We’re officially one week into what will likely evolve into a major banking and financial crisis. Understandably, there are comparisons to the Lehman collapse. Such analysis doesn’t seem as lunatic fringe after this week’s upheaval in Europe.

It is commonly believed that the “Great Financial Crisis” could have been avoided had the Federal Reserve bailed out Lehman Brothers. This is along the same lines as the Milton Friedman/Ben Bernanke thesis, that the Great Depression was the result of the Fed’s failure to print sufficient money to recapitalize the U.S. banking system. It’s a central tenet of CBB analysis that “money” – monetary inflation – is the problem, not the solution.

Bernanke concluded his November 8th 2002 speech, “On Milton Friedman’s Ninetieth Birthday”: “I would like to say to Milton and Anna [Schwartz]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Federal Reserve total assets were $836 billion when Bernanke became Fed Chairman in February 2006. Fed assets had inflated five-fold to $4.0 TN by the end of his term (Feb. 2014) –on the way to a peak of $8.97 TN in April of last year (10-fold increase in 14 years!).

Federal Reserve Total Assets surged $297 billion last week to $8.639 TN, in one week reversing four months – and over half – of recent QT (quantitative tightening). A $10 TN balance sheet by year end would not be surprising.

March 13 – Reuters (Dan Burns): “The Federal Reserve on Sunday unveiled a new program to ensure banks can meet the needs of all their depositors amid escalating chances of bank runs following the abrupt collapse of two major banks in the space of 72 hours. The Bank Term Funding Program (BTFP) will offer loans with maturities of up to a year to banks, savings associations, credit unions and other eligible depository institutions. Here are some key elements of the Fed’s program: A key element of the program is acceptable loan collateral – including U.S. Treasuries and mortgage-backed securities among others – will be valued at ‘par’… Loans of up to a year in length will be available under the new facility… Interest rates will be the one-year overnight index swap (OIS) rate plus 10 bps and will be fixed for the term of the advance on the day the advance is made… The loan commitments made by the Fed’s 12 regional banks will be backstopped with $25 billion from the U.S. Treasury’s Exchange Stabilization Fund.”

March 13 – Financial Times (Colby Smith, James Politi, Ortenca Aliaj and James Fontanella-Khan): “Just hours after Wall Street opened for trading on Friday morning, US regulators had seized control of Silicon Valley Bank, which had imploded under the strain of depositors pulling out their money en masse. What at first seemed like the failure of a one-of-its-kind lender with deep ties to the technology industry quickly appeared as though it might spiral out of control. Within 48 hours, regulators were preparing a package of emergency measures to quell panic among depositors and prevent contagion in the rest of the banking system. For some working on the effort, it evoked memories of the response to the coronavirus pandemic in 2020 and the great financial crisis of 2008. By Sunday evening, the US government announced it would guarantee all deposits held at SVB and crypto lender Signature Bank, which was also shut down by regulators at the weekend. The Federal Reserve, meanwhile, launched a lending facility that would be available to lots of other banks in order to ensure depositors’ demands could be met.”

I appreciate that officials last weekend believed they needed to ensure all SVB and Signature depositors to stem a potential systemic bank run. Just as the Bernanke Fed had justification for opening the floodgate for unprecedented money printing; the Yellen Fed for holding the policy rate below 1% until June 2017; the Powell Fed restarting QE in non-crisis September 2019 (unemployment rate multi-decade low 3.6%); and the Fed to full-throttle the printing presses for $5 TN during the pandemic, while holding rates at zero well into 2022 in the face of surging inflation.

Where does it all end? For one thing, the Fed’s balance sheet will be getting much larger. I’ll assume global central bank balance sheets will also inflate. Gold surged $121 this week, second only to the $130 one-week surge in late-March 2020 (Covid panic).

March 16 – Reuters (David Lawder and Doina Chiacu): “The U.S. banking system remains sound and Americans can feel confident that their deposits are safe, Treasury Secretary Janet Yellen said on Thursday, but she denied that emergency actions after two large bank failures mean that a blanket government guarantee now existed for all deposits. In her first public remarks since the weekend’s emergency measures with other regulators to ensure no depositors at Silicon Valley Bank and Signature Bank suffered losses from those lenders’ collapse, Yellen was pressed during a hearing before the U.S. Senate Finance Committee if that meant all uninsured deposits were now guaranteed.”

How can it not be a “blanket government guarantee”? So, Washington will bail out wealthy depositors at SVB and Signature and deny the same treatment to depositors when more traditional banks begin to fail?

March 16 – Wall Street Journal (David Benoit, Dana Cimilluca, Ben Eisen, Rachel Louise Ensign and AnnaMaria Andriotis): “The biggest banks in the U.S. swooped in to rescue First Republic Bank with a flood of cash totaling $30 billion, in an effort to stop a spreading panic following a pair of recent bank failures. JPMorgan…, Citigroup Inc., Bank of America Corp. and Wells Fargo are each making a $5 billion uninsured deposit into First Republic, the banks said… Morgan Stanley and Goldman Sachs… are kicking in $2.5 billion apiece, while five other banks are contributing $1 billion each. The bank’s executives came together in recent days to formulate the plan, discussing it with Treasury Secretary Janet Yellen and other officials and regulators in Washington, D.C…”

Understandably, the Treasury, FDIC and Federal Reserve really hope to avoid a bailout at California’s First Republic Bank, an institution rife with wealthy uninsured depositors. A large liquidity injection from the big banks was clever. But with $176 billion of deposits (12/31), the $30 billion cash injection is little more than a liquidity stop-gap measure. The wealthy will escape unscathed – and I’ll assume the same for the big banks. But I doubt we’ve heard the last of the First Republic saga. Uninsured depositors have good reason to move now, rather than count on a rescue. After all, another wealthy depositor bailout risks unleashing a political firestorm. This week’s First Republic gambit could backfire.

Talk of taxpayers not being on the hook for bank collapses will sound silly in hindsight. The Biden administration faces a major political predicament. At the minimum, an onslaught of tougher bank regulation is a foregone conclusion. Bank executives across the country will swiftly reassess the risk versus reward calculus of high-risk growth strategies. To be sure, there are today extreme financial and economic risks associated with a shuttering of public debt markets (to new issuance) coupled with a precipitous drop in bank lending.

We’re officially one week into what will likely evolve into a major banking and financial crisis. Understandably, there are comparisons to the Lehman collapse. Such analysis doesn’t seem as lunatic fringe after this week’s upheaval in Europe.

March 16 – Financial Times (Joshua Frankli, Owen Walker and Laura Noonan): “Credit Suisse shares rebounded sharply on Thursday after the lender revealed plans to borrow up to SFr50bn ($54bn) from the Swiss central bank and buy back about SFr3bn of its debt in an attempt to boost liquidity and calm investors. The Swiss National Bank had said on Wednesday it was willing to provide a liquidity backstop following a plunge of as much as 30% in the troubled lender’s stock… In a statement on Thursday, Credit Suisse said it had taken the decision ‘to pre-emptively strengthen its liquidity’ by borrowing the funds from the Swiss central bank under a loan facility and short-term liquidity facility.”

The Swiss National Bank (SNB) liquidity injection failed to calm fears – at Credit Suisse or for European banks more generally. Things have quickly erupted into an international banking crisis. Those nagging old derivative and counter-party risks…

Credit Suisse CDS surged an unprecedented 596 this week to record 1,014 bps. In data back to 2007, the previous largest weekly increase was 66 bps in December. The largest weekly gain during the Covid crisis was 37 bps. Swiss mega-bank UBS’s CDS surged 56 to 128 bps, the largest weekly gain since global crash week, September 19th 2008 (107bps). Deutsche Bank CDS surged 64 bps this week, the largest weekly gain in data back to 2019 – even surpassing the two-week 60 bps Covid crisis jump in March 2020. France’s Societe Generale (SocGen) CDS jumped 33 to 95 bps, the largest weekly gain in a decade. Germany’s Commerze Bank CDS rose 28 this week to 94 bps, surpassing the Covid crisis for the largest weekly gain in data back to 2019. Italy’s UniCredit saw CDS jump 26 this week to 122 bps, the largest weekly gain since the Covid panic.

Despite rapidly widening cracks in financial stability, the ECB held firm Thursday with its 50 bps rate increase (the Fed today likely has its sights on 25 bps; by Wednesday they’ll have serious doubts). Europe faces a serious inflation problem. But I couldn’t help but think that perhaps Wednesday’s euro drop conjured memories of past European debt crises. The euro suffered an abrupt 2% dive, before cutting losses to 1.5% by the end of the session.

Hopes that SVB instability would be isolated to U.S. banking were dispelled. Suddenly, the fragile European banks and euro currency were in the crosshairs. And with the dollar facing its own serious issues, yen prospects all at once looked relatively less dire. The yen gained 0.6% Wednesday, the top performing developed currency (ex-U.S. dollar) – on its way to a world-leading 2.4% weekly gain. This is a problem. The global leveraged speculating community is massively short the yen.

March 15 – Bloomberg (Edward Bolingbroke and Michael MacKenzie): “Government debt yields plunged globally Wednesday as mounting financial-stability concerns prompted bond traders to abandon bets on additional central-bank rate hikes and begin pricing in cuts by the Federal Reserve. Investors priced in a drop of more than 100 bps in the US policy rate by year-end and downgraded the odds of additional hikes by the Bank of England and the European Central Bank. A weeklong rout in bank shares globally has unleashed historic demand for government debt and other havens. In the US, two-year Treasury yields plummeted as much as 54 bps to 3.71%, the lowest level since mid-September, while German two-year rates fell 48 bps to 2.41%, a record drop.”

March 13 – Bloomberg (Denitsa Tsekova): “Fast-money quants rushed to extricate themselves from short positions on government bonds as debt markets from the US to Europe clock up their biggest rallies in decades. Commodity trading advisers sitting on $300 billion of wrong-way bets unloaded two-thirds of that in just three days, according to data from JPMorgan…, as widening cracks in the financial system put a Fed pivot to easy policy back on the table. The covering added fuel to a Treasury rally that saw yields plummet past 3.5% from a four-month high of above 4% in the space of 10 days, burning short-sellers. The unwind is a glimpse into a short squeeze that likely ensnared a much broader swath of fund managers since turmoil in the US banking system erupted last week.”

A major global de-risking/deleveraging episode erupted this week. After trading above 5% last Thursday, two-year Treasury yields collapsed to a low of 3.71% in chaotic Wednesday trading. Two-year yields were back up to 4.25% early-Friday, before closing a wild week down 75 bps to 3.84%. Trading interest-rate derivatives was one horrible nightmare. Meanwhile, the currencies turned chaotic, as Credit spreads blew out and CDS prices spiked higher.

For the levered speculators, markets turned against them everything, everywhere all at once. An incredibly intense squeeze engulfed the Treasury market. Yield curve bets were blowing up. Yen shorts and levered “carry trades” were suddenly at risk. JGB and European yields sank. Corporate spreads were blowing out, inflicting losses on levered corporate bond portfolios. Energy prices tanked. And stock market instability was turning increasingly problematic. The favored financial stocks were collapsing, while the heavily shorted technology stocks rallied. For the week, the KBW Bank Index sank 14.6%, while the Nasdaq100 (NDX) jumped 5.8%. Intense squeeze dynamics also spurred a huge rally in crypto, with bitcoin surging a crazy 34%.

Global markets did not “seize up” this week. However, the week had all the characteristics of the start of a serious period of de-risking/deleveraging. The SVB and U.S. banking crisis is, of course, an important dynamic. But the global nature of the unfolding crisis creates a much more complex market and financial backdrop. Derivatives markets in disarray. Hedge funds/family offices are running for cover. And in stark contrast to 2022, currency markets have turned disorderly and unpredictable. No place to hide. No environment for leverage. When markets start malfunctioning like this, my thoughts return to the $65 TN of “hidden leverage” identified by the Bank of International Settlements.

Friday under the MarketWatch (Vivien Lou Chen) headline, “Bond-Market Volatility at Highest Since 2008 Financial Crisis Amid Rolling Fallout From Banks”: “Analysts described the impact on the U.S. and German bond market as a rolling one in nature over the past five days, producing the biggest single-day drops in yields in well over a quarter of a century… On Monday, following a weekend government intervention to protect the depositors of… Silicon Valley Bank and Signature Bank…, the policy-sensitive 2-year U.S. note yield experienced its biggest one-day fall since Oct. 20, 1987… — though, outside of U.S. hours, the rate dropped by the most since 1982. That intraday drop of almost 60 bps exceeded the declines seen during the 2007-2009 financial crisis/recession; the Sept. 11, 2001, terrorist attacks; and 1987’s Black Monday stock-market crash. Two days later, as troubles emerged at Swiss banking giant Credit Suisse, the 2-year German yield saw its biggest daily decline based on available data going back to the country’s reunification period in 1990… The ICE BofAML Move Index, a gauge of bond-market volatility, soared on Wednesday and Thursday to its highest levels since the fourth quarter of 2008, or the height of the Great Financial Crisis…”

There is every reason to take the unfolding crisis most seriously. There will be comparisons to 2008, but we must recognize the potential for something worse.

Some data to ponder: Outstanding Treasury Debt ended 2007 at $6.051 TN, or 41.8% of GDP. Treasury Securities ended 2022 at $26.832 TN, or 105% of GDP. The Fed’s balance sheet was $951 billion (7% of GDP) to close out ‘07. This week it’s $8.639 TN, or 34% of GDP. Bank Loans ended 2007 $8.259 TN. They’re now $14.054 TN. Consumer Credit jumped from $1.132 TN to $2.661 TN. Total Bank Deposits have inflated from $8.487 TN (58% of GDP) to $20.698 TN (79% of GDP) – with Deposits expanding by a third ($5.165 TN) over the past three years.

China and emerging markets were in relatively robust up-cycles in 2008, with their stimulus and speedy recoveries providing a “global locomotive” that helped pull the world economy out of the morass. Chinese bank assets closed 2007 below $8.0 TN. Possibly surpassing $60 TN this year, Chinese bank Credit won’t be the global savior for this cycle.

I’ve argued for a while now that the “government finance Bubble” would prove the end of the line. There’s simply no category of financial claims outside sovereign debt and central bank Credit with the potential to expand sufficiently for Bubble reflation. A major expansion of bank Credit extended the cycle, but that fateful boom is now in jeopardy. Runaway growth in both central bank and sovereign Credit risks a devastating crisis of confidence.

A Lehman bailout wouldn’t have thwarted the crisis. There were Trillions of mispriced securities and too much speculative leverage, dysfunctional finance that fueled deep structural maladjustment. Today, there are tens of Trillions of securities – priced as if they’re actually backed by real economic wealth. The day of reckoning is long overdue.

There were many alarming developments this week. None could prove more consequential than uncharacteristically belligerent comments from one of the world’s leading central banks.

March 15 – Bloomberg: “China’s central bank echoed President Xi Jinping’s warning that the US is seeking to suppress the world’s second-largest economy, an unusual move that suggests the central bank could be looking for ways to safeguard against possible further sanctions. The People’s Bank of China will ‘appropriately respond to the containment and suppression of the US and other Western countries,’ it said in a statement… following a meeting to study Xi’s speeches during the National People’s Congress session…”

After central bank officials have mastered their Xi studies, we shouldn’t bank on the PBOC’s eager participation in concerted policy measures to thwart U.S., European and global financial crises. On many levels, risks today greatly outweigh 2008. And no amount of money-printing will resolve deep structural problems decades in the making. Moreover, we could be entering a major global crisis with every man (central bank) for himself. There will be an inclination to prioritize domestic over international. Some will remain focused on severe inflation problems, while others will pivot to financial instability. There are different agendas – “world orders” and geopolitical considerations to contemplate.

I don’t like being the guy yelling “fire” in the crowded theater. But there’s a fire burning. I hope it can be contained. It’s uncomfortable to hear so many shouting “stay calm, no fire!” And we’ve all grown tired of the false alarms. There’s just so much highly combustible material that has accumulated over the years. The stuff’s everywhere, in the aisles and even obstructing some exits.

How much confidence should we place in those decrepit fire extinguishers working this time around? With all the structural changes, it’s become such a towering theater – the grandeur, the dazzling new technologies and sophistication, filled with the unsuspecting, the rascals and newbies – with the same old small exits. Look at those guys eagerly making their way through the exit. Weren’t they the ones hollering “no fire”? It’s difficult to predict how the jittery crowd will respond to those first whiffs of smoke, but I’m not going to assume things stay orderly.

Original Post 18 March 2023

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Categories: Doug Noland

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