The writer is a lawyer by training who deals with and is involved in technology. Manager of a crypto currency investment fund and lives in the US. Author of the book “A Brief History of Money” and the recording of the KanAmerica.Com podcast. On Twitter @chanansteinhart
It was a small crisis so to speak At a local bank in California with “unique problems regarding the composition of the client portfolio”. But in less than ten days, the world’s largest central banks (in the United States, the European Union, the United Kingdom, Switzerland and Canada) announced that they would cooperate and together establish a mechanism that would provide banks with liquidity. The mechanism, they explained, “will serve as an important tool for creating liquidity, and easing pressures in the credit market for households and businesses.”
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The move was announced on the same day that the international Swiss bank Credit Suisse, one of the 30 largest banks in the world employing approximately 50 thousand employees and holding assets of approximately $1.7 trillion, was purchased at a bargain price and in a “forced marriage” by a competing Swiss bank, USB. The deal was promoted by the Swiss Central Bank, which provided loans totaling 110 billion dollars. The Swiss government also supported the sale with a safety net of 110 billion dollars – together, this is an amount equal to 25% of Switzerland’s national GDP. The deal was intended to prevent the collapse of Credit Suisse, which could have led to a major upheaval in the global financial markets.
The plan of the major central banks came a few days after the Fed announced its own new program to help banks – BTFP (Bank Term Funding Program). The program guaranteed all banks and financial institutions in the United States that own assets of the type approved by the program, the possibility to receive loans from the Fed against those assets, including government bonds for administration, mortgage-backed bonds, packages of agricultural loans, student loans, and more. The amount of the loan will be calculated according to the value of the assets to maturity, i.e. without taking into account depreciation (mark to market). The loans were given for a period of one year (for now) and with an interest rate of about 4.2% – and the program was in immediate demand. In just two weeks, the Fed’s balance sheet increased by $391 billion, erasing all the reductions made since October 2022.
The property crisis is spreading
Meanwhile, the capital and collateral crisis of the banks, which initially appeared to be local and small, is spreading. According to data from the FDIC (Federal Deposit Insurance Corporation), all US banks together have unrealized losses of about 620 billion dollars on bonds. For example, Bank of America, one of the largest banks in the country, has an unrealized loss on bonds The debt in the amount of 109 billion dollars – about 40% of his equity.
620 billion dollars is not a small amount, but according to a study by some researchers from Columbia University it is an underestimate. According to their calculation, the American banking system has a deficit of 2.2 trillion dollars on the value of its assets, compared to the value recorded in the books. Furthermore, according to the researchers, even if only half of the depositors not insured by the FDIC, who hold about 9 trillion dollars, had sought to withdraw their money – 190 banks would have collapsed. If 100% of the uninsured deposits asked to withdraw their money, including through internal withdrawal such as transfers from headquarters to purchase government bonds, more than 1,600 banks (!) would collapse, including very large banks.
Monetary precedent: contraction and expansion in one speech
About a quarter of the assets of the American banking system, more than 7.5 trillion dollars, are covered under the Fed’s new plan. In other words, the financial institutions can receive cheap cash from the central bank of the United States. However, at the same time, last week, the Fed raised the interest rate by 0.25% to a level of 5% in the upper range. Through the high interest rate, the Fed seeks to ensure that the new credit that the banks will take through a program The stabilization (BTEP) will remain within the walls of the bank, and will not flow back to the customers and fuel the rising inflation.
Here is yet another innovation and precedent: “reduction and expansion in one word” – in one week providing unlimited credit against collateral valued at a fictitious value, and in the week after that an interest rate increase. The rising interest rate may in the meantime curb the leakage from the Fed’s balance sheets to the real economy, but it is difficult to see this dynamic lasting long and the banks will probably continue to increase credit to reduce losses in a period of a cooling economy. Thus, it is not impossible that this year we will see the Fed’s balance sheet cross the symbolic line of 10 trillion dollars.
Meanwhile, the US Treasury Secretary, Janet Yellen, hastened to clarify that “we will not insure all depositors in the banking system” – a statement that may have succeeded in adding to the panic in the markets, but it is doubtful whether it will meet reality. Meanwhile, gold, the classic asset of protection in times of lack Financial calm, and Bitcoin, dubbed “the new digital gold”, responded to the events with sharp increases.
Be that as it may, and with the prime interest rate currently standing at 8% in the US, it is likely that in the near term the shrinking hand will win. The new funds will not leave the banks quickly and the rising interest rate, in my estimation, will lead to a real recession this year. In the shrinking high-tech industry and the frozen real estate industry to feel the times of winter, and when it arrives the problem of revaluation of the assets of the banks’ balance sheets will spread.
Most banks in the United States are small
The US banking system has undergone real consolidation since the 1960s. Thus, over 12,000 banking institutions in 1980 have become 4,706 institutions insured by the FDIC by the end of 2022. The total assets of these institutions together equal , according to the corporation’s reports, $23.6 trillion. But to understand the risk in the American banking system, you need to understand how it is structured.
Four large banks with extensive and international distribution own 38% of all American banking assets. Each of them has more than 1.5 trillion dollars in assets on average.
They are followed by ten medium-large banks that each hold between $600 billion and $225 billion in assets. Bank number 15 on the list, by the way, with assets of just over 200 billion dollars is First Republic, the same bank that starred in the banking crisis in recent weeks and has lost about 90% of its value since the middle of 2021.
Then come another 190 medium-sized banks that manage between a few hundred billion dollars and a few dozen each – about 17% of the banking system’s asset pie. At the bottom of the pyramid are 4,500 small and community banks. Each of them has assets of less than 10 billion dollars and sometimes even less than a billion. These concentrate on providing services in small communities and together employ approximately 137,000 employees and serve approximately 28 million customers across the US. Those thousands of small banks own approximately 45% of the assets of financial institutions in America.
When you dive into the nature of the asset portfolios of the small and medium-sized banks, you understand the size of their hold on the American economy.
According to Goldman Sachs, and based on FDIC data, about 80% of commercial real estate loans (about $2.8 trillion) were given by banks with less than $250 billion in assets. An analysis by the International Monetary Fund from the last two weeks paints a complementary picture : 50% of the credit portfolio of the regional and community banks is exposed to the commercial real estate sector (mainly offices, hotels and other yielding real estate). The same sector which is in a particularly problematic place today due to the combination of the increase in supply, the withdrawal from cheap credit, and the decrease in demand due to the cuts in the tech companies and the transition to remote work.
The same banks, the medium and small ones, also hold about 50% of the commercial-industrial credit, (about 2.8 trillion dollars), and about 60% of the residential real estate loans (not including mortgages sold to the government agencies of Freddie and Fannie). Under these circumstances, no It is difficult to imagine how the high interest rates together with the approaching recession will increase the pressures on their balance sheets. In fact, the first buds of these pressures are already reaching the small and medium-sized banks. According to a Fed report from last week, in just eight days and against the background of the collapse of the banks in the US, the small and medium-sized banks (those not included in the list of the top 25) lost about a billion dollars due to the withdrawal of deposits from customers who preferred to switch to the larger and “more stable” banks.
From running to the bank to running to the Fed
At the root of all the cracks in the banking system is a simple fact: an economy that is in debt that is equal to more than three and a half times the GDP, cannot really bear the burden of real interest for a long time. And the banks are nothing but the black hole into which all the weaknesses of the fiat system and the failures of the monetary policy in recent decades drain. Given the pressure of inflation and the need to curb it, the system is going through a phase. From running to the bank to running to the Fed, which has demonstrated in statements as well as in the news programs, that it will not let them or the depositors fall. After all, recycling, increasing loans, and ignoring the true value of the collateral of its kind, is not a bug but a feature of this system and policy. After all, a central bank pouring trillions into the banking system to cover holes in their balance sheets is not a new event in America. The big innovation is the existence of inflation at the same time.
Where do we go from here? A new era of risk
Since we are in a completely new territory, where we have never been before, it is very difficult to assess what is next. Will the run to the Fed develop into a run to the dollar? Will panic and the massive bailout programs force a huge consolidation in the banking sector in America? Will this whole dangerous and innovative move bring the Fed the image of victory against inflation that it so longs for this year, after which it will vigorously start lowering interest rates? Will the combination of the image of victory and the falling interest rate bring the economy back to the atmosphere of 2019 already in 2024, at least until the next inflationary wave?
In the absence of any historical precedent it is very difficult to assess. One thing is clear, the Fed in its monetary policy and in particular since 2001 has pushed the entire world down a path that becomes more and more narrow, steep and dangerous as time goes by. And in the journey on this path, the options are getting smaller and smaller and the systemic risk is increasing.