Can Upside-Down Policies Prevent Another Financial Crisis?

Right now, we can hope that the financial system is safe and stabilized by some quick government actions over the weekend. Stock markets were mostly steady today. Treasury bond rates fell. Gold and silver rallied — that’s not a fabulous sign. At the moment, though, there is no contagion catastrophe in the banking system. At this moment. Look, like everyone, I am hoping the Silicon Valley Bank problem is contained. As somebody who reported on two daily shows throughout the financial meltdown of 2008-09, I know how difficult, indeed heartbreaking, a widespread banking meltdown can be. Especially for typical families, blue-collar working people. Nobody wants to see another stock market crash, or a banking crash. So, like you, I hope this Silicon Valley Bank crisis is contained. I never liked that word “contained,” though, because that’s what government authorities kept saying throughout 2007 and 2008. They’re saying it again now. Meanwhile, we’ll look at what’s been done. The Fed, Treasury, and FDIC have guaranteed all the deposits. The Fed has rolled out a new liquidity facility that will make one-year loans to federally insured depositories, mostly collateralized by bonds that will be valued at par. It includes some help for loans at the Fed’s overnight interest rate and the Fed’s opening the discount window wider for emergency loans. Alright. Bang, bang, bang. They took all those actions. Will this stop the hemorrhaging? I honestly don’t know. This is a known unknown. Recently, a bunch of regional bank stocks fell sharply. That’s not good. This whole story is kind of strange because SVB had a liquidity problem and it badly bungled the risk management of its securities portfolio. It had plenty of money on deposit, but SVB kept using it to buy medium- and long-term treasury bonds, whose value kept falling as the interest rate yields kept rising. Meanwhile, the cost of money on the liability side, including interest rates on the deposits, went up astronomically and went up fast over the past year — right to 5 percent from zero. So, it was a classic asset-liability mismatch: The borrowing rate exceeded the return on assets. The yield curve was upside down, and SVB didn’t know how to deal with it. Now, it may not be alone in flunking risk management, but it sure did flunk, and I think that’s the biggest problem SVB has. Then it start selling assets, chasing lower prices. It’s like catching a falling knife. You can’t do it. So SVB’s equity investors were wiped out, management was properly thrown out, and now the government owns it and is running it. We’ll see how it does. For the moment, the way these government assistance programs are structured, it’s very strange. It’s both inflationary and contractionary. Economist Larry Lindsey got it right this morning: Valuing the bond portfolio at par actually increases liquidity, but the smack-down of the entire bank will lead to stricter lending standards, probably a freeze on all loans. That’s an economic contraction. To some extent, because SVB is the financial pulse of the whole Silicon Valley private equity tech world, I hope it’s still fulfilling its basic banking and payroll operations. But it’s not going to be expanding its loans, and the whole tech world may suffer. I don’t know why the bank hasn’t been sold yet. I don’t get that. There are rumors that one of Elizabeth Warren’s radical socialist protégés from the Federal Trade Commission, now running the CFPB and a board member of the FDIC, is stopping the SVB buyout. If that’s true, it’s plain stupid. Socialism strikes again. But I also have to wonder also about the quality of the loan portfolio. Let me put that on the table. Who knows? It hasn’t been looked into yet. Maybe the final lesson here: Wouldn’t it be great if the left-wing tax-and-spend Bidenomics program were thrown into the trash can once and for all? Because, you know what, the $5 trillion of spending that was injected in early 2021 and continued for two years created great inflationary pressures, and Jerome Powell’s weak-kneed Fed helped them along. All they got was an explosion of inflation, then an interest rate explosion, and then an upside-down yield curve. That seems way too hard to handle for bank risk managers. This whole thing is a sad tale from the very beginning, two-plus years ago. Now, we have to wait on tenterhooks and hope that upside-down economic policies can be prevented from causing another upside-down financial crisis. It’s not good. Let’s hope there is no contagion. From Mr. Kudlow’s broadcast on Fox Business News.

Can Upside-Down Policies Prevent Another Financial Crisis?

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