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Investors are searching for clarity in the wake of Friday’s collapse of Silicon Valley Bank — the biggest failure of a US bank since 2008. And as they attempt to predict what comes next — be it wider financial chaos, more government regulation, a pause in Fed hikes or something else entirely — they’re looking to the past for guidance.
While the collapse of a top-20 bank easily begets comparisons to the global financial crisis of 2008, analysts are looking all the way back to 1991 — though they may only need to go back to last fall.
Here’s how they’re thinking about the state of the banking industry and the economy.
This isn’t 2008: There are some key differences between today’s banking saga and what happened in 2008.
For one thing, the 2008 crisis was caused by assets (like mortgage-backed securities) that were difficult to value, making it hard for banks to determine how much they were worth. This time, however, the assets causing trouble for banks (US Treasuries and bonds) are easy to value and sell. That also makes intervention by the government much more effective.
And it has taken measures. This time around the US federal government stepped in early to guarantee all customer deposits and restore confidence in the US banking system.
The Federal Deposit Insurance Corporation (FDIC) insures depositors up to $250,000 and large US banks have the money to weather storms — they’re regularly stress-tested by the Federal Reserve to make sure that they can.
“Compared to 2008, the system is more transparent, with a more solid foundation, and the government has identified the remaining problems and put programs in place to deal with them,” said Brad McMillan, chief investment officer for Commonwealth Financial Network.
But that doesn’t mean there isn’t more pain ahead. Shares of banks, both regional and large, plummeted on Monday.
“This is bad news for US bank shareholders,” wrote BlackRock analysts in a note on Monday. “We see knock-on effects for the economy — reinforcing our expectation of recession.”
Let’s take it to 1991: Analysts are looking at the Savings and Loans crisis of the late 1980s and early 1990s as a better model for how this current crisis may play out.
Some quick background: S&Ls were like banks, but they specialized in accepting savings deposits and making mortgage loans. In the 1980s, they were deregulated and began making risky investments with depositors’ money. Those investments went sour and S&Ls found themselves at a loss just as the Fed was raising interest rates. That meant that many borrowers couldn’t afford to pay back their loans.
As a result, many S&Ls failed and the government had to step in to bail them out.
“If anything, this appears to be a typical bank failure like we saw during the Savings & Loan crisis,” wrote Jaret Seiberg at TD Cowen. “The only difference is that we are dealing with a bank that focuses on technology rather than on real estate.”
Since the S&L crisis, regulators have pushed banks away from short-term investments “for the very reasons that appear to have brought down Silicon Valley Bank,” Seiberg said.
So what can we learn from the crisis? A review of regulation and central bank policy seems certain, wrote Societe Generale’s Kit Juckes in a note on Monday. “If the S&L crisis is a model of what happens next, we are closer to the peak in rates than the market thought,” he said, meaning that the Federal Reserve could soon stop hiking interest rates to fight inflation. It’s also very possible that the US economy will slip into a mild recession within the next year, he added.
Back to the future: Investors don’t have to look so far back to see their own future. Six months ago an alarm went off in the United Kingdom, when the gilt market (UK government bonds) spun out of control. We may be hearing that same siren across the pond today.
Back in September, former Prime Minister Liz Truss unveiled a huge package of tax cuts, spending and increased borrowing aimed at getting the economy moving. Markets feared the plan would drive up already persistent inflation, forcing the Bank of England to push interest rates significantly higher. As a result, investors dumped UK government bonds, sending yields on some of that debt soaring at the fastest rate on record.
The scale of the tumult put enormous pressure on many pension funds by upending an investing strategy that involves the use of derivatives to hedge their bets.
As the price of government bonds crashed, the funds were asked to pony up billions of pounds in collateral. In a scramble for cash, investment managers were forced to sell whatever they could — including, in some cases, more government bonds. That sent yields even higher, sparking another wave of margin calls.
Here’s the takeaway. The Bank of England was able to bring things back under control quickly by launching into crisis mode. After working through the night, it stepped into the market the day after the plunge with a pledge to buy up to £65 billion ($73 billion) in bonds if needed. That stopped the bleeding and averted what the central bank later told lawmakers was its worst fear: a “self-reinforcing spiral” and “widespread financial instability.”
US authorities are acting in similar ways today.
On Sunday, the Federal Reserve announced a new emergency lending program which would deliver cash to banks facing steep losses because of higher interest rates. Chair Jerome Powell also announced on Monday that the central bank would launch a review into what went wrong at SVB.
Here comes CPI
Former banking regulators, economists and Wall Street analysts are increasingly calling for the Federal Reserve to pause its inflation-fighting interest rate hikes because of the current banking sector chaos. The Fed’s aggressive tightening policy, they say, caused a surge in Treasury yields that led, in part, to the downfall of Silicon Valley Bank.
Prior to the SVB collapse and related banking stresses, the February Consumer Price Index — a closely watched inflation gauge — was being viewed as the potential decisive factor as to whether the Fed would stick with another quarter-point hike or ramp back up to a half-point hike. Now, markets anticipate that it’s more likely that the Fed will go with another quarter-point hike, or even no hike at all.
Last Wednesday, investors were putting 70% odds of a half-point interest rate hike at the Federal Reserve policy meeting next week, according to the CME FedWatch tool.
By Tuesday morning, those odds had fallen to 0%. Investors are now expecting a 74% chance of a quarter point hike and a 26% chance of a pause.
But “those betting on the Fed to end its tightening cycle early because of current banking sector stress may be misguided,” wrote EY chief economist, Gregory Daco in a note on Monday.
It may be difficult to abstract the inflation and interest rate discussion from current banking sector uncertainty, said Daco, but “risking a loss in the battle against inflation is not something Fed Chair Powell wants to do. As such, the February CPI report may still play a defining role in tilting the [Fed] policy decision,” he said.
Fed policymakers continue to “view the robust job gains over the last couple of months — especially in construction, leisure, and retail — the firming of wage growth and the still low unemployment rate as a signal to tighten policy more aggressively,” he added.
What to watch: Tuesday’s CPI report is one of the last major pieces of economic data to come out before the Federal Reserve’s rate-setting meeting next week. Analysts expect the inflation rate to come in at 6% year-over-year (down from 6.4% in January) and at 0.4% month-over-month (down from 0.5% in January).