Higher rates and a liquidity shortage

THERE is no doubt that the significant interest rate changes last year — in whole or in part — are behind the problems for the banks that have been closed or forced to merge within a short time in Switzerland and the United States.

Therefore, speculation inevitably arises as to whether more banks are suffering from the “interest rate risk.” Consider how the European Central Bank has pumped large amounts of liquidity into the financial system at zero percent interest so that European banks can buy up Southern European government bonds with long maturities and weak creditworthiness — basically the same thing that Silicon Valley Bank (SVB) in California tried to do.

Allow me to start in the most conservative stronghold for money: Switzerland. I don’t think I’m giving much away by mentioning that many in the financial market over the last 20 years have noticed the several speculative and marginal businesses that Credit Suisse was involved in. It’s almost a given that at a time of extreme volatility in financial markets, a bank or two will fail when they are so stressed all the time.

It is always easier to be wise about other people’s companies than one’s own store — the experience with SVB adds to this in retrospect. One thing is how the company culture was handled at SVB and where the commercial focus has been. Based on a number of media reports, it has been made clear that there was also a direct parallel between the increase in interest rate speculation and the increase in salary levels for the bank’s management.

The bank had a significant deposit surplus, which yielded zero percent in return. It was decided to place this liquidity in bonds so an additional income could be created via a higher yield. This went well for a long period, and every time the bank needed to increase earnings, the bond portfolio was moved further out on the yield curve to increase the return. It also meant that, at the same time, the interest rate risk was increased. So when long-term interest rates in the US suddenly rose quickly and violently, the bond portfolio ended up showing such a large loss that SVB tilted.

A few other niche and regional banks have gotten into trouble in the US in a similar way, but in SVB’s case, I think it is quite clear that they

tried to increase earnings through pure speculation, which turned out to look like bets in a casino.

As it is all about banks in Europe and the USA, I can’t see the justification for calling it a global banking crisis. There is no systemic similarity between the banks in question, apart from the fact that the respective managements pushed the banks into unacceptable risks. Furthermore, the banking sector in Asia is doing quite well, and therefore I do not see the global aspect in the challenges either. If one finally wants to compare with the global financial crisis in 2008 to 2009, then I would rather look at the difference. Back then, it really was a global crisis, and it was bitterly hard.

Right now, the situation is quite different, and that is why I am currently not worried about a global banking crisis. But this does not mean that the credit market is riskfree again. The American central bank, in particular, will continue to provoke a reaction in the American economy so inflation comes down to a controlled area. The central bank obviously has raised interest rates but in a number of economies

I also expect that there will be an increasing shortage of liquidity. I can well imagine that situation lasting until mid-2024, which will be a nuisance, not least for commercial companies.

One open question that I continue to pay particular attention to is how much the US real estate market will be affected by the monetary tightening. Right now, house prices are staying at a stable level, which is important in relation to whether the concern about a banking crisis in the US increases further.

It seems it is only the construction activity that is slowing, so I therefore also continue to expect that the IT (information technology) sector and the construction sector will be the two major sectors to drag down activity in the US. With this, I still have the same assessment as before: that the dam holds, the glass is more than half full, and the US will experience a recession in certain sectors. Overall, the country will be free of a recession.

Peter Lundgreen is the founding CEO of Lundgreen’s Capital. He is a professional investment advisor with over 30 years of experience and a power entrepreneur in investment and finance. Lundgreen is an international columnist and speaker on topics about the global financial markets.