Morning Wire XX
[0] The Federal Reserve raised the Fed funds rate by 25 basis points on Wednesday after a tumultuous few weeks in the banking industry.
[1] Fed Chairman Jerome Powell said the banking turmoil might trigger a credit crunch moving forward, but the Fed needs to stay focused on inflation and more rate hikes could occur in the future.
[2] In this episode of Morning Wire, we break down the rate hike, the banking crisis, and what it means to the American consumer.
[3] It's March 26th, and this is your Sunday Extra Edition.
[4] of Morning Wire.
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[12] Joining us to discuss is Peter Earle, an economist at the American Institute for Economic Research.
[13] Peter, thanks for coming on.
[14] Thanks for having me. Now, let's start with the Fed's decision to raise the federal funds rate another 25 basis points this week.
[15] A lot of people thought the Fed might pause raising rates due to all the economic uncertainty, but they didn't.
[16] What does this tell us about the Fed's priorities and what can we expect going forward?
[17] So what we saw yesterday was the Fed raising 25 basis points.
[18] The interest rate range is now between 4 .75 and 5%.
[19] And Powell changed his language abate.
[20] He didn't say anything about ongoing rate hikes, but instead he said that if necessary, rate hikes will continue and more importantly that he didn't see any interest rate lowering this year.
[21] And there's two things that are significant about that.
[22] The first is that the Fed, especially with the latest news in banking, this seeming weakness of a few banks has been distracted by a growing list of mandates, one of which, of course, is price stability, and that's what they do when they fight inflation.
[23] But the other is financial stability, and that's keeping the banking system stable.
[24] The statements that they made and the action that they took in raising the interest rate 25 basis points is they're making clear that their commitment is to their price stability mandate.
[25] And how did the market react to that?
[26] Well, it was interesting.
[27] The market first seemed to take it in stride and then fell.
[28] very hard at the end of the session because it seems to view the instability in the banking system as an ongoing issue and one that may see the Fed eventually have to abandon the inflation mandate.
[29] However, what's interesting is that in the various markets that sort of forecast what they think the Fed will do, those fell to about 4 or 4 .25%, indicating that no matter what Powell has said, in fact, the markets believe that rates will be lower by almost three -quarters of a percent at the end of 2023.
[30] Now, I want to dig into the failure of Silicon Valley Bank and Signature Bank.
[31] First off, can you explain the circumstances behind those failures?
[32] Sure.
[33] Silicon Valley Bank is a regional bank, so it's deeply involved in local businesses, which in the case of Silicon Valley, of course, is banking for tech startup firms.
[34] Most banks have a pretty diverse depositor base, meaning that they carry bank accounts for a wide variety of different firms and individuals.
[35] But because of the very diverse nature of Silicon Valley Bank's deposit base.
[36] It was exposed to trends within that industry.
[37] So early in the pandemic, you had people locked out at home.
[38] At the same time, you have the Fed lowering interest rates and the Treasury sending out stimulus checks and that sort of thing.
[39] So it's a huge monetary expansion and stimulus program.
[40] People are at home, they start spending that money.
[41] They start buying goods and services.
[42] They're doing gaming.
[43] They're doing streaming services.
[44] And so as these tech firms see their revenues grow, the bank balances at Silicon Valley Bank expand as well.
[45] At that same time, the bank decides to invest its money in long -dated treasuries, 20 -and -30 -year treasury bonds and agency securities, yielding 1%, something like that.
[46] So we step forward a year or two, it's a good situation where you're receiving 1 % or 2%, and you're paying out 0 .1 % on deposits.
[47] But soon we have inflation, the Fed begins raising rates, and what begins to happen is deposits begin leaving, both because of the fortunes of the tech firms.
[48] They're not keeping up after the pandemic.
[49] And soon we have what's called the duration mismatch, which means the bank is receiving interest rates from its assets, which are not high enough to meet the requirements of depositors and probably not high enough if there was a sudden withdrawal of deposits to keep up with them.
[50] So was this something that Silicon Valley Bank could have predicted or should have been prepared for?
[51] Or was this more just a rare confluence of factors?
[52] So there are confluence of factors.
[53] most banks, as I mentioned, don't have as narrow a deposit base as SVB.
[54] But the fact is that stress tests probably would not have taken into account what the Fed did between 2022 and 2023.
[55] Most stress tests are based upon previous crises, you know, 1987, post -911, 2008, that sort of thing.
[56] And you can bet that in the future, stress tests will take into account the quick and aggressive rise in the interest rates that the Fed put into place to fight inflation.
[57] They just weren't ready for it.
[58] Now, the banking crisis seems to have stabilized somewhat.
[59] Do you expect the instability in the banks to spread, or do you think the banking industry is fundamentally healthy?
[60] There may be a few other banks that have problems.
[61] But I think unless we see something very unusual, the Fed is probably near the end of its hiking cycle.
[62] So I don't think we're going to see many more problems of this sort.
[63] All right.
[64] So for the people who are concerned about another 2008, you don't think that's what we're looking at right now.
[65] I think it's a different kind of crisis that we're seeing this time.
[66] one that's probably mostly in the rearview mirror at this point.
[67] Now, let's talk about the government's response.
[68] Why do you think Janet Yellen chose to bail out SVB?
[69] And was that the right choice?
[70] So there's an issue of moral hazard there, to be sure.
[71] I think that there was a systemic element to the SVB collapse, and that was not one where it might take down other banks, but that Silicon Valley is a major tax source and it's a major revenue source for the U .S. government and for California.
[72] you know, there are implications if that entire region of the country is suddenly unable to access money.
[73] So I think that's one of the reasons why this bank was rescued.
[74] But every time we do something like this, every time the government makes a policy that's an exception to what has been established, you know, we paved the way for the next episode of moral hazard.
[75] You know, would this have happened if there hadn't been bank bailouts in 2008?
[76] If there hadn't been airline bailouts in 2001, I'm not sure.
[77] But I definitely think that every time something that this happens, we pave the way to more expectations for the government to rescue firms and individuals from their own mistakes.
[78] I do believe that we make grievous errors when we privatize or allow gains and successes to be private, but we make losses and errors public.
[79] I think that's a terrible thing that the government does.
[80] And there were banks out there that did the right thing.
[81] So the idea that we would rescue one, regardless of its impact on revenue, is just another step down a moral hazard fraught lane or path.
[82] Now, what can everyday Americans expect for the economy going forward?
[83] So first with inflation, what we've seen is over the last two months the pace of disinflation has slowed.
[84] And actually, in some cases, we see service prices, especially in the areas like rents and owner -equivalent rents rising.
[85] So that suggests that maybe the Fed's target of a 5 .1 percent terminal rate, which means the high point rate that they anticipate lifting rates to for this cycle, may be on the low side.
[86] However, I also think that the existing situation with banks has also sort of led the Fed to pause right now.
[87] They said they'll raise rates that they have to.
[88] They may do another 25 basis point range.
[89] So I think they're going to try to thread a very narrow line between keeping the banking system stable and fighting inflation.
[90] But I think for most Americans, service prices are a little bit different than goods because there's just a bit more what we call stickiness to them.
[91] So I think we're going to see elevate inflation for a bit longer.
[92] it might hover between the three or four to five percent range for a while, but the Fed is going to attempt to get those rates down by using the various tools that they have.
[93] I'm not sure how successful they're going to be at this point.
[94] As for a recession, I definitely think that there's a chance that the economy slows a bit more.
[95] A soft landing is probably out of the question to this point.
[96] I think the question is rather within the next 24 months, whether we get a slowdown or we get an actual recession by definition.
[97] Thanks for coming on today.
[98] That was Peter Earl, economist at the American Institute for Economic Research.
[99] And this has been a Sunday extra edition of Morning Wire.