Dr Santosh Kumar Mohapatra*
The US is considered as the most advanced country and Centre of capitalism which preaches the virtues of the market economy to the entire world. But the same US economy is always being plagued by various financial crises, which have cascading and rippling effects on the entire world economy. The reason is that when the US sneezes, the world catches a cold.
The capitalistic system is so fragile and vulnerable that in the month of March 2023, eleven days of turmoil brought down 3 banks, leaving another teetering. The scenarios that brought them down were each unique has left investors reeling. The banks were taken over by others or liquidated.
From March to May 2023, the three US banks that collapsed this year — First Republic, Silicon Valley Bank, and Signature Bank of New York — had more combined assets under management than all 25 federally insured lenders that failed in 2008 at the onset of the Great Recession. The US banking sector was dealt another blow when the FDIC stepped in to seize control of First Republic — marking the second-largest bank failure in US history by assets — and to sell it to JPMorgan Chase.
As of the end of last year, First Republic had approximately $213 billion in assets under management. SVB had $209 billion in assets under management as of last Dec. 31, while Signature Bank had roughly $110 billion under its control. When combined, the three failed banks held a whopping $532 billion in total assets.
Meanwhile, the 25 banks with FDIC insurance that failed in 2008, including one-time industry giant Washington Mutual, had $526 billion in combined assets at their points of collapse when adjusted for inflation, according to the New York Times. The sum does not include failed investment banks, such as Lehman Brothers and Bear Stearns. Still, it provides an indication of the brutal hit to the US banking sector this year as large regional lenders face pressure from a rapid uptick in interest rates.
Switzerland has long been a preferred place for the world’s wealthy to stash their cash. But, one of the country’s biggest and oldest banks, Credit Suisse, collapsed over the weekend, forcing the Swiss government to broker a deal that saw rival UBS buy the bank for $3.2 billion.
The banking crisis is not new in the US. The US banks were sitting on $620 billion in unrealized losses (assets that have decreased in price but haven’t been sold yet) at the end of 2022, according to the Federal Deposit Insurance Corporation (FDIC). This is not the first time that banks have failed in the US. Literally, thousands of US banks have failed during the country’s 246-year history. In total, a whopping 9,000 US banks faced insolvency in the 1930s in the midst of and following ‘the Great Depression’ — when an estimated $140 billion in depositors’ money vanished in thin air.
From 2001 to 2008, 25 US banks went under. Lehman Brothers, founded in 1847, the fourth-largest investment bank in the US then (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch) collapsed — 158 years after it was founded- triggering a global financial crisis known as the great recession. Between 2008 and 2015, more than 500 US banks failed, according to American Deposit Management, a US financial services company.
Banks are susceptible to a range of risks. These include credit risk (loans and other assets turn bad and cease to perform), liquidity risk (withdrawals exceed the available funds), and interest rate risk (rising interest rates reduce the value of bonds held by the bank, and force the bank to pay relatively more on its deposits than it receives on its loans). In general, a bank is considered to have “collapsed” or “failed” when its asset value drops below the market value of the bank’s liabilities —money owed to depositors and creditors. But there are unforeseen triggers too. It’s never easy to predict when a bank will collapse — until it happens.
“Bank runs are not uncommon. A bank run or run on the bank occurs when many clients withdraw their money from a bank because they believe the bank may fail in the near future. It can also happen if the bank’s borrowers want their money back and the bank does not have enough cash on hand. The bank can become illiquid. A bank “fails” when it can’t meet its financial obligations to creditors and depositors. This could occur because the bank concerned has become “insolvent” (unable to pay debts owed) — or because it no longer has enough liquid assets (cash) to fulfil its payment obligations (like withdrawal from depositors). When the bank can still have some capital, but less than the minimum required by regulations is called “technical insolvency”.
It is important to note that illiquidity and insolvency are two different things. For example, a bank can be solvent but illiquid (that is, it can have enough capital but not enough liquidity on its hands). A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at the same time, as people suddenly try to convert their threatened deposits into cash or try to get out of their domestic banking system altogether.
A systemic banking crisis occurs when many banks in a country are in serious solvency or liquidity problems at the same time—either because there are all hit by the same outside shock or because failure in one bank or a group of banks spreads to other banks in the system. More specifically, a systemic banking crisis is a situation when a country’s corporate and financial sectors experience a large number of defaults, and financial institutions and corporations face great difficulties repaying contracts on time. Some crises turned out to be contagious, rapidly spreading to other countries with no apparent vulnerabilities.
Among the many causes of banking crises have been unsustainable macroeconomic policies (including large current account deficits and unsustainable public debt), excessive credit booms, large capital inflows, and balance sheet fragilities, combined with policy paralysis due to a variety of political and economic constraints. In many banking crises, currency and maturity mismatches were a salient feature, while in others off-balance sheet operations of the banking sector were prominent.
It turns out that neither age nor experience guarantees resilience. Financial panic (1819-1821), Speculation (1837 to mid-1840s), Stock market crash, and Great Depression (1929 to 1930s), Savings and Loan (S&L) crisis (1980s and 1990s), Economic contagion (Great Recession of 2008), the COVID-19 pandemic (2020) are the causes of the banking crisis during the periods mentioned in brackets.
The present crisis lies with ending the era of rock-bottom interest rates or ultra-low interest regimes. First banks were made addicted to liquidity infusion through ultra-low interest regimes. The US banks scooped up lots of Treasuries and bonds. Now, the Federal Reserve hiked interest rates to fight inflation. When interest rates increased, newly issued bonds started paying higher rates to investors, which made the older bonds with lower rates less attractive and less valuable. The result was that most banks have unrealized losses on their books.
The People preferred to withdraw old bonds and invest in new bonds for higher returns. Since in the US, 87 % of deposits are uninsured, this impelled a crisis of a bank run – as a large number of customers of a bank or other financial institution withdraw their deposits at the same time over fears about the bank’s solvency. In the US, the Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per person.
Apart from the bank run, Credit Suisse’s failings included a criminal conviction for allowing drug dealers to launder money in Bulgaria, entanglement in a Mozambique corruption case, a spying scandal involving a former employee and an executive and a massive leak of client data to the media.
In the aftermath of the global crisis of 2008, in July 2009, during a visit to the London School of Economics, Queen Elizabeth, asked a group of eminent economists why no one had predicted the credit crunch, and foresaw the timing, extent, and severity of the recession. The three-page missive, blames a failure of the collective imagination of many bright people both in this country and internationally, to understand the risks to the system as a whole. Britain’s economy had been contracting for 15 months, and the recession is deeper than any since the 1930s, outside of wartime.
Signed by LSE professor Tim Besley, a member of the Bank of England monetary policy committee, and the eminent historian of government Peter Hennessy tells of the “psychology of denial” that gripped the financial and political world in the run-up to the crisis. The term psychology of denial was first used in Sigmund Freud’s paper “The Neuro-Psychoses of Defence” (1894) means conscious refusal to perceive that painful facts exist.
The content was discussed at a seminar at the British Academy in June that was attended by economic heavyweights including Treasury permanent secretary Nick MacPherson, Goldman Sachs chief economist Jim O’Neill and Observer economics columnist William Keegan. The letter explains that as low interest rates made borrowing cheap, the “feelgood factor” masked how out-of-kilter the world economy had become beneath the surface, with some countries, such as the United States, running up enormous debts by borrowing from others, including China and the oil-rich Middle Eastern states, that were sitting on vast piles of cash.
Despite these yawning imbalances, they say, “financial wizards” managed to convince themselves and the world’s politicians that they had found clever ways to spread risk throughout financial markets – whereas “it is difficult to recall a greater example of wishful thinking combined with hubris”.”Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well,” they say. “The failure was to see how collectively this added up to a series of interconnected imbalances over which no single authority had jurisdiction.”
Actually, bank runs are just symptoms of a capitalist crisis. Capitalism that whets speculation deceit fraud, greed, and fear is responsible for such unending crises. According to U.S. Treasury Secretary Timothy Geithner, “Most financial crises are caused by a mix of stupidity and greed and recklessness and risk-taking and hope. Historical accounts of financial crises suggest that fear and greed are the common denominators of these disruptive events: periods of unchecked greed eventually led to excessive leverage and unsustainable asset-price levels, and the inevitable collapse results in unbridled fear, which must subside before any recovery is possible.
A new book from a University of Wollongong (UOW) banking and finance specialist explores the US investment banking industry and the institutional drivers behind the global financial crisis (GFC). The exploitation of customers, the misalignment of governance frameworks and practices, and the profit-driven performance incentives which drive self-interest combine to maintain a culture underpinned by power and greed.
What is reprehensible is that over the past several years, regulatory red lines have been blurred in the US to cater to excessive greed. For example, the Glass-Steagall Act of 1933 signed into law by President Franklin Delano Roosevelt on June 16, 1933, forced commercial banks to refrain from investment banking, and insurance activities to protect depositors from potential losses through stock speculation and prevent a repeat of the 1929 stock market crash and the wave of commercial bank failures.
But the Gramm-Leach-Bliley Act of 1999 (GLBA) was a bi-partisan regulation under President Bill Clinton, passed by Congress on November 12, 1999, to repeal the Glass-Steagall Act amid long-standing concern that the limitations it imposed on the banking sector were unhealthy and that allowing banks to diversify would reduce risk. This led to the formation of the conglomerate Citigroup, which offered not only commercial banking and insurance services but also lines of business related to securities.
The Dodd-Frank Wall Street Reform and Consumer Protection Act is legislation that was passed by the U.S. Congress during Obama in response to financial industry behaviour that led to the financial crisis of 2007–2008. It sought to make the U.S. financial system safer for consumers and taxpayers. Under pressure from corporate behemoths, critics of the law argued that the regulatory burdens it imposes could make U.S. firms less competitive than their foreign counterparts. In 2018, during the Trump regime, Congress passed a new law that rolled back some of Dodd-Frank’s restrictions. The dilution of this law is one of the causes of the banking crisis in the US.
Excessive greed without regulatory red lines spurs to use of ultra-risky investment avenues like credit default swaps, hedge funds, mortgage-backed securities (MBSs) collateralized debt obligations (CDOs), and cryptocurrencies for higher returns but trigger crises too. “Greed is good,” said Gordon Gekko, played by Michael Douglas, in the 1987 film “Wall Street.” In 2009, Hollywood filmmaker Oliver Stone is again taking on the financial world in a sequel to 1988’s successful Wall Street, but this time he said greed is not only good – it’s legal. With two more decades of life experience and wisdom, in 2008, Gekko said in the sequel that greed and its consequences are “weapons of mass destruction.”
According to U.S. Treasury Secretary Timothy Geithner “Most financial crises are caused by a mix of stupidity and greed and recklessness and risk-taking and hope. Historical accounts of financial crises suggest that fear and greed are the common denominators of these disruptive events: periods of unchecked greed eventually led to excessive leverage and unsustainable asset-price levels, and the inevitable collapse results in unbridled fear, which must subside before any recovery is possible.
A new book from a University of Wollongong (UOW) banking and finance specialist explores the US investment banking industry and the institutional drivers behind the global financial crisis (GFC). Exploitation of customers, the misalignment of governance frameworks and practices, and the profit driven performance incentives which drive self-interest combine to maintain a culture underpinned by power and greed.
The author is an Odisha-based eminent columnist/economist and social thinker. He can be reached through e-mail at [email protected]
DISCLAIMER: The views expressed in the article are solely those of the author and do not in any way represent the views of Sambad English.