If there is one thing we must understand about banking crises, it is that it is not known with certainty how they start, but how and where they will end. “In that place where no one wants to go”, as Emilio Saracho prophesied months before the collapse, intervention and sale of Banco Popular in June 2017. The irony of fate has wanted that bank resolution these days to be an example of what must be do, provided you have the time, means, and anticipation to do it. The skill that the FROB and the SRB showed at the time with a bank the size of Silicon Valley Bank (SVB Financial), has not been seen even remotely by the US or Swiss authorities when it comes to acting on their banks.
The current crisis of confidence in banks comes from several fronts. First, poor risk management in the face of the current rising interest rate cycle by the SVB, which had to resort to selling bonds to meet liquidity needs, ended up suffering massive losses and was unable to stop the stampede of customers on time. Second, the contagion effect to other entities that passed through there but that may be in the same situation. Third, the legal insecurity of politicians reacting on the fly and adapting the regulations to the letter to execute the feared bailouts, in the case of Janet Yellen (US Treasury) or Karin Keller-Sutter (Finance Minister).
The betrayal of the rules of the game hides an absolute contempt for the capital of the bank, which is the essence for it to function and to be able to stand. The decision to sacrifice shareholders and part of the bondholders with the SVB but save depositors in Silicon Valley Bank has continued in the rescue of Credit Suisse, in which the shareholders collected but the bondholders who had hybrid debt (CoCos) they remain at zero despite the fact that they are instruments convertible into shares. Faced with this panorama, what path have bank investors taken on one side or the other? Take those of Villadiego. Hence the various falls in stock prices and sudden purchases of default insurance on debt issued by financial institutions.
If you haven’t figured it out yet, modern banking finances itself in the markets in a very relevant way. It is critical for several reasons. The typical intermediary business between what you charge for the loans and what you pay for the deposits would end up in a severe credit crunch without giving rise to wholesale financing. But what supports all this is the guarantee of capital, either through the money of the shareholders or bondholders who buy the senior, junior or hybrid bonds. It is solvency that is ultimately at stake and that is what has been called into question in Switzerland and the US.
Who is going to invest in shares, bonds and other instruments issued by banks? If Silicon Valley Bank hadn’t failed miserably alongside Goldman Sachs in its share placement on March 9, it would still be alive and kicking today. We wouldn’t be talking about this nightmare. Nor if Credit Suisse’s creditors had not launched en masse to buy default insurance (credit default swaps) in the face of the fall in the price of their bonds and the consequent collapse in the stock market. It is the same virus that has begun to infect Deutsche Bank this week despite the fact that it is a different case. But the same was said about its Swiss rival and it has had to be bailed out by UBS, the central bank SNB and the Swiss government.
The hour of the ECB’s monetary superbazooka
The certain thing is that after almost three weeks of financial turmoil, the size of the problems does not to grow. The fall of the SVB put a bank with 200,000 million in assets on edge. With Credit Suisse, just over 500,000 million. That Deutsche Bank, with a perimeter of 1.3 trillion euros and incalculable exposure to the derivatives market, is being questioned is another story. Time, once again, is a key factor in financial fires: the longer they last, the greater the destruction.
The good news is that the European Central Bank (ECB), unlike the Fed in the US or the Swiss SNB, has the room for maneuver and the ability to stop the crisis with a ‘superpower’ that was created in July 2022 called the Instrument for the Protection of the Transmission of Monetary Policy (TPI, for its acronym in English). Due attention was not paid to it because that day the center stage was monopolized by the ECB’s first rate hike since 2011. as what it is: an anti-catastrophe tool. Some smack rained down on us from ignorance and political sectarianism that does not attend to reasons but only to electoral polls.
We now know that the ECB is willing to use it to deliver a definitive message to buyers of opaque CDSs, short investors making a killing, and generally investor confidence in banking. Deutsche Bank is not touched because if it is, there will be no protection, neither in gold, Bitcoin, sovereign debt or in the best equipped bunker. Too big to fall. On the TPI, the ECB council recorded on March 16 in its statement that “it is available to counteract unjustified and disorderly market dynamics that constitute a serious threat.”
The current situation seems to fit that description. There is an emergency but someone has to push the ‘code red’ button. The device’s capacity is unlimited and it would make it possible to put the bond and bank stock markets in order, which are so affected by this crisis of confidence that will continue to spread unless a definitive ‘vaccine’ is launched. “I would prefer not to use it but we will not hesitate to do so if necessary,” ECB Vice President Luis de Guindos promised when he presented it to the public eight months ago. The time to find out if this is the case seems to have arrived.
