Courtenay Brown and Neil Irwin open their Friday column with these startling headline-like declarations:
“Sunday night bank bailouts on both sides of the Atlantic. Joint announcements by global central banks. Fear and uncertainty sweeping markets.”
Brown and Irwin say the last 10 days have felt similar to the 2008 Great Recession.
But there are crucial differences, they point out, that lower the risk that recent events will have “the same seismic impact on the world economy” as back then.
Undoubtedly, the still-unfolding run on bank deposits has raised the odds of a recession, especially with a Fed’s hellbent focus on bringing down inflation at virtually whatever cost.
Crisis? What Crisis?
By Dave Allen for Discount Gold & Silver
Courtenay Brown and Neil Irwin open their Friday column with these startling headline-like declarations:
“Sunday night bank bailouts on both sides of the Atlantic. Joint announcements by global central banks. Fear and uncertainty sweeping markets.”
Brown and Irwin say the last 10 days have felt similar to the 2008 Great Recession.
But there are crucial differences, they point out, that lower the risk that recent events will have “the same seismic impact on the world economy” as back then.
Undoubtedly, the still-unfolding run on bank deposits has raised the odds of a recession, especially with a Fed’s hellbent focus on bringing down inflation at virtually whatever cost.
Crisis? What Crisis?
But when you drill down on what’s actually happening, you might think twice about this becoming another all-out mega-crisis.
Brown and Irwin explain the root cause of the two crises. In 2008, they note, all kinds of highly leveraged institutions owned complex derivative securities, particularly backed by home mortgages, that turned out to be far less valuable than advertised.
The 2008 crisis, they argue, was effectively a “series of institutions either failing or being bailed out as those losses became apparent.”
This time around, however, the root problem isn't bad loans. Granted, there are plenty of bad loans out there that should have never been made.
Rather, the Fed's rapid credit tightening has created significant paper losses for banks that made loans or bought long-term bonds when rates were much lower.
The paper losses have been pressuring many depositors to withdraw their cash, forcing those banks to sell bonds, turning paper losses into real ones.
Brown and Irwin point to three major differences. First, they say, what made the 2008 crisis so tough was that many losses occurred in a financial system that was lightly regulated or unregulated altogether.
For example, remember Lehman Brothers, Bear Stearns and AIG, the giant insurance company. Regulators at the time had limited visibility into the massive market for asset-backed securities.
Fast forwarding to 2023, the problems this time around are happening in traditional banks.
For one thing, these institutions have an entire infrastructure of deposit insurance, access to nearly unlimited emergency Fed lending, and supposed oversight to reassure the public about their solvency.
Second, the post-2008 reforms in the Dodd-Frank Act really did change some things.
Most importantly, banks’ capital ratios are higher than they were in 2008, dramatically so at the largest banks, giving them a greater financial cushion for downturns like now.
And regulators have more authority to deal with even a too big to fail failed bank, which is intended to prevent a frenzied scenario like what followed Lehman’s bankruptcy.
Third, and perhaps most importantly, the problems now should have less risk of feeding on themselves in the kind of vicious cycle that made the 2008 financial crisis so damaging.
If, say, the economy were to start to falter because of a credit crunch brought on by QT, continued banking turmoil or other factors, the Fed could put on the brakes and start cutting rates.
That, in turn, would ease the very pressure on bank balance sheets that created the credit squeeze in the first place.
Brown and Irwin contrast that to 2008, when bad mortgages soured credit markets and slowed the economy.
Then, weakening growth caused more mortgage defaults. It was a self-acceleratingcycle, not a self-correcting one.
What Are Banks Doing Now?
Banks reduced their borrowings from two Fed backstop lending programs last week, a sign that liquidity demand may be stabilizing.
U.S. banks had a combined $152.6 billion in outstanding borrowings in the week ending March 29th, compared with $163.9 billion the previous week.
These latest figures suggest efforts by the Fed to stem a series of falling dominoes is working – although banks are still borrowing a lot more than what’s typical during periods like these.
Data show $88.2 billion in outstanding borrowing from the Fed’s traditional backstop discount window program.
That’s compared with $110.2 billion the previous week and a record $152.9 billion in a period of bank panic earlier this month.
The discount window is the Fed’s oldest liquidity backstop for banks. Loans can be extended for 90 days and banks can post a broad range of collateral.
Outstanding borrowings from the Bank Term Funding Program stood at $64.4 billion compared with $53.7 billion the previous week.
The BTFP was opened March 12th after the Fed declared emergency conditions following the collapse of Silicon Valley and Signature Banks.
Credit can be extended for one year under the program and collateral guidelines are tighter.
The reduction in usage “suggests a slightly improving (but still uncertain) bank liquidity picture,” according to TD Securities strategists Priya Misra and Molly McGown.
They point to data for the period through March 15th showing bank deposits falling by $98.4 billion to $17.5 trillion in the week ended March 15.
Fed loans to bridge banks established by the Federal Deposit Insurance Corp. to resolve SVB and Signature Bank rose slightly to $180.1 billion in the week through March 29th from $179.8 the previous week.
Foreign central banks tapped the Fed’s Foreign and International Monetary Authorities repurchase agreement program for $55 billion in the week through March 29th – after reaching an all-time high of $60 billion the prior week.
In an aggregate sense, look at what’s happened with the Fed’s balance sheet since SVB and Signature Bank.
As the chart above shows, after nearly a year of slowly but steadily unwinding its Treasuries and mortgage-backed securities, the balance sheet – which peaked at $8.965 trillion last April – fell to $8.342 trillion the week ending March 8, 2023.
Then over the ensuing two weeks, as emergency lending kicked in, it rose by $392 billion to $8.734 trillion, before again unwinding to $8.706 on Wednesday.
What Does It Mean?
Those factors are raising important questions but seem to be pointing toward this month’s banking run causing less economic damage than the 2008 crisis.
But there are some other differences between then and now that Brown and Irwin say could “cut the other way.”
One needs to look no further than the political environment in Washington today compared to 2008.
Should Congressional action be needed to rescue the financial system, it would likely be next to impossible for the Biden administration to get enough votes – in either house.
In fact, I'm not sure the House and Senate could muster enough votes to
When things started getting really out of control in the fall of 2008, the Bush administration proposed the $800 billion Troubled Asset Relief Program (TARP).
The Democratic House leadership was on board, even though the bailout program was widely unpopular with the voting public.
Even with Speaker Nancy Pelosi and a 38-seat majority, there were enough "no" votes that TARP failed on its first vote, sending markets into a tailspin.
It's hard to imagine a Republican speaker striking a deal with Biden for any rescue plan today, and even if he did – at the peril of his Speakership – it would be even less clear where any R votes would come from.
Plus, the debt ceiling impasse that looks likely to play out this summer would add to complexity and risk to an already-highly volatile financial backdrop in unknown ways.
And while Dodd-Frank strengthened regulation to some extent, it also restricted the Fed's ability to use its emergency lending authority for bailouts, to prevent anything like the AIG bailout from happening again.
So, there are important reasons to think that recent banking troubles should be more manageable and less disastrous than the crisis 15 years ago.
But, as Brown and Irwin conclude, “the nature of a financial crisis is that events move fast and in non-linear, unpredictable ways.”
Hold onto your hats…the wild ride continues!