Tim Bartz und Michael Brächer
It’s not often that central bank executives directly inform the public at large about what they discuss behind closed doors. But Thursday saw one of those rare moments. Christine Lagarde, president of the European Central Bank (ECB), went before the press in Frankfurt to announce that it was bumping up interest rates by half a percentage point, just as it had in February.
Unusually, though, Lagarde made clear that the decision had not been unanimous. She said that of the 26 members of the bank’s Governing Council, there were "three or four that did not support the decision" to raise rates and would have preferred to wait and see how the situation in the banking sector would develop. As she made clear: "It’s not business as usual."
Lagarde’s noteworthy comments came on the heels of several days of turbulence on global capital markets that awakened ominous memories of autumn 2008 and the ensuing financial crisis. A number of pressing questions have suddenly arisen, and the press conference held by the ECB president did little to change that: Whether the markets can be restabilized; whether more banks will start wobbling; whether we are facing a new crisis.
The only sure thing: Fear has returned.
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ECB President Christine Lagarde: "It's not business as usual." Foto: Thomas Pirot / laif
It all began a week ago with the collapse of the Silicon Valley Bank (SVB) in California, a financial institution known in the startup scene, but which most average investors had never heard of before. The bank experienced rapid growth in recent years, but completely misjudged the consequences of the recent interest rate increases and was facing collapse as its panicked clients rushed to empty their accounts.
Following a series of emergency meetings, American financial authorities were forced to do something a number of regulatory and liquidation provisions had been designed to prevent: rescue a bank with government help.
Shortly afterward, U.S. President Joe Biden spoke to the country: "Americans can have confidence that the banking system is safe," he said on Monday. "Your deposits will be there when you need them."
They were statements reminiscent of pledges made by other leaders during the last crisis. Then-German Chancellor Angela Merkel told her compatriots: "Your savings are secure." Mario Draghi, Lagarde’s predecessor at the ECB, was even more dramatic: "Whatever it takes," were his words.
“Americans can have confidence that the banking system is safe. Your deposits will be there when you need them."
U.S. President Joe Biden
Despite Biden’s efforts, though, stock markets around the world plunged this week, with bank shares bearing the brunt of the slaughter. Investor trust eroded by the minute, and even German financial institutions, like Deutsche Bank and Commerzbank, saw their stock prices temporarily plummet into the abyss.
The situation at Credit Suisse then provided the cherry on top of this troublesome week. For years, the Swiss bank has been stumbling from one homemade scandal to the next. Once a beacon of the Alpine banking industry, the institution burned through billions with bad investments in addition to providing financial services to corrupt politicians, war criminals, human traffickers and drug dealers. In the fourth quarter of 2022 alone, wealthy and concerned clients withdrew 107 billion francs from the financial institution. The exodus has continued this year.
Founded in 1856, Credit Suisse is intricately linked internationally and considered "too big to fail" – and is now seen as the greatest threat currently facing the global financial system. In an effort to plug the gap, Credit Suisse last October turned to the Saudi National Bank for fresh capital, an ignominy for a country that sees itself as a bastion of stability and political independence. The Swiss still haven’t gotten over the trauma of Swissair’s collapse in 2001 and the 2008 bailout of its largest bank, UBS, the headquarters of which lie across Zurich’s Paradeplatz square from Credit Suisse.
With its 10-percent holding, Saudi Arabia is now Credit Suisse’s largest investor, but the Gulf country’s financial elite is clearly not entirely pleased about that fact. In a televised interview on Wednesday, Saudi National Bank President Ammar Al Khudairy ruled out sending additional cash to Switzerland, saying it was "a regulatory issue" – only to then add: "I can cite five or six other reasons."
He had hardly finished speaking before Credit Suisse stocks fell off a cliff – to the point that the Swiss National Bank had to step in. Credit Suisse "meets the capital and liquidity requirements imposed on systemically important banks," the SNB said in a public statement. Such statements are only made when the financial system faces a systemic danger.
And Credit Suisse is, in fact, well endowed with capital and securities that can quickly be sold off if necessary. But once customers lose trust and begin to abandon a bank en masse, survival can quickly be at stake – as happened in faraway California.
Overnight Bailout
Just how acute worries have become about Credit Suisse could be seen overnight from Wednesday to Thursday. The SNB quickly put together a package of 50 billion francs (the equivalent of 51 billion euros) to boost Credit Suisse’s liquidity in case customers continued to withdraw their assets. No details were provided regarding the conditions attached to the liquidity injection, but they were likely generous. As a sign of strength, the beleaguered bank also announced it was buying back up to 3 billion francs worth of debt.
"Without SNB intervention, Europe would have had its own Lehman moment," says Volker Brühl, the managing director of the Center for Financial Studies who was active as an investment banker during the 2008 financial crisis. And the move produced the desired results for now: Credit Suisse share prices stabilized on Thursday, as did those of most other European financial institutions. In Frankfurt, Lagarde assured that "the euro area banking sector is resilient, with strong capital and liquidity positions" – only to then add: "In any case, our policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed."
It remains unclear, though, whether a Lehman moment may ultimately materialize anyway, and what the consequences of the sudden panic on the markets might have for the real economy. "These events could very well lead to a recession," says economist Tiffany Wilding from Allianz subsidiary Pimco, one of the largest investors in the world.
Bild vergrößernA man walking out of the Lehman Brothers building in September 2008 after losing his job: "Without SNB intervention, Europe would have had its own Lehman moment." Foto: Joshua Lott / REUTERS
The latest signs of instability come just as it seemed the global economy had finally managed to get past the coronavirus pandemic and learned to live with Russia’s invasion of Ukraine. Furthermore, the banks – which were responsible for triggering the financial earthquake of 2008 – seemed solid, aside from Credit Suisse. Even longtime laggards like Deutsche Bank and Commerzbank have been earning billions in profits of late, thanks to a favorable climate.
They have profited from state aid to industry, a program that prevented large bankruptcies. And banks have also been able to borrow money from the ECB for the last several years without having to pay it back completely. And since the recent reversal in interest rate policy, they have been able to rake in billions without risk by parking their customers’ savings at the ECB.
Lagarde’s Thursday announcement that the ECB was raising its key rate by half a percentage point is yet another windfall for the banks. Deposits with the ECB now earn 3.5 percent, translating to additional earnings in the three-figure billions.
That is the positive side of the interest rate hikes that Lagarde, her U.S. counterpart Jerome Powell and others have introduced. Initially, they had underestimated the inflationary pressures that began accumulating in the real economy in 2021. But ever since Russia’s invasion of Ukraine and the resulting explosion in energy prices, they have been combating rising prices with a rapid series of interest rate increases.
The strategy pursued by Lagarde and Powell has yet to bear fruit when it comes to getting inflation under control. But the downsides of their monetary policy are becoming increasingly clear: Rapidly climbing interest rates weigh on stocks and bonds, threaten the investment plans of industrial corporations, hamstring real-estate markets and drastically limit the financial flexibility available to governments. The capitalist system, which is built on a foundation of debt, is under permanent duress.
"This is one price we’re already paying for years of easy money," wrote Blackrock CEO Larry Fink, founder of the world’s largest asset management company, in his annual letter to investors this week. The interest rate increases, he wrote, "was the first domino to drop." The question, he continued, is whether other dominoes are now to come.
The shift toward rising interest rates marks a radical departure from paradisiacal conditions, when the world was awash in cheap money and barriers to taking on debt were low. It was a time when business models such as the one pursued by Silicon Valley Bank found great success – until they didn’t any longer.
The San Francisco-based bank – the 16th largest in the U.S. when ranked by asset value – was at the center of an elite group of tech entrepreneurs and venture capitalists. A number of well-known startups held company and payroll accounts at SVB, flooding it with cash. The bank also accepted stakes in growth-stage startups as loan collateral. It was the financial industry groupie in digital La La Land.
It was a risky strategy, and it worked as long as new money was being injected into startups. But since the advent of inflation and rising interest rates, investors are no longer quite as free with their money. Californian tech firms have laid off tens of thousands of workers as liquidity has dried up.
Bild vergrößernFederal Reserve chief Jerome Powell has hinted that interest rate increases may slow. Foto: Jack Gruber / USA TODAY Network / IMAGO
Many young companies shift their money between accounts in the search for the best interest. Banks, by extension, must invest their customers’ money smartly so they can offer the best conditions.
SVB proved unable to do so. The startup stakes on the banks’ books lost significant amounts of money. And even worse were the investment mistakes made by CEO Greg Becker – in part because there was no one at the bank to look over his shoulder. For several months, the bank did without a chief risk officer, a situation which opened the door for poor investment decisions.
Becker invested his clients’ money almost exclusively in long-term U.S. government bonds. Such bonds are extremely safe, but they don’t produce much interest. And the longer the periods of such bonds are, the more difficult the situation becomes for banks when their customers begin demanding higher interest rates on their savings.
SVB could no longer navigate its way out of this corner. In order to quickly obtain cash, the bank had to sell its bonds – at a loss of $1.8 billion relative to purchase price.
That, too, is a bit of collateral damage that comes from rising interest rates: As the rates rise, bonds lose value. In the U.S. alone, banks are sitting on potential bond losses worth $620 billion. That’s not really a problem as long as they don’t have to sell those bonds and cement the losses – as SVB was forced to do.
"I understood that we had 72 hours to come up with a plan to address this catastrophe."
Anna Eshoo, Democratic Congresswoman for Silicon Valley
In Germany, the country’s Sparkassen savings banks were forced to write off 7.8 billion euros in 2022. But because their customers are frugal and stable, the institutions can simply hold onto their bonds for a couple of years until they mature and they can recoup the purchase price. They have the luxury of simply waiting out the potential losses.
SVB, however, didn’t have that luxury. Its attempt to balance out the loss by raising capital failed, triggering a chain reaction. SVB shares tanked and customers began pulling out their money – an unfathomable $42 billion just on Thursday of last week. A good, old-fashioned bank run right in the heart of Silicon Valley.
The panic was fueled by the fact that the Federal Deposit Insurance Corporation (FDIC) only guarantees up to $250,000 in the event of a bank failure. But 97 percent of SVB’s customers, most of them startup entrepreneurs, had far more than that in their accounts. Fears quickly spread to other financial institutions and the U.S. government was forced to intervene.
"I understood that we had 72 hours to come up with a plan to address this catastrophe," said Anna Eshoo, the Democratic Congresswoman who represents much of Silicon Valley in the House of Representatives, in comments to the Financial Times. She compared the collapse of SVB with a magnitude 7.9 earthquake.
A Blank Check for the Startup Elite
And the government delivered. Holders of SVB stocks and bonds lost their investments, but the FDIC guaranteed the deposits of all SVB customers, including accounts larger than $250,000. And the same guarantee was extended to other troubled institutions like First Republic and Signature Bank, the latter of which has now closed its doors.
In addition, all U.S. banks are allowed to deposit their bonds with the Federal Reserve as collateral for one year at cost, and not at their significantly lower market value, in order to obtain fresh cash – a concession reminiscent of 2008.
The blank check issued to the West Coast startup elite, though, is now fueling political conflict, angering Republicans who have already become radicalized. According to James Comer, the Kentucky Republican who chairs the Oversight Committee in the U.S. House of Representatives, the problem wasn’t the lack of regulation, poor financial decision making or panicky customers, it was the bank’s "wokeness," leading it to put too much emphasis on environmentally friendly investments.
Even Donald Trump Jr. made a desperate grab for the beloved spotlight he once bathed in, tweeting "SVB is what happens when you push a leftist/woke ideology and have that take precedent over common sense business practices." He ran out of characters before he could mention that it was his own father who loosened tighter regulations for smaller banks.
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In fact, though, stakeholders like SVB CEO Becker were long ago able to convince politicians and regulatory authorities that their bank was too inconsequential to undergo the regular stress tests undertaken by the Federal Reserve. Those tests now apply only to institutions with balance sheets of $250 billion or larger – a volume that is met only by a handful of Wall Street giants like JP Morgan Chase and Citigroup.
That, European financial overseers have told their U.S. counterparts, was a mistake. As has become clear, even regional banks like SVB and First Republic are "too big to fail."
It is a dilemma for Biden. With just a year and a half to go before presidential elections, he is faced with the need to protect a key industry in the U.S. economy. And representatives of that industry are fully aware of the predicament in which Biden currently finds himself, an awareness that manifested in intense lobbying efforts for the president to fully guarantee SVB deposits. "This is the U.S. versus China. You can’t kill these innovative companies," one of those lobbyists is quoted anonymously as saying to the Financial Times.
It is a rather grotesque sight to watch Silicon Valley bigwigs – who otherwise have a distinctly anti-state, libertarian bent – plea for help from the government. It is also rather ironic that the speed with which SVB and the other banks collapsed is a product of digital advancements made in Silicon Valley. Whereas it used to be that weeks might pass before headlines about financial problems would trigger a bank run, rumors and concerns now spread at the speed of the enter button on a social media post. It was, said Patrick McHenry, chair of the House Financial Services Committee, "the first Twitter-fueled bank run."
The power that social media can have on the financial markets was on full display back in 2021. That year, social media influencers called on followers to buy stocks in companies like Gamestop, driving up their share prices. This time, it was the reverse phenomenon. "The speed of the world has changed,” tweeted Sam Altman, head of the San Francisco-based company OpenAI. "Things can unwind fast. People talk fast. People move money fast."
The SVB failure was also stoked by influencers. "If you are not advising your companies to get the cash out, then you are not doing your job as a Board Member or as a Shareholder," tweeted Mark Tluszcz, CEO of the investment company Mangrove in reference to SVB. The tweet may, however, have been fueled by a bit of self-interest: Mangrove is reportedly interested in a British SVB subsidiary.
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The herd instinct phenomenon isn’t limited to Silicon Valley. After the SVB bankruptcy, the social media crowd identified New York’s Signature Bank as the next shaky candidate. The bank had been betting on the cryptocurrency business, which came under considerable pressure after the bankruptcy of the scandalous FTX exchange. Less than 72 hours passed before a problem turned into an existential crisis. The bank’s financial cushion shrank by $10 billion within hours. To get the panic under control, New York’s financial regulator closed the bank so quickly that even its senior management was taken by surprise.
The fact that Signature, of all banks, has become the second victim of the new banking crisis, holds a double irony: Barney Frank, the longtime former Congressman with the Democratic Party who helped shape the new financial regulations after the 2008 crisis, is a member of Signature’s board of directors. And he, too, was caught off guard by the run on the bank, as he was forced to contritely admit.
In light of the events, central bank heads like Lagarde and her U.S. counterpart Jerome Powell, in particular, now find themselves in an almost unresolvable dilemma. They are determined to continue fighting the stubborn inflation they have tolerated for too long by raising interest rates. For years, they had given the economy breathing room by keeping key interest rates low and buying up bonds on the capital market. Now, though, if they continue to raise interest rates, the already critical situation could escalate.
Events in London this past autumn underscored how quickly things can spiral out of control. The British government caused the prices of its government bonds to plummet with half-baked tax-cut plans and nearly drove British pension funds into bankruptcy. The Bank of England had no choice but to switch to emergency mode – and return to loose monetary policy despite high inflation. The concerns about the financial system were too great.
In the U.S., Powell could soon shift down a gear in the fight against inflation and not raise interest rates for the time being. Many on the capital markets are now expecting interest rates to be cut in the late summer if the economy weakens.
Lagarde isn’t that far yet. But the ECB president was also more cautious on Thursday than recently about further interest rate hikes. It was true, she said, that the fight against inflation, which had long been neglected, remained a priority. In the future, however, prices and other data would determine the central bank’s policies more than ever.
"I was around in 2008, so I have clear recollection of what happened and what we had to do," she said. But her mien also seemed a lot more serious than usual.
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