Tuesday, March 21, 2023

Will the Federal Reserve Have a Change of Heart?

By: Hussain Al-Qemzi

Investing short-term loans in long-term assets is a recipe for bankruptcy and financial disaster. The global financial crisis in 2008, which was a credit crisis and its global causes were toxic assets in mortgages, would not have been a problem of this magnitude in our region had it not been for the fact that many institutions had been exposed to the risks of repayment due to the short term of their debts invested in long-term assets.

This is what happened with the Silicon Valley Bank, which was placed under receivership and announced today that it seeks bankruptcy protection. In the wake of this, markets have become volatile, and a crisis called the Banking Crisis has risen, which is an inevitable consequence of what central banks in the developed world do when they want to revive the economy. The problem ignites when central bankers cut short-term interest rates, which encourages everyone to invest in long-term assets. We can see the impact of that action in commercial real estate, private equity firms, and venture capital, as the return on the commitment to hold long-term assets financed by short-term debt is particularly attractive when funding is plentiful.

Then the bankers in these countries hike interest rates, so short-term financing becomes exorbitant, and these investments turn against the investors and become a nightmare. Silicon Valley Bank has taken on enormous deposits from the private equity firms it has been focusing on lately, and what any bank does is invest these deposits in loans and generating assets. Deposits are always short-term, and the bank must pay them upon request. 65% of deposits were invested in US Treasury Bonds for ten years and more at a low-interest rate of less than 2%. The Bank’s conditions became suddenly precarious when the value of its long-term assets dropped (higher interest rates equals lower bond values) while the short-term financing cost of those investments (customer deposits) rose.

When depositors start fleeing a bank, it is either because they seek a higher return on their deposits elsewhere or simply because they are afraid of not getting their deposits back, and this, of course, is usually followed by people rushing to the bank to withdraw their funds.

Depositors and investors are frightened and reliving the shock of 2008’s global financial crisis, therefore, on the one hand, depositors started avoiding banks and looking for fixed-income investments that are invested in well-yielding government bonds; on the other hand, investors are abandoning bank stocks and causing their value to collapse in financial markets and stock exchanges.

Everyone is awaiting the next week’s FOMC meeting. The Fed has done a lot of tightening, but it doesn’t seem to have noticed that it’s starting to affect the banks. The goal of the Federal Reserve and any other central bank is not to control inflation but to maintain financial stability in the country. There will be no financial stability as banks continue to go bankrupt, and

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