From our point of view, the failures were expected. We were waiting for things to break…now, they’re breaking. And now, somehow, somewhere, sometime, by someone…the losses must be reckoned with.
Who will pay them? That is our subject for today.
‘No losses will be borne by the taxpayers’ said Joe Biden on Monday. Where were the ‘fact checkers’…the truth seekers on the alert for misinformation and lies? They must have been taking the day off. For if there were one thing you could count on it is this: ultimately, the taxpayers will have to bear the losses, probably in the form of inflation. As more banks break, the Fed will have to bail them out…and eventually, it will abandon its rate increases. Consumer prices will rise; households will pay.
Who else would cover the losses?
Who always pays? The 1980 S&L crisis — in which members of Congress, the Keating Five, played a leading role — cost taxpayers US$124 billion.
The 2008 bank bailout, TARP, cost US$500 billion. Investigative reporter Jim Bovard says that more than 4,000 financial institution employees got US$1 million-plus bonuses as a result.
The ‘zero rate’ fantasy of the Fed, after 2008, cost US household savers US$4 trillion.
And thanks to the reform measures of Barney Frank and Elizabeth Warren, in 2010, which were intended to prevent another banking crisis, banks are now saddled with US$600 billion in unrealised losses on their portfolios of government or government-backed securities. That is not just a ‘paper’ loss. That is a real loss. Someone will have to pay.
Usually, you have to pay to borrow money…which forces you to think carefully about what you’re going to do with it. If the interest rate (after inflation) is 4% (the ‘hurdle rate’)…you need to find an investment that will give you more than 4% interest. Otherwise, you will stumble on the hurdle, lose money…and drop in the esteem of your friends, family, and rivals.
Normally, too, there aren’t a lot of investments that will pay off for you…for the very obvious reason that when there are a lot of good investments, people borrow to make them, and the hurdle rate rises. The system is normally self-regulating, preventing too much speculation and too much debt.
But along comes the Fed with its magic elixir — interest rates below inflation. Suddenly, the ‘hurdle’ disappears. Almost any gamble — cryptos, NFTs, new tech, Treasury bonds! — could pay off.
And so, it came to pass, between 2009 and 2022, that people borrowed wantonly. They invested recklessly. And they lost prodigiously.
All fine and good. But what now? Will the deciders decide that they — the ones most responsible for the borrowing bacchanalia — will pay the losses? Barney Frank, Elizabeth Warren, Joe Biden, Janet Yellen? No, in their wisdom, they’ll decide that someone else will pay.
But this is the nature of the regulation-rich, responsibility-poor, judgment-free world. No one should have to bear the costs of his own ill-health, bad judgment, incompetence, job loss, or bank failures. The ‘unhoused’ person — who was evicted for not paying the rent — believes someone should provide a decent home for him. The ‘unwed’ mother expects the government to provide her with childcare. Whatever the need…the misfortune…or the misconduct, someone else should pay for it. The insurance company…the government…the rich…someone should bail you out!
Whence cometh the capital?
In the case at hand, the feds now say the bank’s wealthy shareholders will lose, but not the wealthy depositors. Currently, deposits are insured by the FDIC up to US$250,000. But 97% of Signature’s deposits were for more than that amount. They were accounts used by hedge funds, corporations, and speculators, not by Mum-and-Pop savers.
The bank itself no longer has the money to make those depositors whole. So, where will the money come from? The deciders who were supposed to make the banks safe? Or the Wall Street hustlers who used the Fed’s cheap money to make billions — trillions — over the last 12 years? Or the Fed governors, whose ultra-low interest rates created the bubble that is now losing air?
Joe Biden says the taxpayers won’t pay a cent. Whoopee! The losses have vanished.
What will happen next? Ray Dalio describes a scenario. From Markets Insider:
‘In his newsletter Tuesday, the Bridgewater Associates founder called the bank turmoil a “very classic event in the very classic bubble-bursting part of the short-term debt cycle.”
‘The cycle lasts roughly seven years, Dalio explained. In the current phase, inflation and curtailed credit growth catalyze a debt contraction, according to Dalio, and that causes contagion until the Federal Reserve returns to a policy of easy money.’
Most likely, a few more bank failures…and the feds will take another giant step forward towards a risk-free world. They’ll take over the entire banking system…including US$9 trillion in uninsured deposits.
But remember. The feds cannot make the losses go away. They can only move them around…from the people who deserve them to the people who don’t.
For The Daily Reckoning Australia