Taps Coogan – April 12th, 2023

Enjoy The Sounding Line? Click here to subscribe for free.

Boy, do we agree with the Luigi Zingales, University of Chicago Booth School of Business Professor of Finance, who recently called for the creation of a commission to review how it was possible that the Fed didn’t see inflation coming last year and, more recently didn’t see the problem at regional banks.

From Bloomberg:

 

Some excerpts:

“I fear that this is more an institutional problem than just a Chairman problem and it’s easier to just replace the Chairman than to rethink the institution… I think it’s a very consensus (driven) institution, so I think the failures were shared… I think they are getting wrong how unstable the banking system is. I think that they have this idea that deposits are sticky …First of all, we have never experienced in recent time a spread of 400 basis points between what you get on (money markets) and what you get on your deposits… Deposits are mobile. If deposits move in search of better yields then banks have to realize their losses. The idea of losses up to maturity that can stay there and not have any impact …is sort of a fantasy.”

“The Fed has a huge responsibility (for the banking crisis) because they should have understood that you can’t raise rates that fast… They were very complacent (about inflation) and said ‘Oh we have the tools, we’re going to do it…’ I think that their tools were not very sharp and they should have realized that.”

“They put a lot of softness in the banking sector and clearly regional banks which… are the ones that lend to small and medium sized enterprises… The bread and butter of the economy is with regional banks… They see deposits flowing out and they are not going to make loans…”

“No, they can’t (raise deposits rates). They don’t have the returns to do that. If you look at Silicon Valley Bank, if they had increased the return on their deposits by, I think, 75 basis points, they would have wiped out all the profits from last year. So they don’t have a return on assets to justify higher deposit (rates). That’s the conundrum. If the problem could be solved by simply increasing rates, it would be easy, but they cannot afford.”

That certain regional banks have failed is, in and of itself, not an indictment of the Fed. That the Fed so horribly delayed their reaction to inflation and then rushed to raise rates faster than the banking system can handle is an indictment. As for the need for a commission, for anyone that’s keeping track, the Fed is yet to blame its policy mistakes on anything other than unexpected ‘vaccine hesitancy,’ an insult to everyone’s collective intelligence. 

As for the regional banks, Silicon Valley Bank was indicative of the problem but an extreme case. Most banks have the net interest margins to raise deposit rates by at least a couple percent before taking losses and banks can take losses for years, as many European banks have proven. New loans are being made at much higher yields for the banks, so what they need to do is eat some losses, hold on to deposits as best they can, and roll into better yielding assets.