In the not-so-distant era of low interest rates, some experts predicted that interest rates could no longer rise sharply because our financial system would no longer be able to withstand such an increase. Was this assessment wrong? Five months ago, higher interest rates put British pension funds in a predicament. At that time, the Bank of England stabilized the situation.
Now American West Coast banks have gotten into significant trouble that is calling Washington onto the scene. Nervousness characterizes the stock markets; Pessimists fear a new severe financial crisis, which no one really needed in an already complicated political and economic world situation.
The crux of the rising interest rates lies in the price losses they cause for bonds and other fixed-income securities issued during the low-interest phase. These securities are predominantly held by central and commercial banks and other financial institutions such as insurance companies, pension funds and investment funds. The price losses do not lead to disaster if investors simply hold their securities until maturity. At the end of the term, bonds and other fixed-interest securities are redeemed at a nominal value of 100 percent. Then there is no loss.
The banking system is better equipped with reserves
The disaster threatens if investors can not hold their securities, but have to sell them with price losses. The British pension funds had entered into risky forward transactions in order to generate additional profits. When the deals went wrong and back payments became due, their only option was to quickly sell government bonds. Weakly regulated and risky compared to many large banks, Silicon Valley Bank had to sell bonds at high losses in order to remain solvent when its clients reclaimed their deposits before the weekend. Central banks are also threatened with losses on their bond holdings due to rising interest rates. But unlike commercial banks, they can also withstand very high losses because they print their own money.
From this repeated weather glow on the financial markets, it is not possible to conclude with certainty that there is an imminent storm. Overall, the international banking system is better equipped with reserves than it was before the financial crisis of 2008 and 2009. Most banks are also much more strictly regulated than before the financial crisis. This is especially true for the big houses.
However, during the Trump presidency, regulations for medium-sized American banks were partially abolished. Among others, the CEO of Silicon Valley Bank had advocated this. After the easing of regulations, the business of the American regional banks had grown strongly. Their share prices are now under particularly strong pressure. Washington has announced that it will tighten regulation for these banks again.
Keep a cool head
Regional American banking crises are not an unknown phenomenon. In the eighties and nineties of the 20th century, several hundred houses were wound up in the crisis of the so-called savings banks; the damage to the taxpayer amounted to more than $100 billion. Nevertheless, this regional crisis did not give rise to a global crisis.
Everyone involved now needs a cool head. The participants in the financial markets want the fullest possible rescue by Washington, and they will not hesitate to paint a serious crisis on the wall in the event that this rescue does not occur. If Washington gives in to the demands, there will be an immediate calming of the situation and significant price gains on the stock market. Economic historical research by economist Moritz Schularick shows, however, how the willingness of the state to save every market participant leads to even riskier behavior in the future with the danger of even greater crises. This cannot be a solution.
Central banks should also not allow themselves to be put under too much pressure. Its interest rate policy must continue to be primarily geared to safeguarding monetary stability. Rising interest rates may punish dubious business models of individual houses; the fate of Silicon Valley Bank is likely to be shared by more banks in the coming years. But market exits of individual houses do not endanger the entire financial system.
Private investors should therefore also keep a cool head. Falling stock prices are more of a reason to buy stocks than to part with your securities in a fit of panic and get annoyed about it later.