The most serious financial crisis since the Great Depression of the early 20th century took place in 2008 with the outbreak of the Global Financial Crisis. It began with cheap lending in the US that caused a housing bubble and ended by becoming a catastrophic financial crisis worldwide.
The fourth-largest investment bank in the US, Lehman Brothers, filed for bankruptcy triggering a domino effect and causing a massive sell-off in global markets. This hit everyone from the most affluent to the most impoverished and from world banking giants to ordinary people who lost their jobs, savings, and homes.
Today, a similar disaster may be brewing. It was created by the pre-emptive measures taken by the US Federal Reserve, the US central bank, in raising interest rates to slow inflation and being apparently unaware or unheeding of the consequences that could likely follow.
Federal Reserve Chair Jerome Powell said interest rates would reach 5.75 per cent when they had been near to zero only a few months earlier. Raising them in this way struck the US financial market with turbulent force, with an article on the US news site CNBC on 10 March describing the resulting crisis as “the latest fallout from the Federal Reserve’s actions to stem inflation with its most aggressive rate-hiking campaign in four decades.”
The first casualty was the Silicon Valley Bank (SVB). This had invested billions in US Treasury bonds, and the value of these had begun to fall because they now paid lower interest rates than current bank rates.
SVB had to raise $2.25 billion to cover losses from the sale of its bonds. When its clients then withdrew a staggering $42 billion, a quarter of the bank’s total deposits, in a single day, US regulators, citing excessive risk-taking, mismanagement, and uninsured deposits at the bank, intervened and shuttered SVB.
The rapid collapse of SVB unquestionably pounded its clients, including the major corporations that used the bank. Technology giants like Apple and Alphabet, another US technology conglomerate, in addition to hundreds of tech start-ups, were affected. According to CNBC, “the ramifications could be far-reaching, with concerns that start-ups may be unable to pay employees in coming days, venture investors may struggle to raise funds, and an already-battered sector could face a deeper malaise.” Similar repercussions also faced many other banks.
For SVB clients, things were about to get worse before they got better. Those who had not withdrawn their savings before SVB was seized by US regulators assumed that they would not be able to retrieve their money soon or even at all. Most US banks are insured by the Federal Deposit Insurance Corporation (FDIC), so savings at SVB were insured, but only up to a limit of $250,000. Approximately 90 per cent of all accounts at SVB, worth around $150 billion, were not insured.
At first, the Federal Reserve said that insured deposits at SVB would be paid out. However, if most of what was held by SVB was not insured, most clients will not get to see their savings. Despite US President Joe Biden’s reassuring words that the US banking system is safe, those who did not withdraw their deposits and remained with SVB have been wondering if they will ever see their money again.
A strategy to restore confidence in the US banking system had to be implemented in the wake of the collapse of SVB, and in order to reassure investors the US government rescued the bank’s shareholders. The US Federal Reserve and the US Treasury Department have decided to guarantee all SVB deposits, even those that were not insured. This is a huge move by the US government, and despite its cost it may provide the needed faith in the system.
However, further failures by other banks are now occurring fast, and these will also call for major bailouts. MarketWatch, a US website that provides financial information, says 20 banks are sitting on huge potential securities losses in the same way as SVB. They will also fail if similar rescue procedures do not halt their downfall.
A second casualty of the crisis was the US Signature Bank, with US regulators also deciding to shutter it. SVB and Signature Bank were followed by the First Republic Bank after its shares crashed, though this was saved when other banks came together to provide it with a lifeline of $30 billion. The bailout aimed at stabilising the US financial sector more than saving the First Republic Bank itself.
But the domino effect of the crisis is not stopping there, and a shakeup, not only in the US banking system, but also across the Atlantic, is in the making. Since several central banks worldwide had followed suit and also raised their rates too rapidly, they are reeling from similar shocks to those that took place in the US after the actions of the Federal Reserve.
In a last-minute bail out, HSBC acquired the UK interests of SVB for the token amount of £1 even as it had to commit more than $2 billion to SVB’s UK business, probably the best outcome for the latter as HSBC will now acquire its debts and obligations. The action has stabilised matters for the thousands of customers who have over £6 billion in savings in the UK branch of SVB.
By mid-March, the Swiss bank Credit Suisse had lost as much as 30 per cent of its capital when European investors dumped its stock. UBS, Switzerland’s biggest bank, has now agreed to buy Credit Suisse, but the takeover will provide the latter bank’s shareholders with less than 40 per cent of what their shares were worth before the crisis.
Billions of dollars are being mobilised to save the banks from failing, with money apparently becoming unintelligible to the rest of us as it is haphazardly shifted around from one location to another. If the financial system of the most-powerful country in the world can nosedive so speedily, how can less-fortunate countries deal with the tremors that come in its wake? There will most likely be another sharp recession, and there is no chance that this will not affect the world at large.
This is an ongoing story, and we have yet to see the end of it.
* The writer is former professor of communication based in Vancouver, Canada.
* A version of this article appears in print in the 23 March, 2023 edition of Al-Ahram Weekly