March 29, 2023

The last 72 hours have witnessed scenes reminiscent of the global financial crisis of 15 years ago.

To prevent the bankruptcy of the UK branch of Silicon Valley Bank (SVB) that wreaked havoc on Britain’s booming high-tech and biotech industries, Jeremy Hunt and the Bank of England had to move with extraordinary speed.

The purchase of SVB for one pound by HSBC, the largest bank in Britain and Europe, is intended to send a signal to the world that the UK banking system is safe.

No taxpayers’ money has been spent and the Chancellor’s campaign to make the UK a hotbed of technological innovation seems intact. However, it is not at all clear how long this will continue to be the case.

Despite attempts to prevent SVB’s collapse from becoming a full-blown crisis, shocks are being felt in the US and on the mainland, where trading in shares at Credit Suisse and several Italian banks has been suspended. after heavy falls.

To prevent the bankruptcy of the UK division of Silicon Valley Bank (SVB) that wreaked havoc on Britain’s booming high-tech and biotech industries, Jeremy Hunt and the Bank of England had to move with extraordinary speed (file image)

Meanwhile, in New York, Signature Bank, which served the cryptocurrency industry, has closed.

And the iconic First Republic Bank, which towers over San Francisco’s financial district, received a $70 billion (£58 billion) offer from the US central bank, the Federal Reserve. And among regional US lenders there has been a bloodbath with shares falling as much as 50 percent.

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If these signals from the US, the financial and technological center of the world, can be trusted, we are entering a dangerously stressful period for the global economy, with inflation and economic contraction caused by Covid-19 and the invasion from Russia to Ukraine. just behind us.

In fact, the efforts of the Federal Reserve, the Bank of England and other central banks to curb the cost of living crisis by rapidly raising interest rates have inadvertently contributed to the current problems of the banking system.

Widespread increases in interest rates have caused a drop in government bond prices, which is one of the factors behind the current implosion. Government actions are like a seesaw. When interest rates rise, the value of bonds falls and vice versa.

Silicon Valley Bank invested cash deposited by its high-tech clients in long-term bonds. When he tried to get rid of them he suffered heavy losses, leading to the current collapse.

This is not unlike the events of last September when Trussonomics led to the huge sell-off of British government bonds, known as gilts, and put Britain’s billions in pension fund investments at risk. The dominoes have begun to fall in the US, prompting authorities to launch an emergency bailout and move quickly to erect a safety net for the country’s financial system.

US regulators have set up a ‘Bank Term Financing Program’ that allows cash-strapped banks to exchange depreciating assets such as US bonds, mortgage-backed securities and other collateral for cash at the US central bank.

Initially, this is funded by $25bn (£21bn) from the federal government’s currency stabilization fund, a resource that kicks in at times of economic stress.

The US banking system is currently estimated to have potential losses of $300bn (£250bn) of US government bonds, which it intended to hold to maturity.

Events at SVB, Signature and First Republic show that the safety of government bonds is illusory if they cannot be easily exchanged for dollars.

The US Treasury and the Federal Reserve hope that by establishing a backstop they can avoid a repeat of what happened in 2008, when the collapse of investment bank Lehman Brothers triggered a global crisis that resulted in a deep recession.

On this side of the pond, Jeremy Hunt and Bank of England Governor Andrew Bailey have so far managed to control the fallout from the SVB in the UK without putting taxpayer funds back on the line.

The biggest problem for Messrs Hunt and Bailey is how to ensure that the current severe volatility does not affect the battle against inflation.

In his efforts to halve the rise in the cost of living this year, Hunt has already gotten some help from plummeting energy prices. But keeping interest rates high (to suppress inflation) and stopping money printing is a key part of that battle.

Unfortunately, the classic response to the financial and economic crisis is for central banks to do the opposite: lower interest rates and ease credit conditions so that consumer demand and corporate investment appetite don’t plummet.

Faced with what financial markets describe as a ‘deflationary’ shock, it seems inconceivable that the US Federal Reserve and Bank of England would force interest rates higher while the US and European banking sector grapples with turbulence.

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Andrew Bailey and the Bank of England showed their willingness to enter the markets and bail out the pension system last autumn. If a fundamental risk to economic and financial stability develops, they will follow the American lead and intervene, even if it means putting taxpayer dollars on the line once again.

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