The past 72 hours have seen scenes reminiscent of the global financial crisis 15 years ago.
To prevent the collapse of the UK arm of Silicon Valley Bank (SVB) from wreaking havoc on Britain’s burgeoning high-tech and bio-tech industries, Jeremy Hunt and the Bank of England had to act with extraordinary speed.
The £1 purchase of SVB by HSBC – Britain’s and Europe’s largest bank – aims to send a signal to the world that Britain’s banking system is safe.
No taxpayers’ money has been spent and the Chancellor’s campaign to make Britain a hotbed of technological innovation appears intact. However, it is far from clear how long this will remain so.
Despite attempts to prevent the SVB collapse from developing into a full-blown crisis, shocks are being felt in the US and on the continent, where trading at Credit Suisse and several Italian banks halted after sharp falls.
Jeremy Hunt and the Bank of England had to move at extraordinary speed to prevent the failure of the UK arm of Silicon Valley Bank (SVB) from wreaking havoc on Britain’s burgeoning high-tech and biotech industry (stock image)
In New York, meanwhile, Signature Bank, which has been in charge of the cryptocurrency industry, has shut down shop.
And the distinctive First Republic Bank, which towers over San Francisco’s financial district, has been offered a $70 billion (£58 billion) lifeline by the US Federal Reserve. And there was a bloodbath among America’s regional lenders, with stocks plummeting as much as 50 percent.
If these signals from the US – the financial and technology center of the world – can be relied upon, we are entering a dangerously stressful time for the global economy, with inflation and economic contraction caused by Covid-19 and Russia’s invasion of Ukraine behind us.
Indeed, efforts by the Federal Reserve, Bank of England and other central banks to contain the cost-of-living crisis by raising interest rates rapidly have unintentionally contributed to the current problems in the banking system.
Widespread rate hikes have caused government bond prices to fall – which is one of the factors behind the current implosion. Government stocks are like a seesaw. When interest rates rise, the value of bonds falls and vice versa.
Silicon Valley Bank invested cash from its high-tech customers in long-term bonds. It suffered enormous losses trying to dispose of them, triggering the current meltdown.
This is not dissimilar to what happened last September, when the trussonomics led to a major sell-off in UK government bonds, known as gilts, putting billions of dollars in UK pension fund investments at risk. Dominoes across the US have started to fall, prompting authorities to launch an emergency rescue and act quickly to establish a safety net for the country’s financial system.
US regulators have set up a “Bank Term Funding Program” that allows banks with liquidity problems to swap declining assets such as US bonds, mortgage-backed securities and other collateral for cash with the US Federal Reserve.
This will initially be funded with $25 billion (£21 billion) from the federal government’s foreign exchange stabilization fund, a resource that is activated during times of economic stress.
The £1 purchase of SVB by HSBC – Britain’s and Europe’s largest bank – aims to send a signal to the world that Britain’s banking system is safe
It is estimated that the US banking system is currently sitting on a potential loss of $300 billion (£250 billion) on US Treasury bonds it intended to hold to maturity.
The events at SVB, Signature and First Republic show that the security of government bonds is illusory unless they can be easily exchanged for dollars.
The US Treasury and Federal Reserve are hoping by putting in place a backstop they can prevent a repeat of 2008, when the collapse of investment bank Lehman Brothers triggered a global crisis that led to a deep recession.
On this side of the pond, Jeremy Hunt and Bank of England Governor Andrew Bailey have so far managed to control the UK aftermath of SVB without again risking taxpayers’ money.
The bigger issue for Messrs Hunt and Bailey is ensuring that the current high volatility does not hamper the fight against inflation.
Hunt has already received some help from falling energy prices in his efforts to halve the rise in the cost of living this year. But keeping interest rates high (to quell inflation) and stopping money printing is a crucial part of this fight.
Unfortunately, the classic response to the financial and economic crisis is for central banks to do the opposite: cut interest rates and ease credit conditions to keep consumer demand and business investment from slipping.
Given what financial markets are calling a “deflationary” shock, it seems inconceivable that the US Federal Reserve and the Bank of England will continue to raise interest rates while the US and European banking sectors face turmoil.
Andrew Bailey and the Bank of England last autumn showed their willingness to enter the markets and bail out the pension system. If a fundamental risk to economic and financial stability develops, they will follow America’s example and intervene – even if it means risking taxpayers’ money again.
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