This is not 2008
Developments over the past week have felt eerily familiar for those of us who followed the global financial crisis in 2008. Analysts argued in early 2008 that Bear Stearns’ problems were a result of poor management and a failure to hedge risk. The spread of instability to a European bank (Commerzbank) was considered to be limited. Sound familiar? I’ve made the same arguments myself with respect to the collapse of Silicon Valley Bank and Credit Suisse in recent days. But for now, that is where the similarities end.
The financial instability we have experienced is a question of liquidity rather than solvency and policymakers have responded swiftly. There is no reason to assume that we are in a banking crisis. That said, banking is all about confidence. Just because we aren’t in a banking crisis now does not mean markets can’t create a self-fulfilling prophecy.
The banks that have come under severe pressure recently – Silvergate Bank, SVB, Signature Bank and First Republic in the US and Credit Suisse in Europe – are idiosyncratic. Silvergate Bank, SVB and Signature Bank were unusually exposed to interest rate risk. This was partly due to their clientele, which were either tech startups or crypto firms – phenomena of a low interest rate environment. As the Fed hiked rates, venture capitalists stopped forking money over to these clients and so deposits in the banks fell. As clients started yanking their cash, the banks had to sell the long-term to redeem the deposits, crystallizing huge losses.
The Federal Reserve, Treasury and Federal Deposit Insurance Corporation (FDIC) stepped in to insure all deposits in SVB and Signature Bank. The Fed also extended a loan to banks for which it would accept collateral at par, preventing other banks holding long-dated bonds from having a fire sale of their assets. First Republic Bank was caught up in contagion from the other regional lenders and saw its stock tumble over 60 percent over the past week. Eleven large lenders in the US converged to inject $30 billion in the smaller bank to create a firewall against further contagion.
Credit Suisse has wobbled for different reasons. It isn’t in trouble because of the interest rate environment; the lender is less sensitive to interest rate moves and has substantial high-quality liquid assets. CS saw significant capital outflows over 2022 as a result of scandals, management changes and new restructuring strategies. The bank saw its stock plummet when the chairman of its largest shareholder, Saudi National Bank, ruled out raising any more capital for the bank on March 15. The Swiss National Bank (SNB) stepped in with a liquidity backstop of up to CHF 50 billion.
We have a saying in economics: “Whenever the Fed hits the brakes, someone goes through the windshield.” It would be strange if there weren’t any financial strains as the Fed hikes interest rates aggressively after over a decade of cheap money. But so far each of these troubled lenders is idiosyncratic and has a liquidity problem (the bank can’t raise cash quickly enough to meet the demands of its clients and counterparties) rather than a 2008-style solvency problem (the bank has to write down the value of its assets). There is a playbook for successfully tackling a liquidity crisis: The central bank steps in as a lender of last resort, as the Fed and the SNB did very swiftly. The S&P 1500 Regional Banks Index has stabilized (at low levels) and CS equities soared after the SNB’s announcement.
Bank runs are a question of psychology and Global Wall Street doesn’t seem to be in the mood to discern between idiosyncratic versus systemic issues
There are other differences with 2008. Banks are much better regulated and capitalized now. This is particularly the case outside of the US, where Basel III rules are applied across the entire banking system. Deregulation legislation in the US in 2018 allowed smaller banks to avoid Dodd-Frank requirements. The larger banks are subject to liquidity coverage ratios and net stable funding ratios, which means their capital position is healthy enough to extend loans, absorb losses and shore up weak banks like First Republic. Greater regulation of smaller lenders will be inevitable in the US going forward.
Even if we are not in a banking crisis, stress is clearly widespread in the US. The Fed reported that borrowing from the discount window in the week ending March 15 soared to $152.85 billion, a record high. Though the situation today is very different, the overreaction of markets to recent developments has been very reminiscent of 2008. Bank runs are a question of psychology and Global Wall Street doesn’t seem to be in the mood to discern between idiosyncratic versus systemic issues or between liquidity versus solvency problems. Markets are capable of generating self-fulfilling prophecies.
The liquidity operations the Fed and the SNB swiftly launched should be enough to stem the immediate panic. But as central banks continue to hike rates and shrink their balance sheets, we can expect to hit more pockets of market dislocation. Hopefully they will continue to be the kind that central banks can paper over with liquidity – as the Bank of England did last fall when the pension system nearly blew up and the Fed and the SNB have done recently. We are not in a banking crisis now. But the risk of ending up in one is higher than it was a week ago.
Megan Greene is a senior fellow at Brown University.
