SVB’s failure, and the massive contagion it sparked, looks like a classic banking run. It is a pattern commonly seen in the nineteenth century, and during the Great Depression, but rare from 1933 until 2007, when the threat reemerged. The response from the US Treasury and the US Federal Reserve – which applied nineteenth-century British economist Walter Bagehot’s principle that, to stem panics, a lender of last resort is needed – also looks quite familiar.
But there are two novelties this time, both legacies of the last global financial crisis. First, in 2008, the worry about collapse was so intense that a crucial component of Bagehot’s logic – that only solvent (but illiquid) banks should be the subject of lender-of-last-resort rescues – was ignored. Similarly, with SVB, bondholders and stock-owners will lose their assets, but all depositors (insured or not) are made whole. Otherwise, the threat of contagion would be too great: if any mid-size bank were left to fail, all depositors would move their deposits quickly to large banks, thereby fueling market concentration. The US has thus effectively guaranteed its entire banking system. But it has also made nonsense of the principle of insurance and the FDIC’s operations, and perhaps also – as many critics of its response are suggesting – of the principle of liability that lies at the heart of the capitalist system.
The second similarity with 2008 is that large countries like the US and China can afford to prop up their banking systems, whereas small countries – especially those with very large and internationally exposed banking systems – cannot. Iceland and Ireland learned that the hard way in 2008. Switzerland – whose big banks’ assets amounted to multiples of GDP at the time – had a very narrow (and lucky) escape. Now, it must reckon seriously with the prospect of the failure of a bank whose total assets and liabilities are roughly equal to Swiss GDP. Is that manageable?
The consequence of the SVB shock will be twofold. First, bank rescue will be divisive, as in 2008, and could trigger a backlash against both the financial system and the government that imposed the burden of bailouts on taxpayers – possibly breathing new life into Donald Trump-style populism. Second, in other countries, suspicion and resentment about the way the US rescues its financial system will intensify, potentially stoking anti-Americanism at exactly the moment when the US is playing a vital role in defending the rules-based international order in Ukraine. Vladimir Putin is probably rubbing his hands with glee.
We suddenly find ourselves in the middle of a new financial crisis, with the effects of recent bank failures reverberating around the world. Just like 2008, national authorities in the US, Europe, and elsewhere find themselves in a position where there are no good choices.
The first phase of such crises is a run on banks with weak balance sheets, meaning large potential losses relative to their levels of equity capital. In the case of SVB, these fears spurred those with uninsured deposits to race for the exits at record speed, desperate to get out before a potential collapse. The subsequent pressure on Credit Suisse was from its broader unsecured creditors, but the concerns are remarkably parallel.
The next stage on which the current crisis plays out will be in Europe, where eurozone authorities will show the extent to which they will support banks that face a loss of market confidence. The signs today – including statements from regulators criticizing what the US did for uninsured depositors at SVB, and a 50-basis-point interest-rate increase by the European Central Bank – give some cause for concern.
Phase Two of the crisis will focus on concerns about credit quality as interest rates increase. The precise fault lines are not yet clear, and there is still time to get ahead of contagion.
The US, for its part, took decisive steps on SVB and Signature Bank. The Fed has opened a generous credit facility, and a well-designed extension of deposit insurance (with premiums paid by large depositors) would help considerably. The eurozone eventually will need to take similar measures. But how long will that take? And what policy mistakes will we encounter along the way?
Stephen S. Roach
There is usually a distinct warning sign before every financial crisis. Capital outflows presaged the Asian Financial Crisis of the late 1990s. A surge in speculation on internet-related stocks preceded the dot-com crash in 2000. The subprime-mortgage bubble burst before the 2008 global financial crisis. Could SVB’s astonishing failure point to yet another crisis?
No two crises are alike. But they all inevitably reflect the interplay of greed, fear, and policy blunders. That is also the case today. There can be little question about the greed of a major financial institution that was unwilling to accept the risks of the Fed’s belated exit from near-zero interest rates. And SVB is certainly not alone in having made that mistake. Signs of spreading collateral damage are already evident – not just among domestic institutions (such as Signature Bank and First Republic Bank), but also in the international arena (for example, Credit Suisse). As is typical in major crises, firewalls have ended up being more porous than we thought, unable to prevent contagion.
But there is a new and important risk today that was not evident in earlier crises: a serious outbreak of inflation. Since the late 1990s, financial crises have occurred in eras of sharp and prolonged disinflation: America’s CPI-based inflation averaged just 2.1% from 1997 to 2020. That provided inflation-targeting central banks with ample leeway to respond to crises by opening their liquidity spigots and slashing policy rates to zero. The circumstances are very different today: inflation is stubbornly sticky and well above target, and policy rates remain too low to address that problem.
If central banks flinch on interest-rate hikes, as financial markets are now expecting them to do, the odds of a return to price stability will fall. As a result, far more monetary tightening will ultimately be required to contain inflation. Sound familiar?
SVB could well be the proverbial canary in the coal mine.
The ECB has gone with its 50-basis-point hike, on the theory that projecting normality will help restore confidence in European banks. The European Central Bank, after a slow start in the hiking cycle, does need to admit openly and clearly that inflation is a problem. If it expects to re-anchor low inflation expectations after bond holders have been so badly burned, it will need to convince markets it is willing to take some real pain to get the job done.
But make no mistake, the shift to a likely prolonged era of high real interest rates will inevitably be one of more financial stresses, particularly if Europe goes into recession. Zero real interest rates have been the glue that has held the eurozone together, and, absent further reform in Europe’s governance, the end of the era of zero real rates will cause huge headaches for Italy among others. As for the United States, outsize actions by the Fed and the Treasury have for now stemmed the panic. Unfortunately, financial crises almost always evolve in waves, and there is likely more to come.
Anne C. Sibert
Banks that invested heavily in long-term debt have seen the value of their assets decline, as interest rates have risen. Prudent banks – or those overseen by diligent supervisors – hedged this foreseeable risk and adjusted their capital.
The case of SVB appears idiosyncratic. It was a poorly managed institution – operating without a chief risk officer for most of 2022 – and had not hedged its interest-rate risk. But while the collapse of a few mid-size banks alone poses no threat to the financial system, the worry is that – through systemic risk and contagion – their failure might trigger a domino effect. But there is less systemic risk today than in 2007, and central banks ought to be better at handling contagion. For now, it seems there is little danger of a banking crisis.
The likelihood of a financial crisis (or just a worse economic outcome) depends to some extent on how policymakers react. The US government’s heavy-handed response to the SVB collapse might have worsened matters, by suggesting that policymakers were more worried than surface facts suggested they should have been. This might have been what provoked the immediate flight to safe assets, though this risk now appears contained.
SVB’s volatile, homogeneous, and almost entirely uninsured depositor base – comprising private-equity and venture-capital firms – increased the likelihood of a coordinated withdrawal. The streaming service Roku alone had nearly a half-billion dollars in uninsured deposits. It is extraordinary that the firm never noted the bank’s poor risk control or worried about the composition of its depositors. Allowing Roku and other depositors to suffer the consequences of this failure might have led to better monitoring of banks and discouraged firms from a single industry from clustering at one institution. Letting other banks pay the bill may have made crises more likely.