A banking crisis was long overdue

It has been a year since the Fed started to raise interest rates and banks are starting to fall over in the U.S. Anybody who thinks Silicon Valley Bank was a one-off is deluding themselves. Financial crises have occurred on average once a decade over the past half century so the one unfolding now is if anything overdue.

The reckoning has been delayed because since 2008 banks have been operating in a world of ultra-low interest rates and qualitative easing (QE) from central banks. Originally seen as temporary measures after the collapse of Lehman Brothers, cheap and plentiful money became a constant prop for the markets. The market went on a super bull run.

Over the years, there was debate about what would happen were central banks to raise interest rates and to suck the money they had created out of the financial system. Now we know.

The action deemed necessary to rein in inflation has deflated housing bubbles, sent share prices plunging and left banks nursing big losses on their holdings of government bonds.

Dhaval Joshi of BCA Research pointed out last week there are 3 classic signs that a recession is coming in the US: a downturn in the housing market, bank failures, and rising unemployment. Housebuilding is down by 20% in the past year, which means the first has already happened. The problems at SVB and other US regional banks suggest the second condition is now being met. The third sign of a US recession is a rise in the US unemployment rate of 0.5%. So far it is up by 0.2%.

"Banks tend to fail just before recessions begin," Joshi says. "Ahead of the recession that began in Dec 2007, no US bank failed in 2005 or 2006. The first three bank failures happened in Feb, Sep, and Oct of 2007, just before the recession onset.

"Fast forward, and no US bank failed in 2021 or 2022. The first bank failures of this cycle - Silicon Valley Bank and Signature Bank - have just happened. If history is any guide, the start of bank failures presages an economic recession that is more imminent than many people anticipate."

Central banks seem to think there is no problem in achieving price stability while maintaining financial stability. Good luck with that. The Fed, the ECB and the Bank of England have tightened policy aggressively and things are starting to break.

There is no political appetite for taking on an immensely powerful financial sector. But that, as has become evident in the past 15 years, has its costs.

One is that economies dominated by the financial sector only really deliver for the better off: the owners of property and shares. A second is that the financial markets have become hooked on the stimulus that has been provided by central banks. A third is that the crises endemic to the system become much more likely when - as now - that stimulus is removed. Which means that eventually more stimulus will be provided, the markets will boom, and the seeds of the next crash will be sown.

Source : Silicon Valley Bank's collapse will not be a one-off – a banking crisis was long overdue

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