Another Huge Dose of QE

Last Friday morning, I wrote about the crash of SVB before most people had ever heard of it. By today, nearly everyone with money in a bank has heard of it. When I wrote about it on Friday morning, the bank had not yet gone bust, but its shares had collapsed, as it went to the capital markets to try to raise nearly $2 billion from new shares, to cover its capital losses from a forced sale of Treasury Bonds. Not surprisingly, few wanted to buy the new shares, and its depositors started a run in the bank, similar to that in Northern Rock, in 2007, except now, with electronic banking, you can try to shift your money at the press of a computer key. The bank became insolvent, and the authorities closed it down, leaving them with the question of what to do next.

In the hours following the closure of SVB, other similar small banks were forced to close their doors, such as Signature Bank in New York. But, dozens of small US regional banks have also seen their share prices crash, and the crisis-ridden European banks have also seen a continued sharp fall in their shares, in early Monday trading. The basic reason for the problem is what I explained more than a decade ago, and again summarised on Friday. The huge asset prices bubbles blown up as a result of central banks creating excess liquidity over the last 30 years, to protect and enhance the form of property of the ruling class – fictitious capital – means that the balance sheets of banks and finance houses are themselves a fiction, because the book value of the assets sitting on those balance sheets, massively overstate any real value of them, which is manifest whenever a crisis erupts, as in 2007/8.

In theory, the value of the Treasury Bonds on the books of SVB, provided it with adequate capital that could be used to cover any trading losses or deposit withdrawals by its customers. But, that ws only true provided those bonds could be sold at their book value, or at their nominal value if held to maturity. The problem is that, when the bank did face a requirement for cash to cover trading losses and deposit withdrawals from customers, it could not wait a year, 5 years, or 10 years for those bond to mature, so as to redeem them at par. It had to sell some of them immediately. But, as interest rates have risen the market value of those bonds has crashed, meaning that it would suffer a huge capital loss on the sale, of around $2 billion. Other banks, and not just small banks are in the same situation.

The problem also arises because the structure of banking and finance has changed over the last 30 years along with this action by central banks to create huge asset price inflation, via the injection of excess liquidity. Banks used to operate by having shareholders provide a large chunk of the bank's capital; they also used to rely on depositors to put money into the bank, which they used alongside that capital to make loans. The loans themselves also used to be to finance things like real capital accumulation by businesses. Where they made loans to consumers for things like buying a car, the car and so on, acted as something that could be used as collateral and sold to redeem the loan value. Even with mortgages, the loans were limited, usually to just 2.5 times the household income of the borrower, and then only after the borrower had shown they had been able to save a considerable amount, so as to provide at least a 10% deposit to buy a house.

But, in the 1980's, as a result of the deregulation brought about by Thatcher, in Britain, and Reagan, in the US, all that changed. Prior to the 1980's, the large majority of people, in Britain, lived at home with their parents, until they got married, usually in their mid 20's, before they would consider buying a house, or applying for a council house. A comparison of household composition over time illustrates that point.

In 1971, 79% of UK households were multi-occupancy, 70% were occupied by married couples. Only 19% were occupied by single people, with a further 2% occupied by lone parents. By 2011, those figures had changed drastically. Only 59% were multi-occupancy, the number of married couples had dropped to just 40% with a further 12% co-habiting, and another 7% other multi-occupants. By contrast, the number of homes occupied by one person had almost doubled to 33%, with 8% occupied by lone parents. Of the 19%, in 1971, that were single occupancy, the majority of those were old people who had lived in the house for a long time, and whose families had grown up and left, and spouses had died etc.

The fact that borrowers could only borrow 2.5 times their combined income, limited how much they could offer to pay for houses, and that put a limit on how fast house prices could rise. But, when Thatcher deregulated financial markets, in 1986, this limit on borrowing went. Now, the limit on how much you could offer for a house depended not on how much your income was, directly, but on how much you could afford to spend each month on a mortgage, and that depended on mortgage rates. In the 1980's, banks and building societies also introduced interest only mortgages, which further exacerbated that. As interest rates fell throughout the 1980's, and 90's, so the amount borrowers could afford each month on a morgage translated into larger and larger mortgages, which in turn meant they could offer larger and larger amounts for houses, directly pushing house prices higher.

It was also manifest in the fact that not only did banks and building societies, then, enable borrowers to borrow many, many more times their income, but they also gave mortgages for more than 100% of the market price of the house, on the basis that house prices would continue rising significantly each year, enabling them to get their money back, if they needed to foreclose. With everyone encouraged to borrow, whether to cover consumption, or to speculate – be it on a house, or to buy shares, PEP's, ISA's or private pensions – and no one saving, the banks and building societies increasingly financed their own lending, by borrowing themselves in capital markets. They loaned money long, at higher interest rates for mortgages and so on, but borrowed short, at lower interest rates, making a trading profit on the difference in rates.

But, that model collapsed overnight in 2007, when Northern Rock and other banks and finance houses found that overnight borrowing costs soared, as a credit crunch developed. The interest rates at which they could now borrow, were higher than the interest rates they were charging, and often locked into on the loans and mortgages they had provided, leaving them with trading losses, and a lack of liquidity. In reality, however, that lack of liquidity was a result of a lack of capital. But, that was just one aspect of the change that had occurred, because, now, 90% of bank lending went to finance this kind of property speculation that depended on ever rising house prices, with very little going to finance real capital accumulation by firms, particularly small firms, who found they could only borrow by much more expensive means, using personal credit cards, overdraughts, and so on.

Ironically, big companies that could borrow easily by issuing their own corporate bonds, did so, and enjoyed low rates of interest on those bonds, as asset prices rose, but used the proceeds, largely, not to finance real capital accumulation, but to finance the buy back of shares, inflating share prices, as part of the ever upward spiral of asset prices. And, although this fiction, based upon an ever expanding web of inter-connected debt instruments was exposed with the crash of 2008, unlike previous financial crashes, such as 1847, 1857, or 1929, this time, the state and central banks acted to simply reflate those asset prices, and so restore the paper wealth of the ruling-class, which owns its wealth, now, in that form, even at the cost of destroying the real economy, with austerity, the use of tax to buy up the worthless paper assets, and bail-out their owners, to inflate the currency by even larger amounts, so as to buy up and inflate the asset prices, and to hold back economic growth, whether by austerity, trade restrictions, or physical lockdowns, so as to hold down interest rate rises, which cause asset prices to fall.

In 2007, at its height, before the crash, the Dow Jones was at 14,000. Until recent falls it was at 37,000, and is still at around 33,000, or around 2.5 times its level at the bubble top. It fell to around 6,500. Even that was secured, only, by huge levels of support by the state asset purchase programme, and central bank intervention. But, compared to that, its now more than 5 times that level, almost entirely due to the actions of the central bank in inflating the currency supply, and the liquidity being diverted into speculation in assets.

And, all of the house of cards of derivatives that led to contagion in 2008, and during the Eurozone Debt Crisis of 2010, is still there. Back in 2013, I noted the reports that Germany's Deutsche Bank had exposure to around €55 trillion of derivatives, an amount equal to the entire global GDP. The position has not improved, but been papered over, and now we have other large European banks like Credit Suisse teetering on the edge. Its shares have been falling for months, and today, as bank shares continue to be hit, they have fallen another 12%, to just 2.20 Swiss Francs.

The response is again to rely on central banks not to raise interest rates further, and to engage in another bout of QE to bail out the banks and reflate asset prices, even though that is the cause of the problem, and also of the high levels of commodity price inflation also now afflicting the global economy. SVB Bank in Britain has been bought by HSBC for just £1, showing that the British government can drop its objections to Chinese interference when it wants to! States have generally said that depositors in SVB will be guaranteed 100% of their deposits, and not just what is guaranteed under various existing deposit guarantee schemes.

Depositors should be protected 100%, because, if you put your saving in a bank, you should expect that they are safe, and that the state is ensuring that by properly regulating the banks. Its not like speculating, in which you know the risk that you might lose some or all of your money. In addition, such guarantees are necessary to ensure the circulation of money, and so also of capital and commodities, required for the continued operation of the real economy. Businesses have money from sales going into bank accounts continuously, and similarly going out to make payments to suppliers, workers and so on. There is no reason why a financial crisis, resulting from speculation in assets should be allowed to affect that.

Or take someone selling a house. The money from the sale goes into their account, or into the account of the conveyancer. If that money in the account was not fully guaranteed, people would be unwilling to even engage in buying and selling their houses, if they feared at any time, the bank might collapse, and they would lose their money. This protection of deposits, and of the continued operation of the mechanism of liquidity circulation is the responsibility of the state, and quite separate from any speculative losses that individuals or institutions might suffer from the fall of various asset prices.

In the US, the Federal Reserve has now said that banks that require liquidity, and who face the same problem as SVB that if they sell bonds, they will suffer large capital losses, can now sell those bonds to the Fed at par. In other words, this is a new large dose of QE. The Fed is agreeing to buy Treasury bonds from banks at their face value, even though the current market value of those bonds might be only a fraction of it. The Fed will have to print more money tokens to be able to buy up those bonds, i.e. QE. This is at a time when it and other central banks were supposed to be stepping up QT!.

So far, this Bank Term Funding Programme is limited to $25 billion and lasts for a year. But, much more than that is likely to be required. The following chart shows that US Banks have securities the current losses on which, if they had to realise them, via sale, would amount to around $600 billion.

The speed with which that potential crisis has developed, is also indicated in the chart. But, SVB, and other small banks, plus what happened last year, with UK Pension Funds, shows just how quickly the crisis can erupt, as banks and other financial institutions have to sell assets whose prices have been grossly inflated, as a result of speculation driven by excess liquidity, and a global economy that has increasingly been driven not by the needs and laws of real capital, but purely by the requirement to keep asset prices inflated, so as to protect the form of wealth of the ruling class.

It indicates the extent to which that ruling class is now simply parasitic on the real economy, on the further development even of capital.