By Paul Sutton

On March 13^th, 2023 President Biden stated he would do “whatever is needed” to shore up US banks following the largest bank failure in the US since the financial crisis in 2008. The collapse of Silicon Valley Bank, the 16^th largest in the US, followed shortly after by the failure of Signature Bank (the third largest bank failure in US history), saw a slump in bank share prices not only in the US but also in Europe and Asia. In the UK the Bank of England quickly stepped in to declare the London branch of SVB insolvent. The fear of further bank failures was again in the air despite prompt action in the US and elsewhere to reassure depositors that their money was safe.

BANK FAILURES

It was not enough however to save Credit Suisse, the second largest bank in Switzerland. It had been badly managed and carrying huge losses for several years, US$8 billion alone in 2022. Its potential failure was magnified following a decision by its single largest shareholder, the Saudi National Bank, to no longer support it prompting the Swiss National Bank to extend emergency funding of £44 billion. Further action however was needed and on 19^th March USB, the largest Swiss bank, offered to take it over at a fire-sale price. While the failure of Silicon Valley Bank was serious the failure of Credit Suisse was potentially catastrophic for the global banking system. Since 2011 a list of around thirty Globally Systemically Important Banks (GSIBs), any one of whose failure would have the potential to destabilise the global financial system, has been compiled by the Financial Stability Board. Credit Suisse has been on the list since the beginning.

Given their global importance, because of their size and interconnectedness, GSIBs are subject to stricter regulation and higher stress tests than are ordinary banks. One wonders what was missed in the case of Credit Suisse – or perhaps it wasn’t considered important? In recent years it has been fined for serious mismanagement, including commissioning spying on seven of its senior executives, for facilitating tax and sanctions evasion, and for a multi-million pound fraud in Mozambique. Its most recent annual report devoted more than 10,000 words to listing lawsuits, government investigations and settlements (Wall Street Journal, 19/3/23). If such revelations did not spook the regulators it did the investors who were steadily losing confidence and who began withdrawing billions following the Saudi National Bank decision, and which the emergency lending by the Swiss National Bank did nothing to stem. The acquisition by USB duly followed.

Failures in the regulation of US banks have also been cited in the cases of Silicon Valley Bank (SVB) and Sovereign Bank. In a letter to the Federal Reserve (the US equivalent to the Bank of England) twelve US Senators, including Bernie Sanders and Elizabeth Warren, warned that a loosening of the regulations on banks which was approved by the Trump administration in 2018, be reconsidered or rolled-back, particularly for regional banks with assets of between US$100-250 billion (which would have included SVB and Sovereign).  “Irresponsible and excessive risk taking by SVB and Signature executives should serve as a clear reminder that banks cannot be left to supervise themselves,” they wrote. “The Fed has a responsibility to ensure financial stability, and in order to fulfil that responsibility, it must ensure that all banks with potential systemic significance are subject to rigorous safety and soundness rules” (CNN Business, March 23). In other words, while the failure of SVB and Sovereign were for the moment contained, there was nevertheless a real risk of contagion i.e. fears about the ‘soundness’ of other banks leading to panic runs on the banks by depositors, leading to more failures.

The introduction of tighter rules on banks following the 2008 financial crisis was supposed to solve this issue. It clearly did not and the system as a whole remains inherently fragile. It cannot be otherwise since risk is a central element of finance capital, the reward for which is higher profits. The greater the risks, the greater the gains. Similarly, contradictions are a central dynamic of capitalism. It makes economic policy difficult to formulate and apply leading to winners and losers in nearly every case – summed up in the image of the two-handed economist who in recommending a policy says ‘on the one hand this, but on the other that’.

CAPITALIST CONTRADICTIONS

This is well illustrated in the current issue of how inflation is handled. A sound monetary system is an essential element of a modern economy. A key property of sound money is that its value must be relatively stable over the long term. Inflation directly threatens this in that it erodes its purchasing power meaning less can be bought with the same amount of money. Everyone understands this and everyone understands that inflation needs to be controlled. In the UK this is the job of the Bank of England which is mandated to keep inflation at around 2% per annum. It is currently over 10%, in part driving the current cost of living crisis (1).

The 2% figure to guide policymakers is designed to avoid actions that would cause negative inflation i.e. deflation, which is considered far worse since it would lead inexorably to recession and most probably depression as in the 1930s. The 2% target was adopted by the Federal Reserve in 2012 and quickly copied by the Bank of England and then other major national banks such as the Swiss National Bank. In itself this shows the continued dominance of the US in global finance alongside the City of London. The close linkage continues as demonstrated in the decision of the Federal Reserve to raise interest rates by a quarter point on 22nd March to a new target range of 4.75%-5%, followed a day later by the Bank of England making the same rise and consequently setting the bank rate at 4.25%. The rationale in both cases was to slow, and if possible begin to reverse, the rise in inflation by making borrowing more expensive, curtailing economic activity.

The strain such rises in bank rates imposes, the eleventh consecutive rise in the case of the Bank of England, is clear for anyone with a mortgage since their costs each month will rise either immediately, if they are on a variable rate, or when they re-mortgage.  It also puts a strain on banks, increasing the likelihood of business failures and hence potential bad debt losses and forcing changes to the way they do business.

The period preceding the current rise in inflation saw inflation levels of 1% or less with corresponding low interest rates posted by central banks over many years. This encouraged banks to buy bonds. The global bond market is around US$128 trillion which is higher than the global stock market (US$100 trillion.) It is where governments, large firms and big banks go to borrow money. Bonds and especially long-term government bonds are considered safe investments. They work in the opposite direction to interest rates. If interest rates increase the price of bonds decreases and vice-versa (2). The recent quick succession of interest rate rises has reduced the price of bonds. Ten-year UK government bond prices were about 20% lower in March 2023 than they were at the end of 2021. Banks were sitting on substantial ‘unrealised losses’. (3).

In the US alone these were calculated as around US$620 billion. In the case of SVB its loss was US$2 billion. The capital base of banks was exposed as weak. To avoid further defaults “the Federal Reserve reversed decades of orthodoxy and offered emergency lending against the full-face value of government bond holdings rather than their much lower market value” (The Guardian, 20/3/23). And it went on to state: “It points to a recognition that banks’ unrealised losses on their bond portfolios are sufficiently large as to represent a systemic risk that requires an extraordinary policy response”. To bring down inflation governments in the major capitalist economies had to increase interest rates but this weakened the capital base of banks and threatened to bring some of them down. The two-handed economist at work – on the one hand, but on the other. Or alternatively, another capitalist contradiction.

FRAGILE SYSTEM

The banking crises identified above have shown the potential fragility of the banking system and the broader vulnerability of the global financial system. This was commented on in October 2022 by Kristalina Georgieva, the Managing Director of the IMF. In an address tellingly titled ‘Navigating a More Fragile World’ she said: “We are experiencing a fundamental shift (her emphasis) in the global economy. From a world of relative predictability – with a rules-based framework for international economic cooperation, low interest rates, and low inflation…To a world with more fragility – greater uncertainty, higher economic volatility, geopolitical confrontations, and more frequent and devastating natural disasters – a world in which any country (my emphasis) can be thrown off course more easily and more often”.

She didn’t emphasise ‘any country’ but I have done so because it would include the UK or the US or China. The US or the UK could bring down the North Atlantic economic system of which they are the key players and which nearly happened in the 2008 financial crisis. The system did not collapse then because it was bailed out in large part by the actions of China in stimulating its economy with a Keynesian style intervention. Would this happen now given current US-China hostility? Is this not one of the ‘geopolitical confrontations’ Georgieva speaks of?

She goes on to state: “What can we do to prevent this period of heightened fragility from becoming a dangerous ‘new normal’. First and foremost, we must stabilise (her emphasis) the global economy by addressing the most immediate challenges. Stay the course to bring down inflation (her emphasis). Here the cost of a policy misstep can be enormous. Not tightening enough would cause inflation to become de-anchored and entrenched – which would require future interest rates to be much higher and more sustained causing massive harm on growth and massive harm on people. On the other hand, tightening monetary policy too much and too fast – and doing so in a synchronised manner across countries – could push many economies into prolonged recession”. We meet our two-handed economist again. The goals are clear (stability and inflation reduction) but the policies contradictory.

The IMF remains the main intergovernmental organisation overseeing the global financial system. It has changed in recent years and is not quite so subservient to the US as it was some years ago, even if it still takes its lead from it. Its message needs to be taken seriously. But it cannot and will not propose the sort of policies that would guarantee a better financial stability. It relies on the assurances that the major capitalist countries have put in place strong enough measures to stabilise their own economies. Recent events have shown they have not. It requires for a start thoroughgoing reform of Wall Street and the City of London, beginning with the banks, but as past events unsurprisingly have shown, they calculate that is not in their immediate interest and so it is beyond them. Nothing substantial will happen until the next financial crisis and then the one after that until the capitalist financial system finally implodes under the weight of its own contradictions.

(1) Many other things contribute to the cost of living crisis, above all stagnant wages and growing inequality between classes, which in the last 15 years has left British workers £11,000  a year worse off. (BBC Panorama, 20/3/23).

(2) A bond is a fixed-income instrument that represents a loan made by an investor e.g. a bank to a borrower (typically corporate or governmental). A good discussion with examples is given by Investopedia at https://www.investopedia.com/terms/b/bond.asp

(3) Unrealised losses is a banking/accountancy term for paper losses which are potential losses but not yet realised i.e. have not yet taken place but could well do so.

 

Credit Suisse Bank in Chur, Switzerland. Photo by Cayambe

Kristalina Georgieva, the Managing Director of the IMF Photo by Grant Ellis