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London Telegraph: Central banks have pushed us to the precipice again

Section: Daily Dispatches

From The Telegraph, London
Sunday, March 19, 2023

After the collapse of California's Silicon Valley Bank left Prime Minister Rishi Sunak promising reporters a week ago there was "no systemic contagion risk," here we are again. 

Now the threat is even closer to home, with UBS in talks to take over all or part of Credit Suisse, in a deal brokered by a desperate Swiss government.

... Dispatch continues below ...


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The sudden run on deposits at SVB was bad enough. It was the biggest U.S. lender to fail in more than a decade. Credit Suisse is in a different league altogether -- one of only 30 banks worldwide classed as systemically important. 

Already, there are warning signs that the move could threaten thousands of City jobs in London. 

UBS has also made it clear it does not want to take on the full liabilities of Credit Suisse, asking the Swiss government for a backstop guarantee. The problem, of course, is that the combined balance sheet of the merged Swiss group would be much larger than Switzerland's GDP -- not a good place for a small country in the early stages of another global storm.

The fault for this slow-moving crisis is not hard to identify. Overconfident central banks and regulators, convinced of their godlike power to manage the world's economy and keep it from danger, have once again pushed us to the precipice.

While individual banks deserve to face the consequences of their investment decisions, and directors, shareholders, and bondholders are ultimately responsible, it would be too easy to focus on their errors alone. The arrogance of financial regulatory authorities has helped to make the situation worse.

The immediate cause for the banks' distress is a recent spate of interest rate hikes. The Federal Reserve in America runs annual stress tests on the banking sector to keep participants behaving responsibly. It emerged last week that, for the past decade, these tests have not assessed how banks would cope after a sudden, sharp rise in interest rates. False assurance in the system's robustness came from the top down.

The impact of these hikes was then worsened by a regulatory system that assured financial institutions that government bonds such as U.S. Treasuries were the safest possible bet. Bond prices fall when rates rise, leaving any institution that swallowed the guidance nursing huge paper losses. That can be fine, unless these investments suddenly need to be turned into real money. 

SVB appears an extreme example of where that advice could lead.

The interest rate rises that are now causing such havoc are themselves the result of earlier errors. Central banks decided that they had no choice but to act after inflation suddenly raged out of control last year, after decades of moderation. 

Yes, Putin's war of aggression in Ukraine played some role in this economic shock. But the greatest culprit was once again a bout of desperate ingenuity from the center. This time it was the extraordinary fiscal stimulus unleashed during the Covid pandemic. Worldwide, nearly $11 trillion was pumped into the system: a staggering 10% of global GDP. 

Little wonder that our systems struggled to adjust in its aftermath.

Nor is this the beginning of the story. We have been living in the Alice-in-Wonderland world of easy money since 2008, or, arguably, since Alan Greenspan's time at the Fed. 

Quantitative easing and near-zero interest rates have kept the global economy on life support for a decade and a half. In this crisis too the ratings agencies proved asleep at the wheel. How can so few have realised the obvious: Interest rates that fall can also rise, and rise very quickly? Since when had the laws of finance and economics been repealed?

False confidence from regulators breeds instability. Interest rates need to be allowed to normalise from their artificially low levels so they can play their proper coordinating role in a free economy. 

Yet in the brittle, artificial situation the gods of the central banks have created, every crisis produces more action and every action produces another crisis.

At some point we need to break the chain of failed interventions and acknowledge the limits to the power of central banks.

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