No easy way out from banking crisis

Credit Suisse had to be sold off hurriedly

The latest banking crisis is a sign that the central banks that manage global capitalism are running out of options. 

They responded to the last banking crisis in 2007-8 by throwing money at the financial system. They prevented the Great Recession of 2009 from developing into a slump on the scale of the 1930s by cutting interest rates to zero and by quantitative easing (QE)—buying up bonds as a way of creating new money and pumping it into the banks.

But the global financial crisis was ultimately caused by a low rate of profit that discouraged productive investment and stimulated financial speculation. By avoiding the large-scale destruction of uncompetitive capital the rescues prevented a robust recovery of profitability.

The global economic system therefore continued to depend on low interest rates and QE. Attempts by the US Federal Reserve Board in 2013 and 2018 to return to financial “normality” failed. 

At the start of the Covid-19 pandemic in March 2020, faced with financial markets freezing on an even greater scale than 2007-8, the central banks extended QE. They also created new money for governments to spend on subsidising incomes and jobs. Ultra-free-marketeers have been warning for the past 15 years that all this extra money would lead to rising inflation. 

But when inflation did increase sharply in 2021-22, the causes lay mainly in the productive system. 

The pandemic disrupted supply chains that now bind together the global economy. Households responded to the lockdowns by buying more, pulling up prices. And, as East Asia switched away from coal, natural gas competition increased. Nevertheless, central banks responded according to neoliberal orthodoxy by treating inflation as if it were a result of all the extra money in the economy. They started to abandon QE and pushed up interest rates hard and fast. 

They were playing brutal class politics—weaken workers’ bargaining power by forcing unemployment up and wages down to protect profits. But this strategy is destabilising sectors of the financial system. This first became visible when Liz Truss and Kwasi Kwarteng’s gamble on tax cuts last autumn caused the price of gilts—British government bonds—to fall sharply. Many pension funds, which had bet heavily on gilts, were threatened with collapse.

The insolvency of Silicon Valley Bank (SVB) last week is another example.  This bank specialised in serving the tech industry in northern California. New start-ups take time to become profitable so they initially depend on loans from venture capital. 

They deposited this with SVB, which invested heavily in long-term US government bonds that paid a bit more when interest rates were very low. But rising interest rates led to a fall in bond prices. When its depositors woke up to this, they pulled their money out. 

This was an electronic version of the depression-era bank run depicted in It’s a Wonderful Life. But when this led to SVB’s collapse, the depositors lobbied frenziedly, alongside Democratic Congressional representatives and rich political donors, for Washington to rescue them, which is what happened at the start of last week. But this didn’t stop the rot. 

This is partly because speculators are trying to make money by probing the system for weaknesses. One target has been the big Swiss bank Credit Suisse, almost comically dogged by scandal in the past few years, After a £44 billion loan from the central bank, it is being taken over by its rival UBS.

This “shotgun wedding”, as the Financial Times calls it, is failing to calm financial markets. This is because £14 billion worth of Credit Suisse bonds have been wiped out. 

This is spooking the bondholders of other banks. In the US, the SVB rescue was designed to protect the largest banks. So investors and depositors are deserting the small and medium banks, which are now demanding the same protection.

More fundamentally, the system’s managers don’t know what to do. If the central banks start cutting interest rates this may generate a panic about inflation, if they carry on raising rates, this may blow more holes in the financial system.