The past 72 hours have seen scenes reminiscent of the global financial crisis 15 years ago.
To prevent the bankruptcy of the British branch of Silicon Valley Bank (SVB) from wreaking havoc on Britain’s burgeoning high-tech and biotech industries, Jeremy Hunt and the Bank of England had to act extraordinarily fast.
The purchase of SVB for one pound by HSBC – Britain’s and Europe’s largest bank – is intended to send a signal to the world that the British banking system is safe.
No taxpayer money has been spent and the Chancellor’s campaign to make the UK a hotbed of technological innovation appears to be intact. How long that will remain the case, however, is far from clear.
Despite efforts to prevent the collapse of the SVB from turning into a full-blown crisis, shocks are being felt in the US and on the mainland, where stock trading in Credit Suisse and several Italian banks was suspended after sharp declines.
To prevent the bankruptcy of the British branch of Silicon Valley Bank (SVB) from wreaking havoc on Britain’s burgeoning high-tech and biotech industries, Jeremy Hunt and the Bank of England had to act with extraordinary speed (stock image)
In New York, the Signature Bank, which dealt with the crypto-currency industry, has meanwhile closed its doors.
And the historic First Republic Bank, which towers over San Francisco’s financial district, has received a $70 billion bailout from the Federal Reserve. And among America’s regional lenders, there has been a bloodbath with stocks crashing by as much as 50 percent.
If we are to rely on these signals from the US – the world’s financial and technological hub – we are entering a dangerously stressful period for the global economy, with the inflation and economic contraction caused by Covid-19 and the Russian invasion of Ukraine. barely behind us.
Attempts by the Federal Reserve, the Bank of England and other central banks to curb the cost-of-living crisis by quickly raising interest rates have inadvertently contributed to the current problems of the banking system.
Widespread interest rate hikes have led to a fall in government bond prices, which is one of the factors behind the current implosion. Government stocks are like a seesaw. If interest rates rise, the value of bonds falls and vice versa.
The Silicon Valley Bank invested cash deposited by its high-tech clients in long-term bonds. When it tried to get rid of them, it took huge losses, leading to the current crisis.
This is similar to the events of last September, when Trussonomics led to the major sell-off of UK government bonds, known as gilts, jeopardizing Britain’s billions of investment in pension funds. The dominoes in the US are starting to fall, prompting authorities to launch an emergency rescue operation and take swift action to set up a safety net for the country’s financial system.
US regulators have created a ‘Bank Term Funding Program’ that allows banks with money problems to exchange depreciating assets such as US bonds, mortgage-backed securities and other collateral for cash at the US central bank.
This will be funded initially with $25bn (£21bn) from the federal government’s foreign exchange stabilization fund, a resource activated during times of economic stress.
The purchase of SVB for one pound by HSBC – Britain’s and Europe’s largest bank – aims to send a signal to the world that the UK banking system is safe
It is estimated that the US banking system is currently suffering from potential losses of $300bn (£250bn) in US Treasury bonds, which it planned to hold until they mature.
Events at SVB, Signature and First Republic show that the safety of government bonds is illusory if they cannot be easily converted into dollars.
The U.S. Treasury and Federal Reserve hope that by introducing a safety net, they can prevent a repeat of 2008, when the collapse of investment bank Lehman Brothers sparked a global crisis that resulted in a deep recession.
On this side of the pond, Jeremy Hunt and Bank of England Governor Andrew Bailey have so far managed to manage the impact of the SVB in the UK without again putting taxpayers’ money on the line.
The bigger problem for Messrs Hunt and Bailey is how to ensure that the current severe volatility does not affect the fight against inflation.
In his efforts to halve the rise in the cost of living this year, Hunt has already received some help from plummeting energy prices. But keeping interest rates high (to quell inflation) and ending money printing is a critical part of that battle.
Unfortunately, the classic response to the financial and economic crisis is for central banks to do the opposite: lower interest rates and loosen credit conditions so that consumer demand and corporate investment appetites don’t fall off a cliff.
In light of what financial markets are describing as a ‘deflationary’ shock, it seems inconceivable that the US Fed and the Bank of England will raise interest rates even further while the banking sector in the US and Europe is in turmoil.
Andrew Bailey and the Bank of England last autumn showed their willingness to enter the markets and save the pension system. If a fundamental risk to economic and financial stability develops, they will follow the US lead and intervene – even if it means putting taxpayers’ money on the line again.
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