The Banking Crisis Enigma
This morning, I received the following inquiry from LeadStories.com about my May 2023 Bloomberg appearance:
Hugh, I’m editor in chief of LeadStories.com, a 3rd party factchecking org for Meta and TikTok. We are factchecking articles that claim you are warning Americans that the US govt is planning to freeze all bank accounts. Could you read this example and let me know your thoughts. Is this misrepresenting your commments? https://www.wnd.com/2023/05/u-s-may-freeze-bank-withdrawals-currency-fear-rises-expert-warns/
My response below:
Hi Alan,
Oh la vache...
Thanks for reaching out.
Several points to make.
This is a very old comment made almost one year ago in May 2023, with the bankruptcy of several prominent banks in the US.
The article you refer to has given it a very obvious political angle when that was never my intention.
Despite the article referring to an interview from this time last year, it does retain a degree of relevance.
And several banks remain in a perilous condition.
The Federal Reserve as regulator of the US banking system permitted banks to own US Treasuries and should they choose, they could hold them in on 'hold to maturity' basis and never have to mark any losses through to their income statement.
This practice is common throughout the world.
It is effectively an inducement from governments to encourage banks to hold Treasury debt securities and facilitate their fiscal spending.
I referred to the conceit and arrogance of good arguments. The policy has merit but unforeseen and potentially catastrophic consequences.
Similar to the same intelligent logic that argued in 2006 that a portfolio of diversified US mortgages was a very safe investment. True, but it did not figure that US house price could decline simultaneously across the continent of the US. When this very low became a reality, the policy led to the bankruptcy of the entire banking system.
I was therefore postulating that another unforeseen event, the rise and rise of US or Federal Reserve interest rates could have similar calamitous effects.
Higher interest rates create huge losses for the banks on their 'held-to-maturity' Treasury portfolios. At the same time, the higher return from money market funds encourages bank depositors to transfer money from their checking accounts into higher return money market funds. This happened early last year and forced the most vulnerable banks to liquidate their Treasuries and book a huge loss which wiped out their equity.
The article has relevance once more because inflation is proving stubbornly high and the US economy continues to grow beyond expectation. The price of Treasuries is once again falling precipitously and creating significant unmarked losses for the US banking system. These remain latent, or existential risks to the US banking system.
In the time that has passed since my comments, the deposits of the US banking system have proven more robust than I imagined. Without a run on deposits the present fragile situation is sustainable and no drastic government intervention is called for.
However, my hedge fund gains were derived from imagining low cost strategies that would deliver huge returns should the unforeseen occur.
The stock market has been very strong over the last year and most investors are bullish. However, there is a dangerous development brewing in the FX markets. The much maligned US dollar is rising, especially against the currencies of Asian export power houses China and Japan. And investors are reassessing the potential for rate cuts.
I still believe that there is the potential for a 1929 style crisis. Markets are predicated on interest rate cuts. Should they not materialise, it is conceivable that house and stock prices could fall sharply. Investors would quickly become more cautious and it is conceivable that they might transfer more money from bank deposits to higher yielding non bank assets. This once again could create a doom loop where weaker banks might need to sell their Treasuries and book enormous losses. Today's fiscal situation of the US Treasury would not be able to accommodate the huge bank bailouts that we saw in 2008 and investors would be most unlikely to fund new stock issues from weak banks. Many banks would fail and their stockholders would be wiped out.
Under this scenario, which i believe is still a very low probability, it seems conceivable that any US administration independent of political party might take steps to prevent depositors from pulling their money from banks.
More likely, however, I foresee the Federal Reserve shocking the market with unexpected rate cuts to bail out the international economic environment which is causing the dollar to appreciate against other currencies. This might be confirmed if we see the dollar-yen appreciate in favour of the greenback through 165. This might put further price pressure on the banks' holding of US treasuries but it is unlikely that there would be deposit flight and hence draconian government oversight.
I hope this clarifies and updates my opinion.
Hugh
The ACID Capitalist Revolution will be televised, my friends.