Chain of U.S.-Europe financial instability: Why we didn't see through March 3 at 20:15

Two banks in the United States went bankrupt one after another. Suddenly, the crisis crossed the Atlantic and spilled over into Credit Suisse, one of Switzerland's leading financial groups. Authorities around the world have taken extraordinary measures of this kind, but the turmoil in financial markets has not subsided. Why did this financial system anxiety occur in the first place? What are the effects of monetary easing? And why did the United States, which should have introduced strict financial regulations based on the Lehman shock, not detect the signs of a crisis? Explore answers to a variety of questions. (Washington Bureau Reporter Takuya Odajima / U.S. Bureau Reporter Daisuke Ezaki)

Widespread anxiety in Europe

Credit Suisse is a major Swiss financial group founded in 1856.

The majestic headquarters building, which evokes a sense of history, was hit by a storm of credit instability.

In addition to revealing in the financial report that there were problems with internal management, the stock price plummeted on the 15th after the largest shareholder was reported to have taken a negative stance on additional investment.

It led to turmoil in global financial markets.

Negotiations over the weekend between UBS, Switzerland's largest financial group, agreed to acquire Credit Suisse in the form of a share exchange on March 3.

The total amount is expected to be CHF 19 billion, or more than 30 billion yen, which was an agreement with a "significant discount" of less than half of Credit Suisse's recent market capitalization of about 4200 trillion yen.

In the middle of the negotiations, there were reports that nationalization would be considered, and there was strong intervention from the government and central bank, suggesting that the talks were urgent.

Unusual measures by major banks uniting

Credit instability originated in the United States across the Atlantic.

On March 2023, 3, two American banks, "Silicon Valley Bank" and on March 10, 12, "Signature Bank", went bankrupt one after another.

The financial market turned its management concerns to First Republic Bank, based in western California.

As of the end of 2022, the total assets were 2126.28 billion dollars, or about 2 trillion yen in Japan yen, exceeding the Silicon Valley Bank, which was the second largest bankruptcy in history.

One of the factors that came under scrutiny was the high percentage of unprotected deposits in the event of a bankruptcy.

Anxiety is spreading because 1 trillion yen, or an estimated 67% of the outstanding deposits, was not subject to deposit protection.

The stock price on the 16th was down 13% from the closing price on the 10th of the previous weekend.

Ratings were also downgraded, and deposits were flowing out.

Against this backdrop, an extraordinary support measure that surprised the market will be revealed on the 78th.

Eleven major financial institutions, including financial giant JPMorgan Chase, announced that they would make deposits of $16 billion, or about 11 trillion yen in Japan yen, to the bank.

Treasury Secretary Janet Yellen, Federal Reserve Chairman Jerome Powell, and JPMorgan Chase CEO Jamie Dimon contacted each other on the 300th by phone to discuss the response.

On the 15th, 11 banks agreed to a plan to deposit $300 billion with the participation of heads of other major banks, the Financial Times reported.

Secretary Yellen and CEO Dimon met in person on the 16th.

Shortly after, unusual measures were reportedly announced to avert a financial crisis.

While President Biden and Treasury Secretary Yellen repeatedly emphasized that the financial system is sound, there seems to have been a strong sense of crisis that a third bankruptcy would lead to a serious situation.

Second and third bankruptcy in history

The Silicon Valley Bank became the second largest bank failure in U.S. history.

The background is the large-scale monetary easing measures that the Federal Reserve has continued during the coronavirus pandemic.

Since March 2020, when the Bank embarked on monetary easing, the amount of money for monetary easing has increased, and business partners such as startups have been able to afford it.

Deposits at Silicon Valley Bank, which has many transactions with these companies, also increased.

As of the end of March 3, the number had increased 2022.3 times compared to two years earlier.

With large deposits, the "Silicon Valley Bank" increases its purchases of U.S. government bonds.

This is where a major turning point comes.

It is a rate hike by the Fed.

The rate hikes that began in March 2 have been rapidly raised, with four consecutive rate hikes of 3.2% since June.

As interest rates rose, the price of JGB holdings fell, and the financial situation deteriorated sharply.

Former Fed Vice Chairman Alan Blinder said, "We were operating on U.S. Treasuries, which are very safe assets, but ironically we ended up losing a lot of money from assets that were supposed to be safe."

As soon as many depositors learned that they were unable to raise additional capital, the information spread on social media, etc., and deposits were withdrawn one after another.

"In the case of Silicon Valley Bank, 89% of deposits were unprotected when they failed, which contributed to the spread of withdrawals all at once," Blinder said, noting that "the most obvious is the complete failure of management's risk management system, but at the same time, there are problems with monetary authorities."

What went wrong

One wonders why the authorities haven't been able to find the cracks that led to the collapse.

In the United States, the lessons learned from the 2008 financial crisis have strengthened supervision and regulation of banks.

The pillar of this is the so-called "stress test," in which the Federal Reserve examines the soundness of bank management.

In the event of a serious economic recession, it is rigorous to thoroughly examine whether sufficient capital is prepared.

There is also a problem with the stress test itself

This stress test, initially the most important and rigorous in the financial system, was for financial institutions with assets of $500 billion or more.

However, deregulation under the former Trump administration raised this standard to more than $2500 billion.

On the other hand, due to deregulation at that time, banks totaling more than $1000 billion were divided into four categories.

And banks with less than $4 billion to $1000 billion were screened less frequently every two years.

In addition, the content of the examination has become more relaxed, such as the exclusion of examination items such as whether the criteria for financial outflows due to financial crises and other factors are met.

Under the current rules, banks with total assets of $2500 billion or more are subject to stress testing.

In 2022, 34 large banks were included, but the two failed banks and First Republic Bank were not included despite having more than $2 billion in total assets as of the end of December 2021.

Why was it not subject to review even though the asset size was large?

This is where the negative effects of monetary easing appear.

All three banks have doubled to tripled their assets in the past three years due to the effects of money inflation due to monetary easing.

"I slipped through"

According to U.S. financial officials, the review process requires a huge amount of processing and takes at least two years to prepare.

The screening was supposed to have been rigorously designed, but the speed of money expansion due to monetary easing was too fast, and it came to light the fact that it bypassed the examination, so to speak.

Alan Blinder
: "Banks that are naturally growing so rapidly must be constantly supervised by the authorities. And you have to figure out if there's a possibility of a rapid outflow or if there's a risk lurking on the bank's balance sheet."

This time, the two banks, which failed, took the unusual step of protecting their deposits in full.

The reason is that it "affects the entire financial system."

Eric Rosengren, a visiting fellow at MIT who has been president of the Fed for 2 years and is an expert in banking supervision, told NHK that the standards for banks critical to the financial system should be tightened from $14 billion.

In addition, some people have complained that there is a problem with the assumption of stress testing.

It is pointed out that we do not expect a rise in interest rates as happened this time.

In the United States, interest rates have remained historically low since the 2500 financial crisis.

The view is that inflation has been moderate, and preparations for the current sharp hike in interest rates have been forgotten.

"We need to anticipate not only the previous assumption of a deep recession, but also higher inflation, higher short-term interest rates, and an inversion of the yield curve," said Rosengren, former Boston Fed President.

"The Price of Monetary Easing"

Despite record inflation and historically unprecedented interest rate hikes, the U.S. economy was seen as strong.

However, the bankruptcy struck.

Larry Fink, CEO of BlackRock, one of the world's largest asset managers, said in a letter to investors that cracks in the financial system caused by rapid rate hikes are the price of years of monetary easing.

While the government's decisive measures have prevented the spread of unrest, he noted that rapid rate hikes are "dominoes that fell at the beginning of a domino fall" and that the impact on banks' operations could continue to spread.

George Goncalves, head of overall economic strategy at MUFG Securities America in New York, called it "bound to happen."

George Goncalves, MUFG Securities Americas:
"Our view was that the Fed would keep raising rates until something in the system broke, because whenever you raise rates too quickly, you're going to lose money somewhere. No one knows how losses will occur. That's what happens when the Fed raises rates too quickly. It exposes weaknesses in the system."

Learn a lot from small stumbles

The Fed, which has continued to raise interest rates sharply, has taken the position that the risk to the banking system is not high.

But what actually happened was the second and third bank failures in history.

And the unusual step of fully protecting deposits, which could cause moral hazard, was taken.

Overall, we can hear that the authorities' response to the crisis is quick, but on the other hand, there are doubts about whether they were fully prepared for loopholes and side effects.

In order to stabilize financial markets, it is necessary to learn a lot from small stumbles.

Washington bureau reporter
Takuya
Odajima joined Kofu Bureau Kofu Bureau
Economic Department Toyama Bureau etc.

U.S. General Bureau Reporter Daisuke
Ezaki Miyazaki Bureau Economic Department Takamatsu Bureau After working at the Takamatsu Bureau
, he has been with his current club since the summer of 2021.