Why Have We Had A Banking Crisis?
Nigel Bolitho April 2023
Few readers will forget the sight of investors queuing for hours outside branches of Northern Rock in late 2007. I well remember the horror story of a friend of a client who had £400,000 invested with Northern Rock: she finally got the money back when the bank was nationalised in February 2008.
The difference today is electronic banking. In March 2023 the UK subsidiary of Silicon Valley Bank (SVB) had 25% of its deposits withdrawn electronically in a day before a takeover by HSBC.
In March 2023 4 banks, 3 in the US and 1 in Switzerland went under. Two of the US banks were crypto-currency linked; the third was Silicon Valley Bank (SVB), the 16th largest US bank in terms of gross assets.
SVB was launched to finance tech start-ups in California because traditional US banks either did not understand techie culture or were too remote as most were and are based on the east coast of the US.
So why did SVB go under? Having lots of senior executives working from home did not help but the key was the fact that money flooded into the bank in 2021 and 2022 and it had to decide what to do with this influx. To earn an extra crust it invested an awful lot of money in fixed interest bonds – now it seems mainly bundled up mortgages.
Whatever they were, they offered a fixed interest return which became progressively less attractive as the Federal Reserve Bank pushed up interest rates to try to combat inflation – a blunt but the only apparent weapon available to central banks to try to curb inflation.
Now we would not have had a crisis at SVB if techie investors had not wanted to withdraw money in 2023. This is because US bank investments are valued at cost or near cost and there is no need to change the value on balance sheets if those investments are held to maturity.
But once SVB had to dip into the bonds to meet withdrawals it had to “mark to market” ie unveil the hidden losses on its fixed interest investments. So mark to market losses totalled around $15bn against shareholder funds of just $16.3bn – as the attached calendar 2022 balance sheet attached indicates.
Credit Suisse (CS) is a different case. It’s 1 of the 30 in the world deemed to be a “systemic risk” – ie too big to fail. Its problem was that it did not stick to core banking and got caught up in all sorts of misdemeanours which led to regular fines. So for example:-
Between 2012 and 2016 it organised £940m loans for the Mozambique Government to buy fishing boats to fish for tuna. A large part of that money was unaccounted for including significant kickbacks estimated to be at least $137m- source The Guardian.
Then came significant losses in the Greensill Capital supply-chain finance scheme. This idea was to settle invoices immediately for a fee and involved former Prime Minister David Cameron as an adviser. CS marketed such investments as low risk and then Greensill went bust.
CS also got caught out by helping a US family office called Archegos which made some bad investment bets and went under.
Then it got fined for failing to implement money laundering procedures on a gang of Bulgarian cocaine smugglers.
You could not make up such a casualty list.
So What Other Banking Horrors Can We Expect?
The main area of concern is so-called “shadow banking” businesses. They are not banks subject to normal banking regulations but are able to take in deposits and lend out money. Such organisations include some independent mortgage lenders, hedge funds and private equity firms.
But I suspect the next hit to the banking sector will come from another source. One feature of the 2008 credit crunch was how credit rating agencies were fooled into giving several organisations higher credit ratings. In the sub-prime mortgage scandal in the US, a range of different quality mortgages were bundled up “sliced and diced” into mortgage packages and given credit ratings that were better than they actually were. It did not take time for this foolishness to be exposed.
Watch This Space!
Know Your Economics
New Kid on the Economic Block called Modern Monetary Theory
Nigel Bolitho June 2020
Here is some background on the three major economic theories of the past 100 years.
You would probably not have had an easy life if you had lived in Britain in the 1930s. By the end of 1930 unemployment had more than doubled from 1m to 2.5m - up from 12% to 20% of the insured workforce and exports had fallen by 50%. One reason for the decline in exports was the fact that Sterling was linked to the Gold Standard at a pre-war exchange rate of $4.86:£1. In addition the US increased import duties to a maximum of 20% in 1935 against just 4% now – source of information JP Morgan. Also calculates rate goes up to 8% if more tariffs on Chinese exports and to 10% if 25% charge on global auto imports to the US.
At the time Governments (including the Labour Party) espoused a classical view of economics which suggested that budgets should balance. So, as a consequence of recession, benefits were cut and taxes increased.
Then along comes John Maynard Keynes. Essentially he said that the way forward out of recession was for the Government to spend money on public projects so employing people digging, for example, ditches. When they were paid they bought goods from other people and so on. This so-called “multiplier” effect slowly boosted the UK economy – as did preparations for the Second World War.
The Keynesian view of economics continued to be in favour until the 1970s when inflation took control; I well remember receiving 3 pay rises in a year then without even asking for them! The Monetarism formula is to control the money supply which can then in turn control the rate of inflation. The key monetarist was Milton Friedman who argued that excessive expansion of the money supply is inherently inflationary, and that monetary authorities should focus solely on maintaining price stability.
Modern Monetary Theory
Now we come to the new kid on the block and, in my view, it is a hooligan. Essentially, Modern Monetary Theory (MMT) says that inflation is not a problem and indeed it has not been for a number of years; indeed at the moment a number of central banks are trying to push up the inflation rate by cutting interest rates. Instead MMT says the key economic aim now should be full employment and to get there Governments can simply create more money: print and spend as much as is required to achieve the full employment goal.
Then (and here is the twist) if and when inflation becomes a problem, taxation or issue of Government debt can be used to withdraw money from circulation and dampen down prices. Rising taxes won’t be popular when many other countries are currently cutting them – and who is going to buy Government debt in this situation?
And unfortunately, far too many leading politicians view MMT as being the common theory they want to follow. That does not only mean Mr Corbyn and the Labour Party but also the candidates to lead the Tory Party and become Prime Minister. Boris Johnson has been quoted as saying that he wants a new Budget to ensure the economy is “going gangbusters” by 31 October 2019 – the deadline for leaving the EU. His defeated rival for the Prime Ministership, Jeremy Hunt, wants to invest a lot of money on new warships (they take some time to build) while Michael Gove wanted to abolish VAT.
It has to be said that the last Chancellor the Exchequer Phillip Hammond did work wonders on UK Government debt and brought in a much more balanced Budget. However, the big danger now is that all his good work is going to go out of the window in a remarkably short period of time
The key aim of MMT is full employment but we are nearly there!
MMT is an economic powderkeg.