Banks on the Brink

What would you do?

You’re the Governor of a central bank which means your job is to set interest rates.

Inflation has been screaming for more than a year and consumers are still hurting.

You’ve pushed rates up further and faster than expected and now borrowers are reeling.

Worst of all, three banks have collapsed around you in the space of a week with more on the brink.

And now you’ve approached the most hazardous intersection of all, and you have to make a decision…

Do you pause rates because you’re worried about more banks collapsing or do you continue hiking rates to tame inflation?

On Wednesday night, news broke that Credit Suisse was in serious trouble, again.

Thankfully the Swiss government bailed them out (sort of) because the contagion effect would have been massive. #understatement

Since then borrowers have been on both knees hoping this crisis is reason enough for central banks to pause rates, or possibly cut them.

But here’s the thing…

Interest rates impacts borrowers.

Inflation impacts everyone.

The problem with inflation is it’s like cancer. The moment you stop fighting it, it metastasizes.

Credit Suisse is a good example of how serious it is…

On Wednesday night when Credit Suisse looked like melted swiss chocolate, the expectation was the European Central Bank would stop hiking rates.

Until the following night…when they hiked rates another 50 basis points.

However, the tide may turn for borrowers.

Watching the banks collapse over the past fortnight reminds me a lot of the early stages of the Global Financial Crisis (GFC).

In April 2008, Bear Stearns almost went under until it was bailed out at the eleventh hour.

A few months later Lehman Brothers collapsed (despite assurances it was ok) and a swag of other banks including Merrill Lynch, AIG, Freddie Mac, Fannie Mae almost went with it.

Consequently, central banks started cutting rates to inject some confidence into the markets but it had the opposite effect.

The markets tanked. And it happens every. single. time.

It’s analogous with a ship captain telling the crew there are no holes in the boat and then jumping into a life raft.

The unfortunate thing is, the mess that’s looming could have largely been avoided.

If central banks started tapping the brakes (interest rates) on the economy two years ago, instead of slamming them one year ago, inflation wouldn’t be out of control and borrowers would be better off.

The paradox is, if central banks start cutting rates now, it’s only because we have a problem worse than inflation.

What would you do?

Have a great weekend!

Adam

Back paddock: as our island of knowledge grows, so does our shoreline of ignorance – John Archibald.