Victoria Scholar discusses rise in interest rates
While greed no doubt plays a part, much of the damage is coming from the very last place anyone would expect.
Much of the trouble is being caused by the lowest-risk asset class in the world. The ultimate safe port in a storm that investors race to in times of trouble, as we saw last year.
This investment is safer than the Swiss franc, Japanese yen and even gold.
That’s what makes it so dangerous. Now it risks bringing the entire global banking system crashing down.
Bankers still haven’t been forgiven for triggering the financial crisis in 2007 by creating too much money, too quickly, and using it to push up house prices and speculate on financial markets.
Taxpayers were forced to bail them out and the crisis dragged on for years, wiping trillions off the global economy.
Nobody wants to see a repeat, but it looks like we may have no choice. Bank after bank is folding and the slow-rolling process is starting to look unstoppable.
It began in March, when US banks Silicon Valley Bank and Signature Bank collapsed within days of each other.
Federal regulators rushed to bail them out and protect depositors, and all seemed well until Swiss bank Credit Suisse went cuckoo.
It was bought up by rival UBS, central bankers pumped markets with liquidity, and everyone settled down.
Then Germany’s Deutsche Bank almost went kaput.
This week, First Republic Bank was salvaged JP Morgan Chase (as were Silicon Valley and Signature).
The respite was shortlived as shares in regional lenders PacWest Bancorp and Western Alliance Bancorp halted trading yesterday, after their shares crashed.
Contagion is spreading and it’s beginning to feel like 2007 all over again. The difference is the trigger.
Last time, bankers were squarely to blame for selling super-high risk mortgage-backed securities and collateralised debt obligations that buyers didn’t understand until they blew up in their faces.
Today’s deadly asset class is at the complete opposite end of the risk spectrum.
US government bonds, known as Treasuries, are the world’s ultimate safe haven.
Most people don’t give the global bond market a second thought but it’s worth $128trillion. To put that into perspective, global stock markets are worth just $107trillion
So it’s a big deal and now it’s gone rogue.
Governments issue bonds to raise spending money. They pay a fixed rate of interest, and return your original capital at maturity.
Most bond buyers are other governments, large firms and big financial services companies such as banks, pension firms and insurers.
Treasury bonds are thought to be entirely-risk free because the full political and financial might of the world’s strongest economy stands behind them.
After the financial crisis, regulators ordered banks to load up on them as a cushion against risks elsewhere.
It seems like a great idea. Everybody supported it. Then last year things went wrong.
Here’s the technical bit. I’ll try to keep it simple.
Bonds pay a fixed rate of interest, which suddenly looked a lot less attractive last year, when inflation rocketed.
As a result, Governments had to pay higher interest on newly-issued bonds to attract investors.
The problem is that when yields on new bonds rise, the prices of existing bonds falls as nobody wants to buy them as they pay less interest.
Last year, bonds suffered the biggest crash since 1949, losing up to a quarter of their value.
Which meant the value of all those bonds that banks were ordered to buy have collapsed.
That’s what brought down Silicon Valley, which suffered a bank run after admitting it had lost $2billion (£1.5billion) on its long-dated government bond holdings.
By some estimates, half of all US banks are insolvent on this measure.
Nobel-prize winning economist Nouriel Roubini has warned that in Europe, unrealised losses on bond portfolios could be even greater.
Banks’ bond holdings aren’t worth enough to cover their liabilities if they had to make a quick sale. That means that any shock could trigger a full-blown banking crisis, exactly what the post-2008 reforms were meant to prevent.
The bond market is supposed to be boring. Today, it’s the most terrifying place in the world.
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