SVB: Run on the Bank: Is it a prelude?

I have lately been questioning the wisdom of my doing PhD in Economics and it seems that I wasted my prime time in the pursuit of knowledge which had little relevance in real world.  It seems the same case of a country accruing unlimited debt with no price to pay. For example, US national debt has increased from $25 trillion in 2019 (106% Debt-GDP ratio) to $ 31.5 trillions (126% Debt to GDP ratio) in 2022; a full 20 percentage points increase in three years. 

Historically speaking, meeting the basic needs of human beings become a challenge during the time of crises and pandemics. People tend to tighten their belt, give sacrifices and even in some cases starve. But just opposite has happened in last three years. Western governments, especially the United States, started doling out money massively as Covid stimulus and relief packages which rose the income of a large segment of population, swelling their bank balances and savings.

As a result, excess money led to an excessive demand in the markets. There was already a severe shortage of goods and services due to Covid-related disruptions and breakup in supply chain. Excess money in peoples’ pockets further exacerbated the situation by putting undue pressure on demand which led to unprecedented inflation, not experienced during the last half a century. 

Federal Reserve reacted belatedly but in an aggressive manner. And to suppress the inflation, it increased interest rate from 0.25% in March 2022 to 4.75% in February 2023 while the inflation hovered above 6% which was less than 1.5% pre-Covid. (Historically, inflation target has been 2%. No one knows the rationale behind target of 2%?)

Since banks and financial system were tuned to a near zero-interest rate regime, they profited from extravagant loans with least control and supervision, and a sudden increase in interest rate pulled carpet off their feet. Federal Reserve raised the interest rate or yield on treasury bonds at the steepest rate in four decades: from 0.5% beginning of 2022 to 5.25% now. As yield on bonds went up, their price went down and the bonds held by banks faced huge erosion in their values: $229 billion or 17% so far this month. In fact, roughly 4,700 small and midsized banks (with total assets of $10.5 trillion) were to pay depositors more to stop them pulling out their money. That squeezed the banks’ margins and plummeted their stock price.

The main culprit of this fiasco is an amendment made in 2018 to Dodd-Frank 2008 legislation to cushion against the systematic financial risk seen in 2007-09. The amendment, passed with votes of both parties in the Senate, led to a drastic curtailment in reform to counter the financial risk. Originally, there was a reserve requirement of 10% for all banks with asset threshold of above $50 million. But in 2018, the threshold was raised significantly and applied only to those banks with assets above $250 million and even that reserve requirement was dropped to a zero percentage after Covid. Drastic increase in interest rate led the depositors to rush in buying treasury bonds by withdrawing money from SVB which caused flee of $42 billion deposits only in one day on March 9th. SVB was just one of three American lenders to collapse in a space of a week.

It could just be the beginning. Banks in Japan and Europe are also not immune to this shock. Credit Suisse is a case in point. Things could be more chaotic if one includes other factors in the messy pot i.e. Russia-Ukraine war, rise of new power block in BRICK, Iran-Saudi Arabia (including UAE) diplomatic thaw, growing China-Russia friendship and Europe’s impoverishment due to energy crunch.