Escape The Matrix
The banking crisis in both Europe and the US has caused concerns about the stability of financial institutions. Most banks hold fixed-interest bonds which become more attractive if interest rates fall. If interest rates rise, the lower fixed-interest rate becomes less attractive to investors, driving down the bond price. With an increase in bank holdings of bonds during the pandemic, the recent declines in asset values have significantly increased the fragility of the banking system to uninsured depositor runs. Economists suggest that these banks are at potential risk of a run without government intervention or recapitalization. In the US, there have been three regional bank failures since March 2023, with another one on the brink. Silicon Valley Bank, which held most of its assets in US government bonds, saw the market value of its bonds fall when interest rates started rising, resulting in the bank’s collapse. Banks have increased their use of an accounting technique that allows them to avoid marking certain assets at their current market value, instead using the face value in their balance sheet calculations. This accounting technique consists of announcing that they intend to hold such assets to maturity. The recent corrective trend in the valuation of financial instruments, as the result of the taming of monetary policy, has caused concern. It is difficult to predict whether banks like Charles Schwab, Bank of Hawaii, or Banco Popular de Puerto Rico are secretly close to insolvency, but the risk of insolvency is currently the highest it has been in over a decade. Central banks can solve liquidity problems while continuing to raise interest rates and fight price inflation, but they cannot solve solvency problems without pivoting monetary policy or through blatant bailouts.