Are we in a financial crisis?
Yes, it’s contagion.
How Fed action is working it’s way through the risk curve.
The largest bank failure since 2008 just happened.
How did we get here?
The money printing during Covid was insane.
Over $5 Trillion flooded into the economy!
Of which $1 Trillion was directly transmitted in the form of personal relief checks.
In less than 12 months, the money supply growth was an astonishing 40% – that’s 25% of US GDP.
As more freshly printed cash started chasing fewer goods, prices exploded everywhere. At peak inflation a dozen eggs were selling for $17.99 at Eli’s Market. People couldn’t afford to pay for groceries or fuel their cars.
The political pressure was immense for the Fed to take action.
And so, the Fed reversed its decade long policy of cheap money.
It lifted the federal funds rate at the quickest pace in history, from effectively 0% in March 2022 to 4.75% today.
Bringing down the CPI figure was the only thing that counted. The commitment was to hike until something breaks – well, something just broke.
The first casualties were the obvious ones…
Primarily tech stocks and crypto, which are on risk curve’s tail end and disproportionately benefitted from a cheap credit environment.
But that was just the beginning.
Now, barely a year into the rate hikes, the bodies are piling up.
Banks look like they’re next on the chopping block, even the prudent ones.
The truth is, Silicon Valley Bank failed despite buying the supposedly safest collateral on earth – US treasuries. They just bought them at the wrong time.
SVB was buying treasuries when interest rates were low – encouraged by regulators who treat treasuries as pristine collateral with a 0% risk weighting.
When the Fed rug pulled them and reversed course, those bonds became worth a lot less – the old fixed rate of 0.2% doesn’t look so good compared to the new rate of ~5%.
It got even uglier when SVB was forced to realize those losses, dumping their bond portfolio into the market in order to fund client withdrawal requests.
Now, try this on for size:
Tons of banks pay 0%-1% on deposits because they’re stuck in long duration bonds from the old interest rate environment. Meanwhile, the free floating rate has soared to 5%.
What happens when people follow the natural incentive to flip their deposits into attractive yielding bonds, not to mention pulling funds out of fear of another bank failure.
Get ready for fireworks. Will Bank of America Collapse?
Now, should SVB have hedged its interest rate risk with swaps? Sure.
However, this becomes the curse of political money.
Central authorities arbitrarily change the rules and thereby arbitrarily pick winners and losers. Even if every bank became properly hedged, the bomb would just detonate with another counterparty.
Being insured with AIG in 2008 wasn’t useful either, because when everyone’s insured, no-one is.
Written by Andrew Axelrod
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Relationship Manager with over a half-decade experience in managing key institutional client relationships in North America, continental Europe, and Asia (ex-Japan) markets with a +95% retention rate.
Moreover, passionate about finding best-in-class financial solutions for FOs, MFOs, UHNWI investors, and institutional clients, including IFAs, asset managers, and licensed broker-dealers.
Furthermore, in today’s world, those best-in-class solutions are in crypto.
Transitioned from TradFi to crypto in 2021, joining Coinbase’s new Prime Broker desk for institutional clients. In addition, help clients gain a foothold in the digital asset space and provide education with a LinkedIn following of 4K and over 1.5M content views.
Are we in a financial crisis?