homemarket NewsFinancial crisis like this go in waves, expect it to continue, says Harvard economist Kenneth Rogoff

Financial crisis like this go in waves, expect it to continue, says Harvard economist Kenneth Rogoff

Financial crisis like this go in waves, expect it to continue, says Harvard economist Kenneth Rogoff
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By CNBCTV18.com Mar 17, 2023 10:53:37 PM IST (Published)

While talking to CNBC-TV18, economist Kenneth Rogoff highlighted that it's far better to sell a bank than to bail it out, pointing out the UK as an example of a country that took this approach. Selling a bank not only helps in avoiding the financial burden of bailing it out, but it also ensures that the market remains competitive and efficient, he noted.

The past week has been marked by turmoil in global stock markets, with banking stocks bearing the brunt of the impact. The crisis began with the collapse of Silicon Valley Bank, followed by Signature Bank and Silvergate. As investors grappled with these developments, Credit Suisse, a major European lender, suffered a significant drop in share prices, prompting the Swiss National Bank to intervene with a massive $54 billion bailout.

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While talking to CNBC-TV18, economist Kenneth Rogoff highlighted that it's far better to sell a bank than to bail it out, pointing out the UK instance of HSBC buying out Silicon Valley Bank arm as an example of a country that took this approach. Selling a bank not only helps in avoiding the financial burden of bailing it out, but it also ensures that the market remains competitive and efficient, he noted.
Here's the full text of the interview.
Q: Let me straight off begin by asking you about the Fed meet next week. Do you think that the Fed will go for a 50 basis point hike or a 25 basis point hike? Or should there be a pause?
A: Well, they are not going to go for a 50 basis point hike. The optics of bailing out the rich depositors at Silicon Valley Bank and in fact, the broader program they did for other big uninsured depositors, and that at the same time, raising the interest rate 50 basis points, that alone which hits Main Street, that alone is probably a reason they won't do it. It's probably more likely than that, they will do half of that.
It all depends on what happens the next few days, a couple of days of next week. If the banking stocks seem calmish, then for sure they are going to do the hike. If we are taking another leg down, and there are more problems they will pause.
Q: So it all depends on the stress in the banking sector. Do you foresee more accidents in the US banking sector? We have seen what has happened with a slew of banks and now first republic bank. Many banks in the US have come to rescue First Republic. But do you think there could be more such accidents?
A: Well, I mean, it's one thing, the question if we are going to have panics where the depositors are all going to be trying to pull out their money. I think the Federal Reserve has made clear and the Treasury, they have bent over backwards, not to have panic, liquidations of banks.
On the other hand, interest rates have gone way up and that hits a lot of banks, we might go into recession, and that's going to hit them a lot more. So if we're talking about banking stocks, it's easy to imagine that they could go way down, I see the problem is worldwide, we have seen this remarkable rise in interest rates. And frankly, I think it was inevitable because we had these ultra-low interest rates that prevailed after the global financial crisis. And it probably wasn't going to last forever. And so there are adjustments to be made. And I expect to see many more problems pop up before this is over.
Q: Could you describe the kinds of stress we may be in for? Many have said that this is a repeat of the Lehman Brothers moment. Do you do you see similarities between what happened in 2008 to today?
A: Well, at least the authorities are going to bend over backwards not to do an exact repeat of Lehman, they would make different mistakes. But they are trying not to repeat that one, to have a bank blow up that's so interconnected, it brings down and freezes lot of the financial system with it.
Credit Suisse, quite frankly, had the possibility of doing that. But I clear that they are going to take what actions are necessary, they're probably going to break it up at the end of the day. I think its stock must be down 95 percent from the peak or something, sell it into pieces, but that's very different than simply having it go bankrupt.
On the other hand, there are many things that are worse than in 2008. We have inflation, (we) didn't have that then. Central banks can't really think about lowering interest rates. We have, of course, war in Europe, which is causing all sorts of problems in trade and further problems they had. I believe that we are in an era of more normal interest rates real and nominal than we were and that also makes things harder. We went through this period that I think was quite exceptional where money was just free for governments for the rich country governments and suddenly it is not.
Q: Also looking at what the ECB did announcing a further rate hike of 50 basis point, clearly seeing inflation as a challenge. Do you see this putting more pressure on the banking sector?
A: It certainly puts more pressure on the banking sector. I understand why they did, what they did, although, frankly, I was surprised, given the stresses in European banks that we are continuing to see today. I think the message they wanted to send was, we are going to beat inflation. We think our banking system is just wonderful. You don't need to worry about it. And they were worried that if they pause, or raise rates less than they had planned to do a week ago, somehow would say no, they know something.
In fact, what brought Credit Suisse down so quickly is their major shareholder, Saudi Arabia, didn't want to put in more money and everybody wondered, why weren't they being given a really good deal? So I think the ECB thought that by raising interest rates, it was sending a positive signal. But the fact is, the high interest rates are stress and we will see what's next.
Q: Now, in terms of the challenges for the US economy in the coming year, we have seen the US Fed, the Treasury Department, Janet Yellen, all of them going on to say that the US banking system is resilient. They have rushed to protect the depositors of banks like SVB, Silvergate, which have collapsed. But what are the other challenges you foresee that could be coming up for the US economy in the weeks and months to come?
A: First of all, what is this Treasury Secretary supposed to say? You should panic, go get your money as soon as possible? Now, her job and the Feds job is to try to tell people no matter what the reality and the risks are, don't rush to take your money out. Because of course, if they all do that, then there will certainly be a problem.
First of all, I want to say the US economy has done better than I would have thought, I think than most people thought. The labour markets still very strong. The consumer doesn't seem to quit initially; that was because there was all this money left over from the stimulus and from savings during COVID. Now they are going into debt. We still have a very strong consumer in the US and firms are still having trouble getting workers. That said, these interest rate hikes are going to start to kick in their long lags, we don't know exactly how long and so at some point we are going to see a lot more attention.
It's hard to know, it might not be till 2024, I don't think there's any way get rid of the inflation, that the US has to get it down from say, 3 to 4 percent and bring it down to 2-2.50 percent. I don’t think there is any way to do that without having a recession. And so what I think the Fed's going to do is say, well, we are going take it slow, and they are going to leave inflation up and then maybe in that case, there won't be a recession.
But it's very hard to know what's going on now. The pandemic has distorted markets, labour markets, supply chains, half our office buildings, the United States are still empty half the time, it is hard to read for everyone. And so far, the US is surprised on the upside. But that doesn't mean there aren’t more surprises on ahead that could be in the other direction.
Q: The SVB Financial Group, the parent body of the Silicon Valley Bank has filed for bankruptcy protection. What kind of trajectory could this take in the days to come? What immediate and medium term ramifications do you see?
A: Well, I think the really big issue is there are two sides to the bank. There's the deposits and they have protected the depositors and frankly, over protected them. Would have been nice to see some of the big depositors get what we call a haircut. But at the same time, this was a bank that was lending to the most innovative sector in the United States, half of the tech sector was doing some business with Silicon Valley Bank. Silicon Valley Bank was making loans to startups that the big banks didn't want to do. Losing that, that’s a huge thing.
It's being acquired, but exactly what that will do we don't know. I think that's what really concerns me. I think there's also going to be huge political fallout from this, not simply from the fact that they bailed out the rich depositor some with billions and deposits, they only insure $250,000. I think there is going to be a lot of questions about why didn't they see this, this was not a huge bank. But it was the 16th largest bank or something like that, who was under the supervision of the San Francisco Federal Reserve.
I am sure that the supervisors could tell us what the carbon footprint was of Silicon Valley Bank, but what was going on with their books? And then I think there are also concerns being raised about why, when it was clear that there was some kind of run and at that point, the bank was probably still solvent. Why didn’t the Federal Reserve step in earlier to provide liquidity to at least calm things down and have a more orderly change? There are a lot of stories, we will be continuing about this in the weeks to come.
Q: Just to ask you about the SVB Bank, once again, as SVB’s UK assets were sold to HSBC for one pound and they did not opt for a bailout like US, which out of the two approaches, according to you is better?
A: It's far better to sell the bank than to do the bailout, it is far better. Silicon Valley is a very valuable enterprise and I was just puzzled, that they didn't find someone to sell it to earlier on. That's the first thing you do in a crisis like this, is you try to wipe out the stockholders, the shareholders, but then, keep it going as a going concern.
I think the post mortem on Lehman in 2008, was they should have sweetened the deal for somebody to make that happen. I don't know why it didn't. I only read rumors, but the rumors in the press are that the Treasury and the Federal Reserve had a buyer that they liked. But the there's a third body the Federal Deposit Insurance Corporation that has to also approve and for some reason, they didn't.
Q: What we have seen now over the last two weeks with four to five banks, do you think this is the last of the contagion? Or will this contagion continue?
A: Financial crisis like this go in waves. And I do think it will continue at some point, but maybe not in the United States, maybe not in Switzerland, maybe not even in Europe, that is the real underlying problem is that interest rates.
Inflation adjusted interest rates have gone up and in my opinion, which used to be contrarian, but I think has now become much more widely accepted, they are probably going to be high this decade. That adjusts the prices of a lot of assets that means a lot of institutions are carrying loans on their books that that are overvalued. Now, there are a lot of institutions that aren't so regulated, we call them the shadow banking system. And I think you have some of this also in India, and they are probably holding a lot of problems as well. But that has yet to come.
Q: What kind of stress do you expect for the Indian banking sector and the Indian economy as a result of what's happening in the United States? What's happening in Europe and with the global economy?
A: Well, India is starting from a much better position, I mean, India was basically the fastest growing large economy in the world. It has benefited from people not wanting to invest in China firms, they are not leaving China, but they are looking other places. And I think India has been benefiting from this a lot and probably will continue to. So certainly starting from a stronger position that alone has to help India.
On the other hand, okay, I'm not an expert on this, but the banking sector in India has a very, very long history of troubles. I think the problem in India's not so much the meltdown in the banking sector... you want a healthy banking sector to make loans, to keep the economy moving, that could be a struggle. But I mean, essentially, if the global economy goes into recession, India's not as open as China but of course, that would be painful.
Q: Credit Suisse has declared material weaknesses related to financial reporting. Even though the Switzerland Central Bank has given $54 billion liquidity as a lifeline to Credit Suisse, what could be the potential impact of this development on stock markets across the world, on investor sentiment?
A: I think they are trying to ring-fence Credit Suisse and my expectation is that it's going to get broken up, but in an orderly way, that hopefully won't cause a lot of problems. But the trouble is, Credit Suisse has long been the problem child, not just the Swiss banking sector, but to the European banking sector. They almost fell in 2008. They have had all sorts of scandals. They have been thinking about breaking it up for a long time. This is no shocker that Credit Suisse had continuing problems.
The trouble is, is what pushed it over the top some of the things that made it worse, were clearly this high interest rate environment, that hurts everyone. And lastly, we are talking about the European banking war and Ukraine, there are problems that had there, I don't think there's any question. Yes, they did a lot of strong regulation after 2008, will it be enough?
Q: How close are we to recession? And what is the one big thing that all major countries, all economies need to do in order to prevent a Lehman Brothers moment?
A: The second question is actually easier than the first question, which is, I think you need to stay on top of supervision, to be able to make a judgment, when you need to bail the banks out. I don't think there's any question that the authorities this time are tilting more towards, 'when in doubt, bail it out'. That's what they did. But that could cause long term problems, we just don't know.
I mean, in terms of how close we are to a recession, just a couple of weeks ago, the IMF, at the end of January, the International Monetary Fund was saying things are much better than we thought, the global economy is looking really good. I think when we see their report in April, they are going to be much more cautious. The odds of a global recession are far from certain, but they have gone way up.
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