Incisive read explaining why Central Bank ‘solutions’ to the banking crisis aren’t actually fixing anything.
Mareike Beck is a Leverhulme Early Career Fellow at King’s College London.
Cross-posted from the LSE EUROPP blog
Banking is a delicate business, and European banks seem to be pretty bad at it. Following in the footsteps of Deutsche Bank and others, Credit Suisse is the latest European banking giant to experience a fall from grace.
Credit Suisse ranked as one of Europe’s 25 biggest banks, was the second largest Swiss lender, and had a balance sheet of 531 billion Swiss francs. The bank’s demise proves once again that the balance sheets of large European banks offer limited insurance against difficulties in contemporary global banking. The ripples from the failure of Silicon Valley Bank in the United States were enough to bring a once powerful European bank to the point of collapse.
After an emergency credit line from the Swiss National Bank failed to end Credit Suisse’s funding troubles, UBS stepped in to buy its former rival for $3.25 billion, following a frantic weekend of negotiations. While financial regulators claim this was a ‘commercial’ solution, UBS is backed up by a federal default guarantee and a liquidity line of 100 billion Swiss francs. Equity holders kept their value, central banks have flooded markets with US dollars, and no one knows where this will end. So far, so familiar in terms of how bank rescues go.
This repetition of quantitative easing and merging-as-rescue gives us a lens into the larger problems of the global financial system, and our inability to solve them. The problems are of course many, but three fallacies in global financial crisis management stand out. These fallacies highlight that the conventional responses of financial regulators and private institutions to crises tend to worsen our ability to calm and properly regulate financial markets.
Merging to create strength
The first fallacy is that a larger capital base can absorb risk. Merging two banks to make the problems of one bank magically disappear has not worked in the past. The takeover of Credit Suisse by UBS is just the latest example in a long line of desperate attempts to create stability through mergers that have seen many large European lenders merging since the global financial crisis.
I say desperate because these deals have not gone very well. For instance, public-private emergency rescues resulted in the disappearance of Dresdner Bank (taken over by Commerzbank) and ABN Amro (which was bought by a consortium of Royal Bank of Scotland, Fortis, and Banco Santander). Both deals were disastrous for the buying banks and more public money followed.
The Dutch government resurrected ABN Amro and the German government still has a stake in Commerzbank. UBS might well see similar problems from the Credit Suisse takeover. While it is unlikely that Credit Suisse has Dresdner’s volume of toxic collateralised debt obligations on its balance sheet, and we are (not yet) experiencing a global financial crisis of similar extend, UBS shares tumbled in value immediately after the Credit Suisse deal.
Merging banks to fabricate a balance sheet volume so large you can hide bad debt is not a solution to the problems of risk, bank runs, or capital shortages. UBS is now the world’s largest wealth manager with $5 trillion of invested assets globally. Credit Suisse had to be rescued with public money because of its systemic importance. Having fewer and fewer banks of larger and larger size is a cause of global systemic risk and vulnerability, not its solution.
European central banks as financial regulators
The second fallacy is that European central banks are the financial authorities responsible for European finance, the managers of the money supply, and the guardians of banks. Indeed, to prevent an even greater financial crisis emerging from the failure of Credit Suisse, several central banks announced a large and coordinated action on 19 March “to enhance the provision of liquidity by the standing US dollar liquidity swap line arrangements”.
The resources central banks have used in this crisis should give pause for thought. We are used to seeing rescue packages using US dollars, but it is worth asking why the failure of Credit Suisse should lead central banks to increase the supply of dollars rather than Swiss francs or euros. The reason for this is that whenever there is a crisis, financial agents rush to security. The US dollar is the safest asset and during a crisis everyone wants to buy it.
To prevent a larger financial crisis, central banks must therefore provide US dollars. We saw that three years ago at the start of the Covid-19 pandemic. This raises questions about who can really save European finance, suggesting it is not European central banks but instead the Federal Reserve that holds this power. While the Swiss National Bank was key to the precise conditions of how Credit Suisse was taken over, it was the dollar swap lines that prevented a larger financial crisis. The dependency of European banks on the US dollar means the Fed has become the only game in town.
Ensuring credit provision
The third fallacy is that saving global financial markets will ensure credit provision to households and corporations, as the central banks’ press release claims. Presumably, this is supposed to bring economic well-being to the household sector but exactly how is never specified. Research has shown that the links between quantitative easing and household credit supplies are ambiguous at best. Instead, expanding US dollar swap lines highlights the fact that central banks have no solution for fixing our crisis-ridden global financial architecture beyond simply supporting it.
The latest crisis shows how bad things really are. Central banks find themselves caught between the rock of a potential US dollar liquidity crisis and the hard place of inflation. Recently, central banks have moved seamlessly, and desperately, between quantitative easing and quantitative tightening.
They embrace quantitative easing whenever a crisis looms but are simultaneously engaging in quantitative tightening to try to stem inflation. Flooding markets seems to be the only solution when instability appears on the horizon, but this ostensibly runs against efforts to tackle inflation and the cost-of-living crisis, the effects of which on households remain unaddressed.
Indeed, the costs of these crises are borne directly by households. The Fed’s press release is silent about how its quantitative easing efforts are supposed to ensure credit provision to households. The distributional impact of its policy is left unacknowledged. The Fed’s approach over recent decades has produced housing price increases and inequality, all of which makes it difficult for households to tackle the current cost of living crisis.
Christine Lagarde is optimistic the current crisis might help to dampen inflation because of reduced lending, but again we might ask who would be most affected by that? After this latest round of quantitative easing, central banks will potentially want to increase interest rates in the future to recollect that money again, causing further price rises for food, rent, and mortgages, if recent rate increases are anything to go by.
A failing system
This banking crisis and the solutions provided demonstrate just how problematic global financial markets have become. While on this occasion, bondholders shouldered some of the losses involved – and were deeply annoyed at that – shareholders walked away with $3.2 billion. Regardless of which financial investor is prioritised in a debt recovery scheme, we should reflect upon the broader issues at stake when individual financial agents fail. By saving banks in crisis without addressing the underlying causes, we entrench further an already failing financial system.
Beyond throwing more public money at global financial markets and creating ever greater financial giants, we would be better served by exploring different solutions. And this is my one proposal. While financial authorities potentially ignore these three fallacies of crisis management, we could start paying attention to the many households that – similarly to global banks – also struggle to receive credit.
Rather than gaining profits from leverage, these households need their leverage to make ends meet. If we open the floodgates to save global finance, maybe we can redirect some of the subsequent credit flows to the goals of reducing inequality and enabling households to navigate the current cost of living crisis. This is one rescue that would be worth pursuing.
Thanks to many generous donors BRAVE NEW EUROPE will be able to continue its work for the rest of 2023 in a reduced form. What we need is a long term solution. So please consider making a monthly recurring donation. It need not be a vast amount as it accumulates in the course of the year. To donate please go HERE.
Be the first to comment