Former Chief Economic Advisor (CEA) Krishnamurthy Subramanian on Tuesday said the banking crisis in America is not over yet and that the regulators are 'kicking the can down the road'. He has also blamed the US for its fiscal profligacy during the Covid period, which he said is costing America now.
America is currently firefighting to restore the confidence of investors in its regional and smaller banks after the quick meltdown of two lenders - Silicon Valley Bank and Signature Bank. They both cracked in no time despite being in a solid position just days ago. And the speed with which they collapsed prompted the regulators to step in to prevent any likely contagion.
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But Subramanian, who served as India's chief economic advisor from 2018 to 2021, thinks the American government's programme may help for now but the crisis hasn't yet fully abated. "Fed program was brought to stop panic leading to bank runs," he said. "While it may help, the crisis (looming bank failures) has not blown over."
Silicon Valley Bank, the 14th largest in the US, collapsed last Friday. And two days later, the regulators also took control of Signature Bank. Over the weekend, US Treasury Secretary Janet Yellen, Federal Reserve Board Chair Jerome Powell, and FDIC Chairman Martin Gruenberg came out with a programme to safeguard the interest of depositors.
In a joint statement, they said all the depositors will have access to their money and no losses associated with the resolution of Silicon Valley Bank "would be borne by the taxpayer". Also, they said the Fed will make available additional funding to depository institutions that will help banks meet the needs of all their depositors.
Silicon Valley Bank collapsed as it had invested heavily in government bonds. And as the interest rate went up to control inflation, the prices of its bonds declined. The bank had to sell the bond holdings worth $21 billion at a loss of $1.8 billion as the deposits had dried up and it had run out of liquidity. The SVB would not be in this position if it had retained the securities till a rebound in their prices (and this would be possible only when the interest rate is back where they were months ago).
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Now, the Fed has tried to protect more banks from selling their investments at loss. Under the new programme, they can now take loans from the central bank for a year to meet their liquidity need. However, Subramanian said that Fed's program essentially pushes the "can down the road" by one year in the hope the policy rate would be lower.
"(The) program is: Banks can borrow from the Fed by putting up their securities as collateral," he said, adding that crucially, collateral gets valued at face value of $100, not the marked-down value. He said the Fed can be both - right and wrong in its assessment.
Subramanian said the Fed's hope that rate would be lower may come true due to an inverted yield curve. "If expectations captured by the yield curve are right (A BIG IF), rates next year will be lower than now," he said.
But, he also hinted that it may not happen because inflation (even in the latest print) is stubborn. "If Fed continued to focus on controlling inflation, even more rate hikes will be required. So, rates next year may be higher than now. If Fed's punt is wrong, then trouble wud be higher," the former CEA said.
Subramanian, who is currently Executive Director at IMF, suggested that the cost of protecting the banks will be borne by taxpayers. "The program is essentially a transfer of money from the Fed (and thereby taxpayers) to the banks," he said, underlining that the penal interest rate is only 0.1 per cent. "Even good banks will exploit the available "arbitrage." Question is: When does the taxpayer, i.e. U.S. Congress, say "enough is enough"?" he asked.
The former CEA, who played a key role in formulating policies during Covid, said the risk of bank failures remains unaltered. "The inescapable conclusion, however, is that fiscal profligacy during Covid is costing the U.S. now," he said, referring to America's stimulus and relief package to its citizens during the pandemic - which fuelled inflation besides other factors. He said America moved for "long-term pain for short-term gain" while India chose the reverse: "short-term pain for long-term gain".
Subramanian also shared a chart showing how US' profligacy resulted in increased deposits in banks. As per the chart, deposits in the bank rose by $5 trillion while consumption increased by just $3 trillion. As consumption did not rise, demands for loans also did not go up. While deposits in banks went up by $ 5 trillion, the demand for loans was only at $2 trillion. Of remaining $3 trillion, banks invested $1.3 trillion in treasury and agency securities, the chart showed.
However, as the policy rate has jumped nearly 5 per cent in 6 months, the value of securities with banks has come down by over $600 billion - this loss is 30 per cent of the total equity of banks. This may make some banks more vulnerable in the future if policy rates don't go down.