Banks as Collateral Damage in a Class War
Central Bank obsession with holding down wages has consequences for fin stability
So much has happened this past week… and there’s more to come. The following post is a reflection on recent events. I am aware that much of what has gone on is expressed in arcane and often inaccessible language. If readers have specific questions about the current financial turmoil they want me to address, please post your questions in the comments. And don’t be shy. You probably know and understand more than many presiding over the current upheaval...
Tightening pain
After tightening Bank of England monetary policy and raising rates in February, 2022, the £575,000-a-year BoE governor, Andrew Bailey, was asked whether he wanted to inflict more pain on workers? His answer was direct:
"Broadly, yes - in the sense of saying: we do need to see a moderation of wage rises. That's painful - I don't want to in any sense sugar that message, it is painful."
Earlier in December, 2021 the TUC outlined the context in which Mr. Bailey argued for futher cuts in the real wages of workers. British workers were already enduring
….the longest period of pay stagnation since the Napoleonic wars. Real wages for millions are less than they were before the bankers’ crisis in 2008.
While gripped by the financial crisis of these last ten days, I’ve been slow to write about the predicted and deplorable outcome of recent decisions by central bankers - so called ‘guardians of the nation’s finances’.
The fact is I found it hard to face up to what central bankers are doing, not just by raising rates, suppressing demand, and lowering wages, as Jon Stewart so emphatically explained in his interview with Larry Summers.
But as importantly, through lack of analysis, regulation, oversight and foresight - central bankers have shown this last week they were prepared to use high rates to risk and even precipitate bank failures and global financial instability. They have done so, and continue to do so by deliberately tightening monetary policy into heavily indebted economies, with falling real incomes. Economies that have still not fully recovered from both the GFC and the pandemic.
I found it hard to get my head around that reality. Namely that together with their Boards and staff, the civil servants that head up central banks seem willing to sacrifice private banks and global financial stability in their rush to raise rates, crush demand, discipline workers and shrink the nation’s income .
In other words, their effective preference is for class war over financial stability.
The proof for what might seem an outrageous accusation is in the ECB’s recent decision-making.
On Wednesday last week, and at the height of US financial instability, the European Central Bank (ECB) Board set out to prove my point.
Ignoring the bank failures caused by the Fed’s too-rapid rate rises, and well aware that a crisis in one part of the system ricochets across the world - the ECB defiantly lifted all three of the their key rates by a whopping 50 bps.
Were they blind to the risks higher rates posed to European banks like Credit Suisse? Just as they are careless of the impact on employment and workers wages?
Or did ideology which elevates inflation above all other indicators trump common sense?
Answers on a postcard please.
Why are banks and the finanical system “collateral damage”?
Like the failed Silicon Valley Bank (SVB), US and European banks and financial institutions have long gorged on government and corporate bonds issued at very low rates of interest. Investors (think Silicon Valley billionaires, asset managers, hedge funds, private equity etc.,) acquired these assets and used them as sound collateral to leverage higher borrowing.
Private debt ballooned as a result.
Central bankers did little to discourage such borrowing by toughening up on regulation and supervision. Instead, after more than a decade of ‘easy money’, increased borrowing and rising debts, they tightened the monetary policy noose.
As is well understood, when central banks raise interest rates, then new government and corporate bonds are issued at higher rates. These higher rates increase ‘returns’ (the yield) on newly issued bonds. The ‘returns’ on these bonds are even more valuable if fewer new bonds enter the market, creating a scarcity of profitable rents. The new higher rated bonds are then more valuable to investors than the multitude of bonds issued under the low rate regime. As a result ‘older’ bonds are sold off as wise investors make a dash for the higher ‘returns’ on scarcer, newer bonds.
As a consequence of this shift in value, the prices of low interest bonds fall.
Now this does not matter if bonds are held to maturity, and there is no pressure to sell. With time future rates might fall, and bond prices rise. But if bonds have been used as collateral - then lenders will notice the borrower’s collateral has fallen in value and will demand more collateral to shore up (often huge) outstanding debts. There will then be a scramble to sell, or to mobilise more capital to satisfy creditors.
The Silicon Valley Bank ignored changes to the value of assets (bonds) triggered by higher rates, rising with greater rapidity than before. (So did the Federal Reserve, for that matter). Nor did they seem to understand the financial implications of falling asset values held by the bank and its indebted investors.
Until that is, a group of Silicon Valley ‘founders’ - led by Peter Thiel - noticed the risks, used their WhatsApp groups to spread panic amongst a select group of Venture Capitalists, who then instantly transferred money out of the bank, and triggered a ‘digital run’ on SVP.
The first ‘frictionless’ run on a bank…No need to queue outside SVP!
By the way, The Financial Times has the story.
Peter Thiel said he had $50mn in Silicon Valley Bank when it went under, even after his venture fund warned portfolio companies that the tech-focused lender was at risk.
Cool eh? After all, what’s the likely loss of $50 million amongst friends?
The big question central bankers must address is this: why did speculators and venture capitalists notice these imbalances while they and financial regulators did not?
The answer may be down to the grip of an economic ideology espoused by tenured Harvard Professors like Larry Summers and Ken Rogoff. Both appear to believe that inflation exceeds in its power all other threats. And that inflation is largely caused by rising wages (even as real wages are falling) - or even the expectation that wages might rise. That to suppress wages and therefore inflation, central bankers are required to continue hiking aggressively even if this does depress demand, raise unemployment and slash wages further.
I disagree and have argued elsewhere that today’s inflation is caused by commodity market speculation, not wages. And if workers demand higher wages to deal with the inflationary impact of higher energy and other commodity prices - that is a consequence, not a cause of commodity price inflation - that regulators and central bankers refuse to manage or regulate. Instead commodity prices are left to the “invisible hand” of global markets awash with capital (thanks in part to QE etc.)
Larry Summers by contrast, in his revealing car-crash interview with Jon Stewart, explained in highly ideological terms that the “sickness” or “disease’ that is inflation can only be cured by ratcheting up what he called the “drug” of high rates.
Their bias may be the result of defending the interests (and debts) of creditors above those of borrowers, when there are more debtors than creditors. They do so because inflation erodes the value of debt. In other words inflation allows borrowers to pay a loan back in money worth less (i.e. money that purchases less) than that originally borrowed.
Hence the fetish with inflation - and the concerns of a minority of creditors or lenders.
It does not occur to orthodox economists and their friends in creditor institutions that to use high rates to slash the incomes of debtors may lead to defaults that ultimately hurt - you guessed it - creditors.
Even after the consequential bank failures of this last week, Ken Rogoff used a Financial Times column to bang the drum of low inflation and class war. He urged central bankers to keep on hiking, even if inflation falls. At the same time he conceded that
“If nothing else, the optics of once again bailing out the financial sector while tightening the screws on Main Street are not good. Yet, like the ECB, the Fed cannot lightly dismiss persistent core inflation over 5 per cent.”
The implication is that central bankers - taxpayer-funded civil servants after all - should dismiss real wage deflation of 5 per cent or more - and the economic, social and political consequences of higher rates, tighter monetary policy, rising unemployment and financial instability.
Credit Suisse
As I write this a ‘Too Big To Fail’ bank is being rescued from bankruptcy by both the Swiss state and the bank’s private competitors. Credit Suisse HQ is far from Santa Monica, California, USA, where the Silicon Valley Bank - (one of the Best Banks in America, according to Forbes) has its HQ.
These geographical facts remind us that The International Financial System is global. A crisis in one corner of the international financial forest can lead to wildfires thousands of miles away.
That is why we must change the System.
How do you assess the recent evidence that corporate profits in US and UK (c58% of inflation) are the major cause of inflation not labour costs (c8%) see for example the EPI
Where is Michael Hudson? We need him up front here.