QE/QT And Deposits

Things seem to be calming down in financial markets, which could be interpreted in one of two ways. The benign interpretation is that a few weak banks failed, but the rest of the financial system is in decent shape. The paranoid interpretation is that crises occur in stages, with pauses between the key failures. So far, I lean towards the benign interpretation — there are some areas of weakness, but not a lot of visible credit failures in the real economy. Things will deteriorate as the cycle ages, but such is the fate of capitalist finance.

I just wanted to comment on bank deposits, which has been attracting some attention. My initial reaction is that we should expect some reversal in deposit growth as the Fed reverses its balance sheet growth. However, the figure above was not exactly what I expected.

Learning From The Crisis (MMT Perspective)?

The panel I am on is shifting its topic a bit to include some discussion of the latest crisis. Although this is more topical, it is not exactly moving in a direction that fits my knowledge of Modern Monetary Theory (MMT). I see two broad issues. The first is the discussion of bank failures (so far!) which I have a limited ability to comment on. The second is more useful for a MMT debate: interest rate policy is not exactly as costless as neoclassical arguments suggest.

Late Fed Hike Comments

The Fed hiked the policy rate by 25 basis points this week, while forecasters were split on the outcome. My feeling is that this is a “dovish hike” — whatever that means. Realistically, the Fed wants to drift into at least a temporary pause while they survey the wreckage left behind by their hiking campaign.

Narrow Banking: A Bad Solution To A Non-Existent Problem

Narrow banking is a concept for a bank that holds 100% reserves against deposits. It attracts people who are deeply concerned about the symbolic content of “money” on both the left (e.g. Positive Money) and the free market right (the Chicago Plan). Devotees of narrow banking are happy to talk your ear off about how their plans work, so I leave finding out more as an exercise as a reader. I just want to focus on the core principle: they want banks to not take risks lending deposits, so that “money” remains “money”: a numeric entry that corresponds in a 1:1 fashion to a claim on a “monetary asset,” like a gold coin or claims on specific gold coins, and not a messy credit relation.

Currency Swap Facility Comment

I have something written on currency swaps, but it is probably too complex. I want to make a brief and hopefully simple comment on the topic. (The fact that I am writing an article a day tells us something about markets.)

The term “currency swap” is the term that we usually see, although there are a few variants. The variants are differentiated by the way in which interest rates are calculated. The cross-currency basis swap1 is the floating rate/floating rate version of a “currency swap,” and is the 800 pound gorilla of cross-currency funding trades. This is the wholesale hedging tool, and other foreign exchange hedging instruments are priced off these swaps. Although “cross-currency basis swap” sounds cool, I will just “currency swap” in this article, since I am not concerned about the interest rate terms.

Bank Capital Contagion Comment

The details of a shotgun marriage between UBS and Credit Suisse arranged by Swiss regulators have been leaking out. Credit Suisse has been plagued by problems, and one might hope that this act would finally clear them up. The concern I am seeing at the time of writing is the risk of contagion.

As an aside, we can tell this is a bit of a crisis by my posting frequency.

Credit Suisse had AT1 notes, which are a subordinated perpetual security that acts as bank capital. Under normal circumstances, perpetuals are senior to equity. However, AT1’s have clauses that allow regulators to write them down to zero — an option that the regulators seemingly exercised. I have seen a lot of people online surprised by this, since they were unaware of the contractual terms. We will find out Monday (possibly the hard way) how many portfolio managers were unaware of them.

Primer: American Bank Insolvency Losses

In this article, I am going to give a basic introduction to insolvency (bankruptcy), as well as a discussion of the principles of how losses are apportioned to the various classes of creditors of American banks. I will only attempt to look at American banks since bankruptcy procedures are specific to each legal jurisdiction. Although I was not a credit analyst, I worked with them and had some training on the topic. The article “U.S. Corporate and Bank Insolvency Regimes: An Economic Comparison and Evaluation” by Robert R. Bliss and George G. Kaufman (URL: https://www.chicagofed.org/-/media/publications/working-papers/2006/wp2006-01-pdf.pdf) covers this topic, and I will use it to justify some assertions about the procedures. I will then discuss some of the issues of the resolution of Silicon Valley Bank, which is underway at the time of writing.

What We Learned: Something Is Seriously Wrong With Silicon Valley

I am seeing a lot of attempts to argue in favour of major changes to banking because of what happened with Silicon Valley Bank. Although I see a chance that Congress might reconsider the lax regulations of regional banks in the same category as Silicon Valley Bank, it is going to be hard to get too much momentum for broad reforms. The actions of everyone involved was breathtakingly stupid, and it is going to be hard to replicate that level of stupid at any other bank of a similar size.

Bailout!

The U.S. Treasury, Federal Reserve, and Federal Deposit Insurance Corp banded together to create the Bank Term Funding Program (BTFP — the bureaucrats are going for the laughs with the acronyms at this point), which gives 1-year financing to eligible banks against Treasury/mortgage-backed security collateral at par. They also announced that uninsured depositors at two failed banks (the known failure Silicon Valley Bank, as well as the newly-shuttered Signature bank) will be made whole.

With the FDIC auction underway, the Silicon Valley Bank Crisis may either be over or raging uncontrollably when you read this. I lean towards the scenario of excitement winding down, but at the same time, I know literally nothing about the quality of SVB’s asset book. Rather than speculate, I just want to point out what I see as key: credit market conditions (including wholesale funding) are the only thing the Fed really cares about. Even if one worries about other large regional banks, credit investors — and existing lending facilities for banks, like the discount window and FHLB advances — can pump money into the back door of a solvent bank faster than a bunch of people who read stuff on Twitter can withdraw it out the front.

Oh No, Panic In Silicon VAlley

The American Federal Deposit Insurance Corporation (FDIC) made the unusual step of shutting down the flailing Silicon Valley Bank (hereafter, SVB) during business hours yesterday (Friday). (FDIC Friday usually involves teams swooping in after the close on Friday.) Since I have to write this article quickly in the morning, I am not sure of what the latest developments are for SVB, rather I want to discuss the possibility of contagion.

Yet More Rambling About My Upcoming MMT Presentation

Along with Eric Tymoigne, I will be on the “pro-” side of a “pro-/con-” Modern Monetary Theory (MMT) panel at the online part of the annual Canadian Economic Association (CEA) conference (on May 30, the live conference is in early June in my old hometown of Winnipeg). As a non-academic non-economist, if I were smart, I would keep my head down and offer fairly cautious remarks from the perspective of an educated outsider (with obvious biases). Whether that happens when I start opening my mouth remains to be seen (“No plan survives contact with the enemy”).

Debt/GDP Ratio: Beware "Real Analysis"

I saw a comment about the drop in the U.S. Federal debt-to-GDP ratio, which reminded me that I wanted to discuss it once the data started to settle down. As can be seen in the above chart, the public debt-to-GDP ratio went from 135% in 2020Q2 to 120% in 2022Q3 (latest figure on FRED). A drop of (roughly) 15% in the ratio without some kind of “austerity” policies might seem surprising — but it is only surprising if you look at debt dynamics the wrong way. That wrong way is relying on “real” variables — real GDP growth, real interest rates — as well as thinking too much about long-term “steady state” or “equilibrium” values.

The reliance on “real analysis” (ha ha) leads to silly things like charts of the U.S. debt/GDP ratio marching in a straight line towards 200%. (Yes, CBO, I am not laughing with you.) This framing also leads to neoclassical economists going on about the question: is r greater or less than g?

Financial Markets And Inflation

Note: this is an unedited draft chapter section from my inflation manuscript. I am not too happy with this, but perhaps getting savaged on the internet might give me some additional things to add. This section follows more detailed discussions of equities and residential real estate.

We will now conclude this chapter with some general comments on the relationship between inflation and the overall financial markets. What we see is that there are some areas of direct linkage between inflation (as measured by a consumer price index) and some financial assets, other assets have a more complex relationship. As a result, making generalisations is difficult – equity prices are not going to move the same way as the prices of cheesy snacks at your local convenience store.