Professor Rajan is one of the few central bankers who seems to know what's what (except maybe for the RBI currency switcheroo of November 2016. That was a fustercluck).
I don't know his co-author (NYU-Stern) on this piece, from Project Syndicate, March 28:
There are four reasons to worry that the latest banking crisis could be systemic. For many years, periodic bouts of quantitative easing have expanded bank balance sheets and stuffed them with more uninsured deposits, making the banks increasingly vulnerable to changes in monetary policy and financial conditions.
CHICAGO – The recent bank collapses in the United States seem to have an obvious cause. Ninety percent of the deposits at Silicon Valley Bank (SVB) and Signature Bank were uninsured, and uninsured deposits are understandably prone to runs. Moreover, both banks had invested significant sums in long-term bonds, the market value of which fell as interest rates rose. When SVB sold some of these bonds to raise funds, the unrealized losses embedded in its bond portfolio started coming to light. A failed equity offering then set off the run on deposits that sealed its fate.
But four elements of this simple explanation suggest that the problem may be more systemic. First, there is typically a huge increase in uninsured bank deposits whenever the US Federal Reserve engages in quantitative easing. Because it involves buying securities from the market in exchange for the central bank’s own liquid reserves (a form of cash), QE not only increases the size of the central-bank balance sheet, but also drives an expansion in the broader banking system’s balance sheet and its uninsured demandable deposits.
We (along with co-authors) called attention to this under-appreciated fact in a paper presented at the Fed’s annual Jackson Hole conference in August 2022. As the Fed resumed QE during the pandemic, uninsured bank deposits rose from about $5.5 trillion at the end of 2019 to over $8 trillion by the first quarter of 2022. At SVB, deposit inflows increased from less than $5 billion in the third quarter of 2019 to an average of $14 billion per quarter during QE. But when the Fed ended QE, raised interest rates, and switched quickly to quantitative tightening (QT), these flows reversed. SVB started seeing an increase in outflows of uninsured deposits (some of which were coincident with the downturn in the tech sector, as the bank’s stressed clients started drawing down cash reserves).
Second, many banks, having benefited from the firehose of deposits, purchased liquid longer-term securities such as Treasury bonds and mortgage-backed securities, in order to generate a profitable “carry”: an interest-rate spread that provided yields above what the banks had to pay on deposits. Ordinarily, this would not be so risky. Long-term interest rates had not moved up much for a long time; and even if they did start to rise, bankers understand that depositors tend to be sleepy and will accept low deposit rates for a long time, even when market interest rates move up. The banks thus felt protected by both history and depositor complacency.
Yet this time was different, because these were flighty uninsured deposits. Having been generated by Fed action, they were always poised to flow out when the Fed changed course. And because large depositors can coordinate easily among themselves, actions taken by just a few can trigger a cascade. Even at healthy banks, depositors who have woken up to bank risk and the healthier interest rates available at money-market funds will want to be compensated with higher interest rates. The juicy interest-rate spreads between investments and somnolent deposits will be threatened, impairing bank profitability and solvency. As an apt saying in the financial sector goes, “The road to hell is paved with positive carry.”....
....MUCH MORE
Some of our posts on Professor (U.Chicago-Booth) Rajan:
February 11, 2022
Former Reserve Bank of India Head, Raghuram Rajan: "Central Banks Have to Start to Move"
«We sort of stopped thinking about countries like Italy. But if we come out of the pandemic and interest rates are not at 1% or 2%, but at 4% or 5%, what happens to public finances? Obviously, the biggest risks are always the ones you don’t see. But this is a risk we haven’t paid attention to for a long time»:—Raghuram Rajan.
Long time readers may remember Professor Rajan from such hits as:
Raghuram Rajan on The Boom and Bust in Farm Land Prices in the United States in the 1920s
and:
India’s Central Bank Governor Discusses Robber-Baron Capitalism and a Fine Veg CutletOkay, I'm being a bit whimsical, the man is brilliant and I wish he was running the U.S. Fed rather than sitting in his comfy endowed chair at the Booth School of Business.
From Neue Zürcher Zeitung's TheMarket.ch, February 10:....
Also:
- Raghuram Rajan: "When the Interests of Monopolists and Authoritarians Coalesce"
- Raghuram Rajan: "Disruption, Concentration, and the New Economy"
- "World Out Of Whack: An Absurd Unintended Consequence Of Abnormally Low Rates"
- Fannie and Freddie Must Die! Some guy in Chicago Takes on Paul Krugman's Version of the Mortgage Mess (FNM; FRE)
