by Alasdair Macleod, GoldMoney:
We are all now aware that the global banking system is extremely fragile. Driving bank failures is contracting credit, which in turn drives interest rates higher. Though it is not generally appreciated, central banks have failed to suppress them.
Some regional banks have failed in the US and the run on Credit Suisse’s deposits has forced the Swiss authorities into forcing a reluctant rescue by UBS. Undoubtedly, as the great credit unwind plays out, there will be more rescues to come.
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In this, the earliest stages of a banking crisis, some questions are being answered. We can probably rule out bail-ins in favour of bail outs, and we can assume that nearly all banks will be rescued — they must be in order to prevent systemic contagion.
In this article I quantify the position of the global systemically important banks (the G-SIBs) and point out that the central banks which are meant to backstop them are themselves bankrupt — or rather they would be properly accounted for.
Because even a minor failure in the banking system could undermine the entire global banking system, the much heralded pivot is now here, but not in plain sight. Because central banks have lost control over interest rates, the focus on preserving the financial markets underpinning the banking system has shifted to supressing bond yields. This is why the Fed has introduced its Bank Term Funding Programme, likely to be copied in other jurisdictions.
It is Powell’s hidden pivot — his line in the sand. But it is the last desperate throw of the dice and depends entirely on inflation being transient and interest rates not rising much more.
The price of even a successful preservation of the banking system is the destruction of fiat currencies, because the bigger picture is still of the greatest credit bubble in history unwinding. And that process has only recently started.
The great unwind accelerates
Now that everyone in finance knows that there is a banking crisis, cynicism prevails. When a central banker or treasury minister tries to reassure the public, it is disbelieved. The risk to an extremely fragile global banking system is that if disbelief in public statements spreads from financial sceptics to the wider public, the system is doomed. All credit is based on confidence and confidence alone.
It is still too early to say that confidence has been irretrievably shaken. But last weekend, UBS was unwillingly forced by the Swiss authorities into taking over Credit Suisse on a share swap, which valued the latter’s shares at about 70 centimes. That put Credit Suisse’s shares on a discount to book value of 94%. Admittedly, this figure is unreliable when deposits are running out of the door and the full value of foreign exchange derivatives are not accounted for. But it does raise a question over the valuations of all the other global systemically important European banks. And why stop there — the G-SIBs have all taken in each other’s laundry, so if one fails so might all the rest. Perhaps they should all be similarly valued.
Presumably, in their groupthink the central bankers represented by the three wise monkeys in the illustration above never thought it would come to this. After all, their regulators have frequently conducted stress tests and all major banks routinely pass them with flying colours. But as Kevin Dowd, Professor of Finance and Economics at Durham University put it in 2016 in one of his several critical reviews of bank regulation,
“The purpose of the stress testing programme should be to highlight the vulnerability of our banking system and the need to rebuild it. Instead, it has achieved the exact opposite, portraying a weak banking system as strong. This is like having a ship radar system that cannot detect an iceberg in plain view.
“As the EU banking system goes into a renewed crisis, the UK banking system is in no fit state to withstand the storm. Once contagion spreads from Italy to Germany and then to the UK, we will have a new banking crisis but on a much grander scale than 2007-08.
“The Bank of England is asleep at the wheel again, and we will be back to beleaguered banksters begging for bailouts – and the taxpayer will be ripped off yet again, but bigger this time.” [i]
Unfortunately, it is Professor Dowd’s analysis and conclusion that have stood the test of time. And nothing, repeat nothing, has been done to alter this situation. Only last Monday, the President of the ECB proved this point by releasing the following official statement:
“I welcome the swift action and the decisions taken by the Swiss authorities. They are instrumental for restoring orderly market conditions and ensuring financial stability. The euro area banking sector is resilient, with strong capital and liquidity positions. In any case, our policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy.” (italics are my emphasis)[ii]
The group-thinking on stress testing is based on commonly agreed parameters between central banks and regulators for constructing stress models, and their desire to be seen discharging their duties rather than the actuality. That being the case, what we have seen in Switzerland which led to Credit Suisse being valued at only 6% of its book value is an important message not just for European bank regulation, but elsewhere as well.
Whatever their mollifying statements, the central bank groupthinkers must now be very worried. But they appear to lack coordination. The Swiss National Bank decided that as part of bailing out Credit Suisse, it would bail in higher ranking bond holders, writing off Sf17bn. That shareholders should get something while senior creditors get nothing is a travesty of company law. Following the market’s reaction, it has been swiftly denounced by regulators in Europe and London, only days after the ECB President issued the formal statement above, extoling the Swiss authorities for their actions.
The consequences of the Swiss National Bank writing off senior creditors are likely not just to impose losses on other banks which are in a fragile state themselves and can ill afford their senior debt to be traduced in this way, but to make future bond financing of banks more difficult. Furthermore, banks, insurance companies, and pension funds will be reassessing their risk exposure to all Swiss franc denominated bonds, even to the extent of impacting UBS, Credit Suisse’s rescuer.
