Financial markets: Lessons from the twin earthquakes in the banks

For many, falling banks arouse glee. There are good reasons for it. But every banking crisis can become a highly threatening matter for an economy: small and large companies are cut off from the money supply, industry is cutting jobs, and people in need can no longer access their sour savings. The great financial crisis of 2008 triggered a global economic crisis. Falling banks primarily endanger the real economy.

The now-defunct Silicon Valley Bank (SVB) is part of this “systemic risk” to the economy. It is considered the house bank for many technology companies and start-ups in Silicon Valley, home of platform giants such as Google and Meta (Facebook). The business of the SVB should have been in balance. But their boss, Greg Becker, and his fellow board members have miscalculated investing in bonds, which are seen as a safe haven. However, Becker did not master the core business of every bank: maturity transformation. The maturities of customers’ savings deposits must correspond to the maturities that apply to loans and other forms of investment.

The SVB – like other US banks – had put a lot of money in long-dated government bonds and other solid securities when interest rates were low and the price was correspondingly high. With the change in monetary policy and the sharp rise in interest rates, the market value of these bonds fell rapidly, sometimes to 70 percent of the issue price. This is not a problem as long as the paper is held to the end of its term, because then the bank gets 100 percent repayment from its debtors (plus interest). However, if the bank sells the securities before their final maturity, price losses are »realized«. That’s exactly what the SVB did: On March 8, it announced that it had sold securities at a loss in order to remain liquid. This was followed by a storm of bank customers who feared for their credit. Becker’s bank went bankrupt.

The same could happen to other medium-sized US banks. According to the state deposit insurance agency FDIC, the unrealized losses in the domestic banking system amount to an impressive 620 billion dollars. To prevent a nationwide bank run, the FDIC, the Fed and the administration of President Joe Biden put together a rescue package that protects even large deposits.

The earthquake in Switzerland was also triggered by board members who did not know their business. For example, the management of Credit Suisse (CS) did not build up sufficient reserves to be prepared for bad times. And she relied heavily on risky and volatile investment banking on her own account. A lavish bonus system also invited the bankers to take excessive risks without worrying about possible subsequent losses. This led to involvement in dubious shadow banks such as Greensill and Archegos, whose bankruptcy cost CS many billions of francs.

Credit Suisse, which is now being taken over by the larger UBS, “had a management team with very little banking experience who didn’t have the risks under control,” analyzes the Swiss trade union federation. One person responsible came from the insurance industry, another from a TV station and a third from the pharmaceutical industry.

The case of the major Swiss bank differs in many respects from the case of the US banks. But in addition to board members who don’t know their trade, there is another important thing they have in common: the mistakes made by politicians in regulation. Apparently too little has been learned from the root cause of the financial crisis. With »Basel III«, a new set of rules was presented at the time that was to be implemented worldwide. That has not happened to this day. International conflicts of interest, lobbying and politicians who are overwhelmed slow down »Basel III«. US President Donald Trump even relaxed the rules for medium-sized banks, which are now in crisis.

In the course of the crisis, popular, more left-wing demands for capital controls or a separate banking system were completely lost over the years. And at the same time a fundamental insight shared by many independent experts from all scientific camps: There are no risk-free banking transactions. Even buying government bonds with the highest rating, which are considered almost completely safe, involves a residual risk. No default risk (the state will probably pay off its debts), but an interest rate risk.

The only remedy to make banks more crisis-proof could be the government requirement to create significantly more equity. But even after the financial crisis, the concept of “risk-weighted” capital was retained. For government bonds and similar safe investments, banks therefore have to put little or no equity on the credit side. At the same time, a reform would offer the opportunity to simplify the complicated set of rules. The decisive security norm would then be the ratio of equity to total assets. This would have to be flanked with rigid restrictions on risky investments such as shares – this is the case for the insurance industry.

Since the financial markets are globally networked, such rules would also have to apply globally. However, this may not be a realistic option. If too little has been learned from the root cause of the financial crisis, the current double earthquake, if it stays that way, will certainly not help to oblige the banks and shadow banks to solve the problem.

The German economist Rudolf Hickel compares the financial markets to a volcano whose “continuously bubbling magma erupts in unpredictable ways”. Stability-oriented regulation would not fundamentally change this. This is exactly where the third lesson from the double earthquake slumbers: some banker always finds a way to do above-average profitable and correspondingly high-risk business. There is also no security for the real economy.