Opinion: ‘Someone needs to tell Jerome Powell that this is not a murder mission at all costs.’ Cut rates now to prevent a full-blown banking crisis.

We are approaching a tipping point as the U.S. economy and banking system either recede from the brink and return to the comfort zone or fall out of the abyss and into a full-blown banking crisis.

The Federal Reserve can solve this problem in one step: Cut interest rates at this week’s meeting.

However, the chances of the Fed taking this step are slim. While most current projections suggest that the US central bank pause to raise interest rates, a pause simply isn’t good enough.

The rate cut releases an economic pressure valve. However, this move is only temporary, a respite is necessary for the health of financial markets and the banking system.

Yes, the Fed wants to tighten control of inflation and, no, rate cuts won’t help in that respect, but someone needs to tell Fed Chairman Jerome Powell that this is not a “killing” mission. at all costs”, because none of us can pay the price for the stability of the banking system.

Squeeze and bleed

Most of the news so far about the fall of Silicon Valley Bank
Silvergate Bank

and Bank Signature

— and instability at First Republic Bank

and others – focused on how these banks managed to get in trouble. It didn’t look closely at the squeeze these businesses face.

Bryce Doty, senior portfolio manager at Sit Investment Associates, summarizes what some experts tell me is being overlooked: “Most banks are in default right now.”

That sounds terrible, but it has more to do with management rules and interest rates than a complete inability to pay off all of the debt.

Read: From the sudden collapse of SVB to the collapse of Credit Suisse: 8 charts showing the turmoil in financial markets

To bring it home, consider if you mortgaged a home with a long-term fixed rate about 10 years ago, when the average mortgage rate was about 3.6%. That’s almost double the 10-year Treasury yield

Back then, that meant some institutions would rather buy your loan than pay for a safer Treasury bond.

Today, you’re still paying 3.6% on the mortgage, but that’s what the 10-year Treasury pays. As a result, the value of your mortgage on your lender’s books is lower today than it was a decade ago. In the banking world, such events are not a problem until the newspaper has to be “marked for market”, priced as if it were for sale today.

Federal regulations allow banks to plan to hold part of their assets to maturity, allowing them to escape temporary losses on paper because forever held securities are not rated. mark on the market (retains book value when purchased). This gives banks much-needed flexibility but can create problems of the “not a problem until it becomes a problem” type, which can only be foreseen if you look specifically at it. careful.

Where the 2008 financial crisis was caused by defaulting loss-making banks, the system’s current problem is not about worthless paper (at least not yet). This time, interest rates rose so quickly that they created losses on paper.

The Fed should have foreseen this.

The Bloomberg US composite bond index fell 13% last year; before that, its worst year was a 3% loss in 1994. Since 1976, the index has fallen in just 5 calendar years — including the past 2.

The Fed should have foreseen this; Its own balance sheet shows that about $9 trillion in bonds lost more than 10% of their value during the rate hike. “The Fed keeps interest rates too low and then raises them up so quickly to zero [financial institution] may re-adjust their bond portfolios to avoid losses,” Doty said in an interview on my Money Life with Chuck Jaffe podcast.

Out of the loop, Doty estimates that if the Fed cuts rates by 100 basis points — one percentage point — “it will eliminate half [the banking industry’s] unrealized losses in a slip and fall. That would create the easiest and shortest banking crisis in history.”

Furthermore, this will ensure that there is no “contagion” from impending banks; remember that it was the banks that came to the rescue of the First Republic this week, seeding one bank’s market-pricing problems into the next institution’s default loss.

That’s how you turn a problem into a disaster. If the Fed pushes interest rates higher without taking a break, the likelihood of a liquidity crunch and a credit crunch increases dramatically.

Hi Recession, your table is ready.

Read: ‘We need to stop this now.’ Bill Ackman says the support of the First Republic is spreading financial contagion.

Jurrien Timmer, global macro director at Fidelity Investments, said in a recent interview on My Show that he can’t see the Fed giving up, noting that no one wants to be the next Arthur Burns, infamous Fed chair during periods of great inflation. of the 1970s.

“They’re committed to never repeating those mistakes, which in the ’70s was keeping policy too loose for too long, letting the god of inflation out of the bottle,” Timmer said.

But this was not the 1970s, and anyone who thought the Fed was then too soft on inflation – which is why they are taking a hard line now – should consider that maybe the central The central bank has backed down because higher interest rates are causing widespread systemic problems.

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

The cuts don’t end the fight against inflation, it just pauses the fight to strengthen and secure its fighting position. Sometimes, the best way to move forward is to start with a step back. Let’s hope the Fed has the guts to do that.

Read: What can be done to ease banking worries: Timing, plus Fed rate hikes.

Than: The First Republic was rescued by opponents. Silicon Valley Bank abandoned by friends.


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