Financial market – a deceptive security
by Rüdiger Rauls,* Germany
(6 June 2023) Gold and American government bonds were considered the most secure investments by far for decades. Regarding US securities, capitalism itself has exposed this creed as a deception. American debt securities are turning more and more into a problem for banks and shadow banks.
Changing context
If the world financial crisis of 2007/8 was triggered by highly speculative investments, the current crisis has its roots precisely in the opposite. The seemingly rock-solid American government bonds have lost about thirty percent of their price value so far due to the interest rate hikes by the US Federal Reserve. Apart from investors, this has particularly hit those banks that have invested large parts of their equity in these securities. Thus, their money was not only supposed to bring interest income, but also to be quickly available at any time.
However, investing in government bonds had another motive: they did not need to be backed by equity capital against payment default like other securities or investments. This is because economics assumes that states cannot become insolvent, which is why government bonds do not require any special collateral. However, in its worldly insanity, government bankruptcies ranging from Argentina to Zimbabwe seem to have escaped attention, as has the fact that the USA, the world’s largest debtor, is currently teetering on the brink of insolvency, yet again.
In any case, many citizens and states have become more critical of the world financial system since the Lehman Brothers bankruptcy. The blind trust that its institutions enjoyed until 2007 has given way to widespread mistrust. In addition, citizens today have completely different options at their disposal to escape the grip of the financial institutions.
The digital citizen
The digitalisation of our daily lives is not limited to banks and accounts. In fact, banks have been able to take advantage of the opportunities offered by digitalisation. More and more banking operations were transferred to the account holder. He himself or she herself took over the management of his or her bank account. With their software, the banks only provided the framework for banking transactions. This opened up enormous opportunities for them to save money. Branches could be closed, employees could be laid off by the thousands and vacancies no longer had to be filled.
With this transfer of account management to the account holder, however, the banks have also relinquished control over the accounts. Now, this is being avenged in the current banking crisis. With a few mouse clicks, an account holder can transfer his balance from one bank to another without the bank being able to influence it. Whereas in 2007/8 it was still possible to shut down bank counters to prevent a bank run, today this would no longer have any effect.
Back then, the German Chancellor’s word was enough to keep customers at bay. Today they don’t even have to go to the bank, they simply storm the banks from home. This change was clearly felt by the American banks in recent weeks. No sooner had doubts about the solidity of the Silicon Valley Bank arisen than customers withdrew billions within seconds and transferred them to the big financial institutions, which were thought to be safer precisely because of their size.
At Silicon Valley Bank, investors “withdrew $42 billion in deposits in just five hours” as the first signs of weakness appeared.1 For the first time, financial market leaders now seemed to acknowledge the dangers lying ahead. The chief supervisor of the European Central Bank (ECB), Andrea Enria, referred to “the dark side of digitalisation. This provides a bank’s customers with very fast escape routes. [...] Such speed of deposit withdrawal had not existed before”.2 Now, what started as a welcome opportunity to save costs threatens to turn out to be a disaster for banking, the digital self-management of the account holder.
Capitalist quacks
What was previously not perceived as a dormant danger, but has now become dramatically obvious, did not happen without reason. The development surrounding the medium-sized American banks is rooted in the interest rate hikes of the last few months. They are supposed to fight inflation, which especially hit Western countries with unprecedented severity. Strictly speaking, this is nothing more than price increases,3 but it is now to be dealt with by the all-purpose weapon of interest rate policy. This is comparable to the doctor administering antibiotics when the pathogen is not clear.
Like monetary policy, this can be effective, but it can also weaken defenses further. In the case of US banks, the interest rate hike policy is turning into the opposite. New bonds are offered on the market with a higher interest rate. The interest rate of the old ones remains unaffected, because it is fixed for the term of the bond. Nevertheless, their yield increases because the prices of the old bonds fall.4 This means that the old bonds, which many banks hold on their balance sheets as equity, lose value and with it their capital.
In the case of Silicon Valley Bank, this brought the rating agency Moodys onto the scene, which believed it had to reassess the bank’s rating. The central banks had obviously not expected their measures to have such an impact. In any case, the FED seemed very surprised. In no time at all, it provided financial injections and changed its plans regarding interest rate hikes. This is not the first time that the leaders of the Western financial world have made it clear through their actions that they do not understand capitalism.
This was already the case before the 2007/8 crisis, when rating agencies promoted a mix of ABS certificates, they believed to be default-proof. A few months later, these very certificates almost led to the collapse of Western financial capitalism. It is hard to believe, but the officials representing capitalism do not know how it works. On the other hand, it’s no wonder that people embrace the confused theories of bourgeois economics but push Marx aside as outdated or refuted.
Bitter medicine
Interest rate hikes are adding to the problems; nevertheless, the Fed and the ECB are sticking to their guns, as the latest hikes show. Inflation is hardly falling, but economic activity is. What is increasing is the debt and the uncertainty of investors. They are fleeing to the big banks, which are considered safe. The only question is who is supposed to save the new UBS, which has been expanded to include Credit Suisse, when its equity melts away under rising interest rates and falling bond prices.
Silicon Valley Bank, in an attempt to regain liquidity after the withdrawal of customer deposits, had sold US government bonds, realising losses that shattered its equity base. It was a similar story for the other US banks that stumbled under the interest rate hikes. This process is not limited to the US. “The Sparkassen Group also had to absorb value adjustments of 7.8 billion euros last year as a result.”5
Even if the exposure to losses still on the books is higher in the USA than in Europe, according to the International Monetary Fund (IMF), it must also be understood that this development has not yet reached its end. Surprises are always possible that no one has reckoned with as yet. Because until now the distortions have only broken out on the surface, i.e., where the banks are concerned.
Under the radar
The consequences of the interest rate hikes around real estate financing are not even visible so far especially when refinancing has to be sorted out for commercial real estate. Here, too, the regional banks are again in the front line, because they are usually the first to be considered as counterparties for real estate financing. The medium-sized institutions are particularly at risk due to their lower capitalisation compared to the big banks.
Clients are faced with the problem that, on the one hand, interest rates for refinancing have risen considerably, but, on the other hand, the value of the property has fallen due to the decline in demand, thus representing less security for a new loan. Closing this gap is not likely to be easy for many clients, but also for the banks. This is because these changed conditions affect the banks’ ability to grant loans. It is therefore very likely that many real estate developers and companies will have to file for bankruptcy thereby leaving the banks with irrecoverable debts.
The greatest dangers, however, lurk in the so-called shadow banks. These include private equity funds, money market funds and hedge funds. In contrast to the commercial banks, these are far less controlled by the banking supervisory authorities. This has led to the outsourcing of the banks’ risky activities precisely to such shadow banks in order to remove them from the control of the banking supervisors. What treacherous mines are buried here is made evident by the latest figures of the Financial Stability Board from Basel: “The assets held by shadow banks now account for half of the global volume.”6
This clearly illustrates the risks hanging over the world financial system if such institutions are shaken by further central bank and political decisions or even start to falter. All the central banks in the western world will probably not be able to raise enough funds to stop a collapse with liquidity support.
| * Rüdiger Rauls, 1952, is a repro photographer and author of several books. The best known are “How Does Money Work?”, “Future Socialism”, “Colony Group War” and “The Development of Early Societies”. |
Source: https://ruedigerraulsblog.wordpress.com/2023/05/13/trugerische-sicherheit, 13 May 2023
(Translation “Swiss Standpoint”)
1 Frankfurter Allgemeine Zeitung (FAZ) 3 May 2023: Stresstest für Bankenaufseher.
2 ibid
3 See also: Rüdiger Rauls – Inflation und Hochwasser
4 See also: Rüdiger Rauls – Notenbanken in Not
5 Frankfurter Allgemeine Zeitung on 3 May 2023:
Stresstest für Bankenaufseher.
6 Frankfurter Allgemeine Zeitung on 2 May 2023: Die im Dunkeln sieht man nicht.