Too Big to Fail Comes to the Rescue

 

The First Banking Crisis Induced by the US Central Bank

The echoes of the 2008 financial crisis reverberate loudly these days. Some of the biggest bank bailouts are taking place right now: following Silicon Valley Bank (SVB) and Signature Bank, it was now First Republic Bank (FRB) that had to be saved. SVB and FRB were among the top 20 banks in the United States according to the size of their balance sheets, roughly comparable to KBC. These smaller - though not small - banks encountered problems due to a typical bank run. Underlying this situation are several factors, including poor risk management. However, this banking crisis can also be attributed to the monetary policy over the last 15 years, ever since the great financial crisis.

Firstly, the loose monetary policy fueled asset inflation, and a strong rise of credit demand. As this policy was aggressively reversed over the past 18 months, stress built up in asset prices (also in so-called riskless US Treasury bonds). Furthermore, TINA (there is no alternative) faded away silently, and as a results deposits shifted to term accounts and better-yielding short-term bonds. Banks were whiplashed between fleeing deposits, lower asset values, and crippling credit demand.

This is probably the first banking crisis induced by the US central bank, whose role is to maintain financial stability. The US Federal Reserve organized a bailout with the help of the largest US banks, in a manner very similar to the rescue of Crédit Suisse by UBS. While the lesson of the 2008 financial crisis was that “Too Big to Fail” should be avoided, “Too Big to Fail” has now come to the rescue of the financial system itself.

 

JP Morgan Created the Federal Reserve

The Federal Reserve, the US central bank, was created in 1913 as an initiative of… JP Morgan. Yes, indeed. JP Morgan had rescued banks, the stock market, and New York City from financial ruin in 1907. The “bank panics” became chronic, and congress passed the Federal Reserve Act, which put the government, and not JP Morgan, in charge of managing financial crises. More than a century later, it seems that history is repeating itself, only this time the FED and JP Morgan are acting in tandem. The result is nevertheless worrisome.

JP Morgan now accounts for more than 30% of the total market capitalization of US banks. Federal regulations typically prevent a bank from acquiring another bank if the combined entity would hold more than 10% of total deposits. However, this has not been the case in the present crisis. This is unprecedented, and against all rules.

The US banking crisis has not yet ended, and the biggest risk is that the credibility of central banks could be questioned. This skepticism could also spread to Europe, where the ECB has yet to be confronted with the lagging effects of its tightening policy on assets, sovereign debt financing, and various financial constructions in sectors such as real estate and private equity. This situation is still unfolding, and its consequences remain to be seen.