An inconvenient silence. This is what is left of the turmoil caused by the failure of several financial institutions in March 2023. After the unprecedentedly swift bank runs on the American Silicon Valley Bank (SVB) and Signature Bank, and the fall of the 167-year-old Swiss institution Credit Suisse, central bankers and others involved in safeguarding stability in the banking system – as well as some account holders – are now anxiously holding their breath.
The silence from the authorities is inconvenient, indeed, because much is being thought but not said out loud, and some important questions are being asked, but not answered. Will this be it, or will other financial institutions follow? Will we be able to contain the crisis or are we facing the early signs of a new great financial meltdown like the one in 2007-2008? If so, will we be able to limit the financial consequences for the general public? Or will the taxpayer pick up the tab, again? So far central bankers and other officials have given us mostly silence (which they have sometimes disguised in some calming cliches: “there is no need to worry”, “all banks have past our stress tests”, and so on).
What to make of all this? Several reasons point to more of what we have already seen and a crisis that could be much worse than the one that started 15 years ago. This may come with quite a bit of social and political upheaval, which, in the end, might even be a good thing.
Let us first debunk the tenacious, widespread misconception that the last financial crisis was “solved”. The truth is that the global financial crisis that started in 2007 has never really ended. It was merely put in a coma with the help of draconian central bank interventions. Most importantly, both the American FED and the European Central Bank (ECB) lowered their interest rates to zero (and even below), which gave banks the opportunity to borrow money for free. The original idea was that they would use this cheap money to clean up their balance sheets. Some banks did precisely this, at least to a certain extent. However, most financial institutions borrowed much more than they needed and used the money to invest in almost everything that promised them a good return. More so, they started lending money against scandalous low interest rates to businesses looking for credit and consumers looking for cheap opportunities to buy their own property.
The effects were easy to predict. Housing prices went through the roof and inflated stock prices steered markets to record highs. Few have been able to resist the lure of the bull market as many joined the ride with borrowed cash. In the Western world, overall debt levels have (on average) tripled since 2008. In China, there is a similar trend, although the curve runs even steeper. Succumbing to the political pressure to ease the social effects of the credit crisis, central banks flushed our society with cheap money and made it addicted – not only bankers, but almost all of us.
However, then inflation started to spiral out of control – partly due central bank policies, partly due to fierce disruption in global supply lines resulting from the COVID-19 crisis and the Russian invasion of Ukraine. This placed central bankers in front of an interesting dilemma: The most important pain-relieving medicine free money – against the causes of the crisis that started in 2007 had finally worn off and is now no longer at central banks’ disposal. By 2022, interest rates have steadily risen again. This brings us not to a new reality, but back to a millennia-old reality in which borrowing money costs money (again).
Shortly after Credit Suisse was rescued in an emergency takeover by UBS – with financial guarantees given by the Swiss government, i.e. by the Swiss taxpayers) – many commentators were quick to argue that this was a one-off incident. This is not just because Credit Swiss was burdened by various scandals for already quite some time, but more importantly because, today, European banks that are regarded as too-big-to-fail hold considerably higher financial buffers than they did in the run-up to the credit crunch of 2007. This argument may ironically be both true and irrelevant. It is true because they do hold substantially higher reserves, but the irony lies in the fact that these buffers were created with free money that is now no longer free. To some extent, buffers can protect you against a bad day or an inevitable write-off of a portion of bad loans, but they cannot protect a bank from the structurally rising costs of borrowing money.
Supervisors and lawmakers have a habit of trying to prevent the last crisis from happening again, instead of preventing the next one. While learning from past mistakes is always a good thing, focusing on them too much creates dangerous blind spots. Furthermore, those who expect a repetition of the credit crunch of 2007-2008 will be disappointed. The now unfolding crisis is merely the next chapter in a structural crisis in our debt- and money system that was long-dormant, but that is now re-awakening. This next episode will follow another storyline, in which the causes and the circumstances in which it is played out are very different. This is not a new debt shock caused by some malicious financial products sold by profit-driven bankers (who sometimes went rogue), but one caused by rising interest rates that will affect the whole financial system, and sooner or later almost all creditor-debtor relations. With interest rates rising and debt contracts maturing, it is merely the question who will fall first and who will be able to bear the heat a little longer.
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The reason the crisis-chapter that is now unfolding will be much more severe than the last one is because both central banks and governments have far fewer instruments to bail out the rotten apples in the system, and to smoothen the effects on the real economy and ordinary taxpayers/consumers. Meanwhile, they behave almost exactly like they did in 2007, when the first banks in the US and the UK got into trouble. They rescued them, while they hastened themselves to tell the public that these were all one-off events. One cannot blame them for this, because it is pretty much the only thing they can do. Although SVB and Credit Suisse are both very different cases then Northern Rock or Bear Stearns, two banks that were bailed out in 2007-2008, the deeper dynamics of what is unfolding are quite similar.
In addition, one of the most fascinating aspects of the fall of Silicon Valley Bank was not its causes, but the speed at which it unfolded. The rapidity with which depositors withdrew their money – many in 48 hours – was never seen before. Improved money wiring schemes and online access to accounts have not only benefited payment velocity, but have given people the possibility to instantly wire their money elsewhere at the first whiff of danger. Trust has always come on foot, while it leaves on horseback, but today this asymmetry has grown larger. Bad rumors and distrust have always been the frictional banking systems’ enemy number one, but the speed at which it can do harm today is new to us all, and so far supervisors have hardly any idea on how to deal with this novelty when things threaten to go south.
While the next chapter of the crisis in our financial system is unfolding and it will probably hit our society in ways we have not yet seen before, it will likely be a good thing in the end.
Society in the most affluent countries has become so entangled in financial debt that sooner or later an implosion of the system is inevitable. The longer we keep the current system afloat with artificial free money or other draconian central bank interventions, the bigger the mountain of debt will grow, and the harder it will fall upon us when it finally collapses under its own weight. Even if, in some miraculous way, we will be able to manage this new crisis in our banking and credit system, we will reach a point in which we are no longer be able to do so.
Let the implosion therefore come sooner rather than later. Perhaps we need such an event, to force us to finally critically evaluate the international frictional banking system and our dependency on it. And let us no longer use our imagination to invent ways to maintain this debt mountain, but instead seek for solutions to unwind it, or to let it implode in the socially least destructive way. In ancient times, societies east and west have had a long traditions with debt jubilees, as the famous late anthropologist David Graeber showed in his book “Debt: the first 5000 years”. Why not allow our generation a modern debt jubilee. Let our society no longer carry the debt mountain on its shoulders, let us finally free ourselves from it.
Having said that, we must acknowledge that where there is a debtor there is a creditor. Off course this begs the question: who will settle the tangle of mutual/intertwined debtor/creditor relations? In the end this is not a meritocratic question that concerns central banks, but a political one that concerns us all. Therefore we need a public debate on how we are going to unwind the debt mountain and on how we, as a society are going to ‘split the bill’. I believe this debate will be inevitable, so may our generation take its responsibility in this, instead of kicking the can further down the road and leave the difficult decisions to the next one.