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March 30, 2023

Banking On It

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Christine Lagarde, the president of the European Central Bank (ECB) recently told European Union leaders that the banking sector on the continent was strong, reported Bloomberg.

Yet on the same day Lagarde spoke, shares of Deutsche Bank plunged as traders worried that the massive German bank would default on its debts, wrote Market Insider. Similar fears fueled selloffs of shares of Switzerland’s UBS, France’s Societe Generale, and Germany’s Commerzbank.

These moves were happening as investors, economists, policymakers and others were trying to figure out the implications of the banking crisis that is now sweeping across the globe. The collapse of Silicon Valley Bank this month in the US, as well as the Swiss government’s sponsoring of UBS’s purchase of troubled financial institution Credit Suisse, have sent ripples of fear through markets that resemble the financial panic of 2008.

As a Bloomberg analysis argued, these changes reflect how the era of easy money is over. In the wake of the 2008 crisis, central banks reduced interest rates to zero and offered discounted capital to lenders to spur investment. They kept rates low through the coronavirus pandemic starting in 2020, when governments hiked spending to fill the vacuum that occurred when businesses closed and consumers stayed home during lockdowns.

Now, as older folks in Western countries retire, helping to trigger labor shortages, the Russian-Ukraine war causes energy and food prices to spike, and other negative factors emerge, inflation is in danger of spiraling out of control. Comedian Jon Stewart, who recently interviewed high-profile economist Larry Summers, also argued that corporate greed played a role in the trouble. Executives, he said, have taken advantage of inflation headlines to raise prices that yielded record fat profits that also stoke inflation.

Everyone is playing a waiting game to see if other banks fall as they grapple with costlier financing. Many hold bonds that are now worth far less than a year ago due to higher interest rates that have slashed their value, the Japan Times wrote.

In the meantime, central bankers worldwide have teamed up to make sure a steady flow of dollars continues throughout the global economy to prevent further shocks, Axios explained. Central banks like the Bank of England, the ECB, and the US Federal Reserve have been further raising interest rates to tackle inflation. As the Financial Times warned, however, these efforts arguably work at cross purposes. They are designed to cool down overheated economies – not necessarily a good approach when a banking crisis is unfolding.

Still, as Spanish newspaper El País noted, most financial authorities and analysts don’t believe the world is headed for another financial crisis. They say they will be able to contain the contagion because they have tools ready from previous crises.

Maybe they learned lessons. But as the Economist noted, some bankers obviously didn’t. Because they had no reason to.

This story originally appeared in the March 30, 2023 newsletter, Banking On It.