We are nearing the tipping point where the US economy and banking system will either tip over the edge and back to safety or fall off a cliff into a full-blown banking crisis. The Federal Reserve can solve this in one step: cutting interest rates at its meeting this week. However, the chances of the Fed taking this step are slim. While most forecasts now have the US central bank holding off on rate hikes, a break is simply not good enough. A cutting rate economic pressure release valve. Although the move will be temporary, the relief is necessary for the health of financial markets and the banking system. Yes, the Fed wants to tighten its grip on inflation and, no, rate cuts won’t help on that front, but someone needs to tell Fed Chairman Jerome Powell that this isn’t an “all-expenses-paid” mission, because none of us banking. The price paid in effort for system stability is unaffordable. The collapse of Silicon Valley Bank SIVB, -60.41% , Silvergate Bank SI, -3.30 suppresses and bleeds most of the coverage so far. % and volatility in Signature Bank SBNY, -22.87% – and First Republic Bank FRC, -32.80% and others – focused on how these banks managed their way through the troubles. It has not taken a hard look at the problems these businesses are suffering. Many experts tell me the point is being ignored, as summed up by Bryce Doty, senior portfolio manager at Sit Investment Associates: “Most banks are insolvent right now.” It sounds scary, but it’s more about regulatory rules and interest rates than the sheer inability to pay off all debt. Read: From SVB’s sudden collapse to Credit Suisse’s fallout: 8 charts show turmoil in financial markets To bring it home, consider if you took out a long-term fixed-rate mortgage on a home about 10 years ago, when the average mortgage rate was around 3.6%. . That was nearly double the rate on the 10-year Treasury TMUBMUSD10Y, at 3.430% at the time, which meant some institutions would want to buy your loan rather than settle for a safer Treasury bond. Nowadays you’re still paying 3.6% on a mortgage, but that’s about what a 10-year Treasury pays. As a result, the value of your mortgage on your lender’s books is lower now than it was a decade ago. In the banking world, such occurrences are not a problem until the paper is “marked to market,” as it is being sold today. Federal regulations allow banks to plan to hold a portion of their assets until maturity, allowing them to eliminate temporary paper losses because held-perpetual securities are not marked to market (remaining on the books at the price they had when purchased). . This gives banks the flexibility they need but it can create issues of the “no problem until there’s a problem” variety, which is only incomprehensible if you’re looking very carefully. Whereas the 2008 financial crisis was caused by banks defaulting on losses, the current problem with the system is not about wasted paper (at least not yet). This time, rates rose so fast that it led to paper losses. “The feds should have seen this coming.” The Bloomberg US Aggregate Bond Index fell 13% last year; Previously, its worst year ever was a loss of 3% in 1994. Since 1976, the index has been down in just five calendar years — including the last two. The Fed should have seen this coming; Its own balance sheet shows that roughly $9 trillion in bonds lose north of 10% of their value during rate hikes. “The Fed kept rates so low and then raised them so fast that no [financial institution] could potentially restructure their bond portfolios to avoid losses,” Doty said in an interview on the My Money Life with Chuck Jaffe podcast. Off-air, Doty speculated that if the Fed raised interest rates by 100 basis points — one percentage point — “that will remove half a percent [the banking industry’s] Unreal loss at once. It would create the easiest and most short-lived banking crisis in history.” Moreover, this would ensure that no “contagion” would occur from emerging banks; note that it was the banks that came to the rescue of First Republic this week, a bank mark-to-market. Sows the seeds for problems so that the next institution defaults. That’s how you turn a problem into a disaster. If the Fed pushes rates higher without giving time for relief, it dramatically increases the likelihood of a liquidity crisis and credit crunch. Hello recession. , your table is ready. Read: ‘We need to stop this now.’ Bill Ackman says First Republic support spreads financial contagion. Jurin Timmer, director of global macro at Fidelity Investments, said in a recent interview on my show that he can’t see the Fed leaving, noting that no one wants to be the next Arthur Burns, the infamous Fed chairman during the Great Inflation. of the 1970s. Timmer said: “They are committed to never repeating the mistakes of the ’70s, which was to loosen policy for too long, letting the inflationary genie out of the bottle.” But this isn’t the 1970s, and anyone who thought the Fed was too soft on inflation — which is why it’s taking a tougher stance today — should consider that perhaps the central bank was pulling back then because higher rates signaled broader systemic problems. were causing The Fed needs to solve problems, not contribute to them. If it means living longer with high inflation, it is still a better choice for a country than to turn a containable banking problem into a global liquidity crisis and a hard landing for the economy. The cut does not end the war on inflation, it merely pauses the war to strengthen and secure its fighting position. Sometimes, the best way forward is to start with a rocking step backwards. Let’s hope the Fed has the guts to do it. Read: What it might take to calm banking-sector concerns: time, plus a Fed rate hike. More: The First Republic was saved by rivals. Silicon Valley Bank was abandoned by its friends.
