ALEX BRUMMER: Banks under the ass

Much of the handling of the eruptions in the banking system is confusing.

A crisis that began with Silicon Valley Bank (SVB) in the US was ultimately triggered by the Federal Reserve’s relentless drive to raise interest rates and curb inflation.

Given that the source of the turmoil was the rapid rise in borrowing costs that drove bond values ​​lower, the Fed and other central banks’ decision this week was to keep raising rates — when they had a pause or even a cut can do – perverse.

We saw how quickly changes in bond markets can affect stability in the UK last year, when Truss-Kwarteng’s flawed mini-budget wreaked havoc on pension funds.

It threatened to trigger a wave of bankruptcies if the Bank of England had not intervened. Central bankers gloss over the impact of economic and monetary policy on financial stability at their peril.

The Bank of England’s Andrew Bailey and the other central bankers argue that by enforcing their own prudential rules, individual countries can insulate their domestic banking system against the turmoil. That was certainly true of Canada and Australia during the financial crisis. But these countries do not form the core of the financial system. The United States, Switzerland, the Eurozone and the United Kingdom are in a very different place from being home to some of the world’s most important financial institutions.

The same hedge funds and financial players that had lost faith in SVB, Signature, First Republic and US regional banks, taking heavy losses, turned against other vulnerable banks. Credit Suisse first and Deutsche Bank in the last trade were in the line of fire.

Banking events are similar to the flood that follows water damage. Water finds the weakest point in the pipes and then flows through.

Deutsche Bank returned to profitability in 2022 after countless loss-making quarters. But the insurances bought to protect investors from losses — known as credit default swaps — show that past weakness hasn’t been flushed through the system. No sooner had Deutsche Bank’s share price faltered, then plummeted, than other European bank stocks in France (amid political turmoil surrounding pensions) and Italy took a hit.

Central bankers’ efforts in recent weeks to argue that monetary policy and financial stability can be managed in separate ways is misleading. The origins of the current problem lie in money printing since the Great Financial Crisis.

It is the reversal of this policy in the face of rising inflation that has so confused bond markets.

The European Central Bank’s Christine Lagarde and her colleagues at other central banks stuck to the fiction that raising interest rates would not fuel the crisis.

As euro-zone banks swooned in trading ahead of the weekend, Lagarde pledged more liquidity. However, it was liquidity in the form of quantitative easing and easy money that were among the factors that provoked the rollback of asset purchases and higher interest rates.

Both the Fed and Bank of England acknowledged this week that the impact of bank failures could lead to tighter credit conditions.

That has already happened. Bond issuance on Wall Street has halted. A UK borrower with a risky property or technology offer is unlikely to be welcomed with open arms. In recent weeks there has been a soar in bank share prices that has weakened capital. Not only that, but the cancellation of Cocos or AT-1 bonds at Credit Suisse led to its own mini-anxiety for the safety of that capital.

Statements from Frankfurt, Brussels, Washington and London that the banking system has been made “resilient” look thinner by the day.

curve ball

Recent bids for Manchester United have reportedly hit the £6billion mark. It’s all incredibly exciting. If such an award were achieved, it would rate the club in the same ballpark as the 27-time World Series winner, the New York Yankees baseball franchise.

A developing credit crunch could quickly thin out the field of potential buyers as borrowing costs rise. Jim Ratcliffe and the other wannabe sports tycoons might have a hard time competing with the Gulf potentates blessed with oil and gas revenues.

But as Yankee legend Yogi Berra observed, the game “isn’t over until it’s over.”