How the Fed's rate hike campaign broke things

2023-03-13

Illustration: Sarah Grillo/Axios

For months and months, everyone who follows markets has warned that the Federal Reserve's aggressive monetary tightening would, inevitably, break things.

The big picture: Over the weekend, we learned what those things were: large regional U.S. banks, and the lengths that regulators would go to keep that breakage from spiraling into a nationwide bank run.

Driving the news: Sunday night, the government said it will fully guarantee depositors in failed Silicon Valley Bank and Signature Bank. The Fed unveiled a new, bottomless facility to ensure all banks can access cash on favorable terms, should they see deposit runs of their own.

While the focus last night was on the deposit guarantee, in many ways the Fed facility — which allows banks to access cash by pledging collateral without a haircut — is the more remarkable step.

Why it matters: The government has stepped up and offered assurance that bank deposits are safe, which helped stem the immediate panic. But the whole episode is evidence that the pain from monetary tightening has only just begun.

Over the last year, higher interest rates have hit the housing industry and the tech sector, but not much else. That may be changing, especially if the events of the last several days cause banks nationwide to tighten their lending standards.

The scene: This whole episode has many echoes of the 2008 crisis, when a series of shocking financial interventions were announced on Sunday evenings. (This was, for that reason, a nostalgic weekend for Neil, a veteran of covering that crisis back before his hair was gray.)

Chair Jerome Powell canceled a planned trip Basel, Switzerland, for meetings with his fellow global central bankers, in order to stay in Washington and attend to the panic.
Fed officials worked late nights and early mornings from home over the weekend to develop the response; officials and staff dropped in and out of an hours-long videoconference.

The backdrop: Silicon Valley Bank ran into problems, not by making loans that went bad, but by piling money into ultra-safe government-backed mortgage securities issued back when mortgage rates were super-low in 2021.

As the Fed raised rates aggressively in 2022, those securities lost value, leaving a hole in the bank's balance sheet.
Things might have eventually been fine if the bank's customers had left their deposits in place. But instead, they withdrew money in droves, especially last week, forcing the bank to reckon with the loss — and regulators to shut the bank down on Friday.

What's next: On paper, the crisis should be over. With the government guaranteeing all deposits for customers of two major banks, Americans should see little need to pull their money out of others, and any banks that do face outflows have a limitless pool of cash from the Fed to access.

But it could reshape banks' behavior and make them more cautious in the loans they make and the customer deposits they accept.
And that, in turn, could amount to a de facto tightening of monetary conditions that slows the economy more than Fed rate hikes alone have managed to do.

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