“Somebody has to tell Jerome Powell this isn’t a kill-at-all-costs mission.” Cut rates now to prevent a full-blown banking crisis.

We are nearing the tipping point where the US economy and banking system will either pull off the cliff and return to safety, or fall off the cliff and plunge into a full-blown banking crisis.

The Federal Reserve could solve this in one step: cut interest rates at its meeting this week.

But the chances of the Fed taking this step are slim. While the US Federal Reserve is currently on hold on raising interest rates in most forecasts, a pause is simply not enough.

Cutting rates release an economical pressure valve. However temporary this move may be, the respite is necessary for the health of financial markets and the banking system.

Yes, the Fed wants to tighten inflation, and no, a rate cut won’t help on that front, but someone needs to tell Fed Chair Jerome Powell that this isn’t a “kill at all costs” mission. because none of us can afford that the stability of the banking system is the price to be paid.

Squeeze and bleed

Most of the previous coverage of the collapse of Silicon Valley Bank SIVB,
Silvergate Bank SI,
and signature bank SBNY,
— and the instability at First Republic Bank FRC,
and others – has focused on how these banks managed to get into trouble. It didn’t look closely at the pressures these companies were facing.

Here’s the problem several pundits tell me is being ignored, summarized by Bryce Doty, senior portfolio manager at Sit Investment Associates: “Most banks are currently in default.”

That sounds terrible, but it’s more about regulation and interest rates than a total default on all debt.

Read: From the sudden collapse of the SVB to the fallout of Credit Suisse: 8 charts show turbulence in the financial markets

To bring it home, consider if you took out a long-term, fixed-rate mortgage on a home about 10 years ago, when the average mortgage rate was about 3.6%. That was about twice the rate of the TMUBMUSD10Y 10-year government bond,
back then, which meant some institutions wanted to buy your credit rather than settle for a safer government bond.

Today you’re still paying 3.6% on the mortgage, but that’s about what the 10-year treasury is paying. As a result, the value of your mortgage on your lender’s books is less today than it was ten years ago. In the banking world, such events are not a problem until the paper has to be “marked” with a price as if it were sold today.

Federal regulations allow banks to hold a portion of their assets to maturity, which allows them to survive temporary paper losses since the forever securities are not valued at market value (remain on the books at the value they were purchased). . This gives banks the flexibility they need, but can create “no problem until it becomes a problem” type of issuance that is only predictable if you look extra closely.

Where the financial crisis of 2008 was caused by bank defaults, the system’s current problem is not bad assets (at least not yet). This time the prices rose so quickly that paper losses arose.

The Fed should have seen this coming.

The Bloomberg US Aggregate Bond Index fell 13% last year; before that, the worst year on record was a 3% loss in 1994. Since 1976, the index has fallen in just five calendar years — including the last two years.

The Fed should have seen this coming; Its own balance sheet shows about $9 trillion in bonds that lose more than 10% of their value when interest rates rise. “The Fed kept rates so low and then just hiked them up so fast that no [financial institution] could potentially rebalance their bond portfolios to avoid the losses,” Doty said in an interview on my Money Life with Chuck Jaffe podcast.

Off-air, Doty estimated that if the Fed cut interest rates by 100 basis points — one percentage point — “it would eliminate half of that.” [the banking industry’s] unrealized losses in one fell swoop. That would be the lightest and shortest-lived banking crisis in history.”

Furthermore, this would ensure that there was no “contagion” from the imploding banks; Remember, it was banks that came to First Republic’s rescue this week, sowing the seeds of one bank’s mark-to-market problems becoming the next institution’s default.

This is how you turn a problem into a disaster. If the Fed hikes rates without allowing time for respite, it dramatically increases the likelihood of a liquidity crunch and a credit crunch.

Hello recession, your table is ready.

Read: “We have to stop this now.” Supporting the First Republic spreads financial contagion, says Bill Ackman.

Jurrien Timmer, director of global macro at Fidelity Investments, said in a recent interview on my show that he couldn’t see the Fed slowing down, noting that no one wants to be the next Arthur Burns, the notorious Fed chairman during the big ones Inflation of the 1970s.

Timmer said: “They have pledged never to repeat those mistakes, which in the ’70s were keeping politics too loose for too long and letting the inflationary genie out of the bottle.”

But we’re not in the 1970s, and anyone who thought the Fed was too soft on inflation then – which is why it’s taking a tough stance today – should consider that the central bank may have backed down then because higher interest rates were widespread caused systemic problems.

The Fed must solve problems, not contribute to them. If that means living longer with higher inflation, it’s still a better choice for the country than turning a contained banking problem into a global liquidity crisis and hard landing for the economy.

A cut does not end the war on inflation, it only interrupts the struggle to strengthen and secure their fighting position. Sometimes the best way to move forward is to start with a rocking step backwards. Let’s hope the Fed has the courage to do so.

Read: What it will take to calm banking sector jitters: time plus a Fed rate hike.

More: First Republic was saved by rivals. The Silicon Valley Bank was left by her friends.

Source : www.marketwatch.com

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