Last month, in the US as well as Europe, there have been new episodes of the international banking crisis which began around two months ago with the bankruptcies of SVB (Silicon Valley Bank) and Signature Bank, and the collapse of Credit Swiss. Why is this crisis happening? How do we describe its dynamic and how does it relate to the broader dynamics of the international economy?
By Alejandro Iturbe
In the US, a third “mid-size” bank, First Republic Bank, has collapsed in less than two months, despite the 30 billion dollar rescue attempt by the country’s major bank investors.
Recently, an FDIC statement announced that the San Francisco-based bank was closing, selling its operations to JP Morgan Chase for US$10.6 billion. According to the FDIC, after the bankruptcy of First Republic Bank, it “will cost the State ‘around US$13 billion’” to guarantee its deposits [1].
This was a great deal for the investment giant JP Morgan Chase, which got to keep the “failed bank’s better quality assets” backed by “a series of ‘golden’ guarantees” while deposits related to “low quality” assets were covered by money provided by the FDIC (i.e., the taxpayers) [2].
A diseased banking system
Evidently, the FDIC’s objective was to prevent a panicked bank run of clients at other troubled banks and a “domino effect” of further failures, in the context of an already extremely malfunctioning banking system.
A Stanford University study shows that the situation of US banks “could be even worse than imagined” and warned of “200 banks in vulnerable situations.” A new Hoover Institute investigation shows that “2,315 financial institutions are sitting on assets worth less than their liabilities,” with a negative difference estimated at “two trillion dollars” [3]. This is the result of the deprecation of the “balance sheet of long-term assets, such as mortgage securities and 10, 20, and 30-year bonds” that have been hurt by the federally driven policy of interest rate hikes.
This total includes banks of various sizes, many small local institutions as well as “mid-sized” regional banks (just behind the banking giants in the order of importance). The three banks under the greatest threat due to “risk aversion” are PacWest Bancorp, Western Alliance Bank, and KeyCorp, because they have experienced “over 50% losses since the failure of SVB in March.”
So far, large investment banks and other giants seem safe from the shockwave of distrust in the system. The policy adopted by the FDIC in the case of First Republic Bank and JP Morgan Chase is designed to prevent such a “contagion,” But concern emerges from “the impact this acquisition will have on JP Morgan’s financial health” – a concern gaining steam on Wall Street that questions the thesis that such banks are “too big to fail” in the US [4].
What do we do now?
There have been very strong criticisms of the FDIC’s policy. For example, hedge-fund manager Bill Ackman, founder of Pershing Square, gives the diagnosis that “the US regional banking system is at risk” [5].
In his analysis, he says that there already exists a deep “crisis of trust” in depositors and investors who are withdrawing their deposits after any sign of alarm: “no regional bank can survive bad news or bad data,” leading to an “inevitable fall in its share price.” Deposits are withdrawn in “the search for strategic alternatives,” creating a “domino effect” that will incur “a large cost to the system and economy.”
Facing this dynamic, he criticizes the FDIC policy for acting on a “case by case” basis and, as in the case of First Republic Bank, “too late.” He proposes the creation of “a system-wide system of guarantees” to prevent “crises of confidence” and bank runs. According to him, “we are running out of time to solve this problem. How many unnecessary bank failures do we have to watch before the FDIC and our government wake up?”
Clearly, as a hedge-fund manager, Ackman is a stakeholder because his field is shrinking and he is affected by the “crisis of trust” in the banking system. But he identifies a real, concrete problem: that FDIC policy has not stopped the shockwave and domino effect phenomena in the mid-size regional bank sector. This, as we have seen, in perspective, can also threaten large investment banks and other giants (“the cost to the system”).
In response to this, his proposal to create a “system-wide structure of guarantees” means creating a “shield” for the mid-size banking sector and covering holes created by their bad business decisions and speculative bets – a shield made of US Treasury funds, that is, funds coming from all the country’s taxpayers (or external purchasers of Treasury bonds).
The policy is similar to Obama’s response to the 2008 banking crisis after the Lehman Brothers collapse. The only difference is that, at the time, the Fed acted directly as an “insurance company” for the big banks and in this case, it would start with the “middle rung” of the banking system.
The US public debt
The US economy is in deficit: that is, it consumes more than it produces: “In recent years, the US economy has been built on the so-called ‘twin deficits’ of the balance between foreign trade and the government budget.” […]
“The sum of both deficits meant that, in 2007, in order to function normally and not grind to a halt, the US economy needed an average of 3 billion dollars a day from abroad, through income from the sale of treasury bonds, other loans, direct investments, remittances of profits and royalties from subsidiaries of companies abroad, etc. Through various mechanisms, the US economy acts as a ‘vacuum cleaner’ for an entire part of the surplus value extracted in other regions of the world” [6].
Having a budget deficit means that the government is spending more than it receives in direct taxes. To pay its bills (suppliers, social security benefits, salaries of government and military workers, etc.) it needs to “borrow” and accumulate public debt. This is done through the issuance and sale of Treasury bonds for which it pays a certain interest rate set by the Fed. This interest, at the same time, increases the State’s payment obligations, as well as the deficit itself.
In reality, this deficit has been growing steadily for decades. There have been periods of greater increase; for example, the one driven by indebtedness derived from Obama’s policy of “injecting liquidity” to save the bankrupt banking system; or the financing of the “economic stimulus packages” pushed through by the Biden administration. The following chart shows its evolution from its floor in the 1990s to the current figure of $31.4 trillion.
The interest rate dilemma
The Treasury bond interest rate set by the Fed acts as the “benchmark rate” for the entire US and, in effect, the global banking system. When the rate is low, it is said to drive a “cheap money policy.” On the contrary, a higher rate implies a policy of “making the cost of money more expensive.” The truth is that the Fed is coming from a year of gradual increases in its rate, which reached 5.25% this month (the highest it’s been in the last fifteen years).
This high interest rate policy from the Fed had two objectives. The first was to secure a fluid sale of Treasury bonds to finance “stimulus packages launched by the Biden government.” The second was to use the policy of “making the cost of money more expensive” to lower the high inflation which characterized the weak post-pandemic economic recovery [7]. That is, to “dry up the markets” in order to reduce inflationary pressure represented by the “excess money” generated by many years of monetary over-issuance (from 2008 to the present).
The bourgeoisie coexists with inflation and uses it as a weapon against the workers, through the erosion of the real value of wages (combining this with adjustment plans in sectors like health and public education, or privatization of services like transportation). But, in doing so, they open a flank of the class struggle which is sharpened by the response of the workers and the youth, as is shown by the great workers’ struggles in Europe (especially in France and Great Britain). Throughout the past few years, glimpses of a similar potential have shown up in the US.
Then, the bourgeoisie began to “fight” inflation with classic monetarist measures: raising interest rates (making the cost of money more expensive) to “dry up” the markets. In this way, it achieves partial success (in the US, inflation fell from over 8.5% in 2021 to an estimated 6% this year [8]).
However, at the same time, this policy of “drying up the markets,” on one hand, increases an already recessive tendency of the economy in general and, on the other, leaves the most compromised banking institutions in a very difficult situation, so several begin to collapse (which is what we are seeing now). In other words, with inflation, imperialist capitalism faces a situation the dilemma of the “short blanket.”[EL1]
Faced with this contradiction, the Fed gives contradictory signals. Just as it announced its final interest rate increase, it left open, with its language, the possibility that it might begin to lower the rate as of 2024. If this materializes, it would produce what bourgeois economists call an “inverted yield curve.” That is, “the interest rates for these assets are higher in the short term (for three or two years) than in the long term (10 years)” [9].
This configuration leads Bank of America experts to predict that this US banking crisis will lead to a “general economic recession” and that this dynamic “could arise during the next quarter.” Its precedents are found in similar situations that occurred in 1990, 2001, and 2008 [10].
The data used by Bank of America experts is extremely technical and it is not even clear what the Fed will set the interest rate by 2024. But this pessimistic forecast expresses the fear of bourgeois analysts and economists that the combination of various factors is brewing the “perfect storm.”
The mess of the debt ceiling
In addition to all the factors already analyzed, there is a conjunctural but very acute problem: on June 1, the US will have reached the point of using the “public debt ceiling” authorized by Congress. The Biden government needs Congress to approve a new extension of this “ceiling” to issue and sell new Treasury Bonds and thus cover its needs. Otherwise, it will default on its current spending and interest payments to Treasury bondholders. This would have a catastrophic impact not only on the US but on the whole world capitalist economy [11].
The last midterm elections (2019) determined a parliamentary impasse: the Democrats hold a very slight majority in the Senate while the Republicans are the majority in the House of Representatives, where bills must be initiated. In other words, the Joe Biden government cannot approve an increase in the debt ceiling without negotiating it with the Republican representatives (or at least, with a sector of them).[EL2] [12]
Negotiations have already begun on a “feverish” basis, with a looming “deadline.” In a year marked by presidential campaigns and upcoming elections, “Republicans are pushing Biden to cut spending, including on some of their flagship programs,” such as the public Medicare healthcare system, in order to erode Joe Biden’s re-election prospects. On their part, Democrats refuse to grant these cuts and “denounce ‘irresponsible Republican extorsion’ which will hurt Americans” [12].
Most likely, the Democrats will end up accepting some minor cuts and, finally, the debt ceiling will be raised. In other words, the situation of defaulting will not occur. What we want to point out is that this political situation is taking place in the context of a very precarious situation for the US banking system and a possible recessionary dynamic in its economy, and contributes to the aggravation of both problems.
Crisis spreads to Europe
The “domino effect” is occurring not only in the US but also has begun to spread to Europe, through the channels of communication and investment across financial institutions.
An example of this is the situation of Alecta, the biggest pension fund in Sweden, which holds assets worth $100 billion for 2.6 million clients [13].
In the last few months, Alecta, having sold its majority stake in Swedish banks (such as Handelsbanken) to invest in US banks which were already experiencing problems and falling share prices.
Thus, Alecta has become the fourth-largest shareholder of Silicon Valley Bank, the fifth-largest of First Republic Bank and the sixth-largest of Signature Bank. This is a kind of risky financial transaction known as “buying short.” The expectation was that the FDIC would bail out these banks, which would raise the stock prices and allow Alecta to make fast substantial profits. But the gamble turned out poorly and those banks eventually failed.
Alecta directly lost $2 billion in this transaction and Magnus Billing, the CEO who decided to pursue it, was forced to resign. Another consequence has been the “flight of clients”: these past few months, the Swedish fund registered 7,000 withdrawal requests.
The deterioration of Alecta’s equity, for now, is small compared to what US banks are going through. The “loss of trust” from its clients is also relatively minor. But it demonstrates the contagious effect which crosses borders and how a part of the equity of financial institutions is based on “bets” in Europe too.
A factor we have not referred to in this article is the class struggle: that is, the response of the workers and masses to the attacks of the bourgeoisies and governments, as demonstrated by the current European reality with its epicenter in France. This ongoing banking crisis and the forecasted recessive dynamic of the world economy mean that the bourgeoisies and governments will intensify these attacks. With that, they stoke the objective conditions which generate this response. If, as we are seeing in France, the class struggle will strengthen, this will be another central factor in shaping the “perfect storm” for imperialist capitalism.
[1] Quebró el First Republic y será rescatado por el JP Morgan (diariopopular.com.ar)
[2] Não acaba no First Republic: mais de 2 mil bancos dos EUA estão com problemas de solvência (um deles tem mais de US$ 1 tri em ativos) – Money Times
[3] Ibid
[4] Ibid
[5] ‘Quantos bancos precisam quebrar antes do governo americano acordar?’, questiona investidor bilionário | Finanças | Valor Econômico (globo.com)
[6] On this topic, we recommend reading “Capítulo 8: EEUU, epicentro de la crisis actual” del libro de Alejandro Iturbe O sistema financeiro e crise da economía mundial, Editora Sundermann, Brasil, 2009. (Chapter 8: The US, epicenter of the current crisis” in Alejandro Iturbe’s book On the financial system and crisis of the world economy)
[7] Economía mundial: recuperación anémica y con muchos problemas – Liga Internacional de los Trabajadores (litci.org)
[8] EEUU: la inflación bajó por octavo mes seguido y se ubicó en el 6% anual, en línea con lo esperado (ambito.com)
[9] La crisis económica podría ser inminente, alertan desde Bank of America (eleconomista.es)
[10] Ibid
[11] Estados Unidos podría caer en default el 1 de junio: ¿Cómo avanzan las negociaciones en el Congreso para evitar una crisis financiera global? (clarin.com)
[12] Translators note: as of the first week of June, Biden passed a bill extending the deadline to Jan 1. 2025. This was done through negotiation with House Speaker Kevin McCarthy, which stirred up anger among the GOP’s dissenting conservative ranks.
[14] El fondo de pensiones de Suecia, la mayor víctima de la crisis bancaria desatada por la quiebra de SVB (eleconomista.es)
