Last week we saw the first cracks in the economy. Two US banks are in trouble. Silvergate and Silicon Valley Banks experienced a bank run. Silver Gate may shut down completely, and SVB is not yet determined. We had a bunch of “experts” coming out telling us what happened. Many are in a panic mode and reporting in a catastrophe tone about the “mini Lehman financial crisis”. And the FED may have a problem.
I am not sure what happened with Silvergate bank besides that it was involved in crypto and couldn’t survive the recent crypto meltdown. But the SVB issue is more related to the FED and its aggressive interest hikes. And here we see some potential trouble the FED may be facing soon. They wanted to break something to bring inflation down. And it starts to seem that they broke the financial sector. Exactly the sector they didn’t want to break.
Wednesday’s selloff was induced by Powell’s “higher and longer” remarks. Thursday’s selloff was triggered by fears that SVB may start the financial crisis that would lead to the economy-wide credit crunch and recession as we saw many times in the past. The 2008 recession was the exact same problem. The inverted yield curve was signaling since last summer that something could break in the financial system if the FED continues to tighten the monetary policy.
The SVB trouble could be the start of the credit crunch and subsequent problems. It may spill into other sectors very quickly, mainly because of the fear of other people and other investors in the market. The FED may choose to ignore it because the SVB bank is too small to bother but the fear of other people is not. And their behavior may spark problems elsewhere. And now the FED may have the crack they wished for. Unfortunately, that is not a crack that would help with inflation. Now, they have to choose between high inflation or a crash in the economy.
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