“This banking crisis won’t wreck the economy”

Here is my latest Bloomberg column, penned on Sunday, these days the VIXes are back down to normal ranges.  Here is one excerpt:

One reason for (relative) optimism is simply that the world, and policymakers, have been preparing for this scenario for some time. Not only do memories of 2008-2009 remain fresh, but we are coming out of a pandemic that in macroeconomic terms induced unprecedented policy reactions in most countries. Before 2008, in contrast, macroeconomic peace had reigned and there was common talk of “ the great moderation,” meaning that the business cycle might be a thing of the past. We now know that view is absurdly wrong.

Circa 2023, we can plausibly expect further disruptions and macroeconomic problems. But this time around the element of surprise is going to be missing, and that should limit the potential for a true financial sector explosion.

The kinds of bank financial problems we are facing also lend themselves to relatively direct solutions. Higher interest rates do mean that the bonds and other assets that many banks hold have lower values, which in turn could imply liquidity and solvency problems. But those underlying financial assets usually are set to pay off their nominal values as expected, as with the government securities held by Silicon Valley Bank. That makes it easier for the Federal Reserve or government to arrange purchases of a failed institution, or to offer discount window borrowing. The losses are relatively transparent and easy to manage, at least compared to 2008-2009, and in most cases repayment is assured, even if those cash flows have lower expected values today, due to higher discount rates.


The various bailouts we have been engaging in are not costless. For instance, they may induce greater moral hazard problems the next time around. But that does not mean we should expect a spectacular financial crash right now. More likely, we will see increases in deposit insurance premiums and also higher capital requirements for financial institutions. The former will fund the current bailouts, and the latter will aim to limit such bailouts in the future. The actual consequences will be a bleeding of funds from the banking system, tighter credit for regional and local lending, and slower rates of economic growth, especially for small and mid-sized firms. Those are reasons to worry, but they do not portend explosive problems right now.

In short, the rational expectation is that the US will muddle through its current problems and patch up the present at the expense of the future. For better or worse, that is how we deal with most of our crises. We hope that America’s innovativeness and strong talent base will make those future problems manageable.

Of course if I am wrong, we will know pretty soon.


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