforcement.
Better to follow the Blanchflower/Murphy rate policy, raise the deposit limit to $5mm get the regulators crawling all over any bank that is growing its balance sheet quickly and let a few banks fail. (If you have $6mm in the bank and lose a million it is sad…. but you still have $5mm!).
I am not proposing this
I am musing on it
A 1.5% rate cut would solve this
I’ve worked around the capital markets most of my working life (nearing retirement now) and nothing like this has ever happened before. The comment about the politicians being ‘influenced’ made may be relevant.
Very, very interesting. I will be listening for other signs of market madness…
Doesn’t this potential banking revolution rather open the door to CBDCs and couldn’t that perhaps be why it’s being openly considered? I’m wondering about that… meanwhile, arguably all Yellen’s open speculation really does is add substance to the notion that the world’s central banks, perhaps with the aid of other actors, are playing at something – but we still don’t know what. Oh, and backing the Western world’s deposit accounts with dollars… that would give said world a clear incentive to maintain the international accepted value of said dollars, would it not, even as it suffers enforced decoupling from, ah, petro? I wonder too whether that’s a factor, while musing it hardly fits with the direction of travel which I’ve lately assumed to be towards dedollarisation. Anyhoo… maybe Yellen’s real motivation here is trying to save the dollar’s value in the emerging post-petrodollar landscape.
Sounds like a proposal for the removal of several layers of “socially useless” financial transactions. As for Repo is it not a variation of the “bed and breakfast” strategies used to temporarily cosmeticise balance sheets or give the reader the impression of deleverage?
Keep coming back to the fact that if you cannot identify the risk then you cannot establish the capital requirement, everthing else is reactive. As we have seen these entitities are simply unable to identify and manage risk.
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