Good Friday Morning! March Madness can give you all the joys of beating Duke one day and losing to Florida Atlantic University the next. It’s extra conflicting for me because FAU beat Tennessee, but I also watched Middle Tennessee State University drop FAU in the regular season, and MTSU didn’t sniff the tournament this year. College basketball gives you bizarre seasons every year.
This week, I’m continuing coverage of the ongoing crisis in banking and pointing to the next major economic crisis: a credit crunch. I’ll get into what that is and how we got here below – links to follow.
Where you can find me this week
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[03/20/2023] What follows bank failures? A credit crunch. – Conservative Institute
[03/24/2023] Yellen promises the moon but delivers a mirage – Conservative Institute
From inflation, to a banking crisis, to a credit crunch.
Last week, I recapped the bank failure saga and briefly touched on where things were going: a possible credit crunch. In my Sunday column, I explained how bank runs and failures could lead to tighter credit, thus leading to a credit crunch in the vein of 2008. When the Federal Reserve hiked rates by 25 basis points on Wednesday, they confirmed that even they had concerns about a looming credit crunch.
To recap, for those who are new this week, here’s what a credit crunch is:
A credit crunch is an economic condition in which investment capital is hard to secure. Banks and other traditional financial institutions become wary of lending funds to individuals and corporations because they fear that the borrowers will default. This scenario causes interest rates to rise as a way to compensate the lender for taking on the additional risk.
Sometimes called a credit squeeze or credit crisis, a credit crunch tends to occur independently of a sudden change in interest rates. Individuals and businesses that could formerly obtain loans to finance major purchases or expand operations suddenly find themselves unable to acquire such funds. The ensuing ripple effect can be felt throughout the entire economy, as home-ownership rates drop and businesses are forced to cut back due to a dearth of capital.
How did we get the conditions for our credit crunch? First, through interest rate hikes from the Federal Reserve. Part of the Fed’s calculation is that making credit more expensive will slow spending in the economy, which slows growth. That chain of events is supposed to slow demand, which cools inflation. We’ve witnessed some of that.
Last summer, the Fed got forced into hiking rates at 75 basis points every other month. With Wednesday’s 25 basis point hike, interest rates have climbed somewhere between 475 – 500 basis points in a year (or 4.75% to 5%).
The question everyone has is this: we know how much the Fed has raised rates, but how much higher are interest rates with these bank runs and bank failures? The Federal Reserve is asking this question. The newest paragraph in their policy statement is this:
The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.
That’s a perfect example of a sandwich paragraph. The first and last sentences are bread, and the middle two are meat. The Fed is telling you they know interest rates and credit are much higher than their hikes, but they don’t know how much more.
Part of the problem is that this is an ever-changing situation. Some banks have failed, while others need help to keep up with depositor outflows. And even those without depositors leaving are squeamish about handing out easy loans now. We know that the Federal Reserve has given hundreds of billions in loans to banks struggling with liquidity.
Danielle DiMartino Booth notes that this is not Quantitative Easing: “Loans to illiquid institutions are lifelines, pure triage that cannot escape the banking system and manifest as velocity. They slow the economy as lending at these banks freezes.” In English, this means that this isn’t easy money that will boost spending, demand, and inflation. These banks need loans to survive depositors leaving, which means they aren’t making new loans themselves. If you need credit, the list of possible banks has gotten shorter.
When Powell got asked about how much extra tightening has occurred, he answered, “No one can do more than guess about the effects of a banking credit crunch on inflation, but ‘we think it’s potentially quite real.'”
Diane Swonk at KPMG and Apollo Global Management believe the bank run crisis we’ve experienced may be the equivalent of 100 – 150 basis point hikes in the last 10-14 days. Remember, the Fed set interest rates between 4.75 – 5%. This recent banking crisis means real interest rates could be 5.75% – 6.5% (remember, the interest rates you and I pay are higher than the Federal Reserve rates).
This could be an overestimate, but if liquidity continues to be a problem, it may not be. Again, the Fed says it doesn’t know.
In the press, you’ll read about how the Feds (Powell, Yellen, and Biden) are fighting on two fronts: the banking crisis and inflation. That’s partially true; it’s three fronts now: banking, inflation, and a credit crunch. The Fed wants to control the rate at which credit is an issue in the country. If banks stop lending, the Fed loses control, and the brakes slam on economic growth.
It’s worth observing: At no point in the last two years has the Federal Reserve, Treasury, or White House controlled inflation. As the Fed said, “Inflation remains elevated … The Committee remains highly attentive to inflation risks … The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”
If they can’t control or get ahead of inflation, I doubt they’ll be able to stop or adjust to a credit crunch.
The Federal Reserve will start sending out its senior loan officer surveys soon. At the beginning of February, that survey showed tightening credit standards. There’s no question there’s been more tightening since February, and the only question is how much and how worse it gets.
You might say, “Well, if the Fed gets in a bind, they can simply reverse course, right?” Sure, the Federal Reserve could start cutting rates to loosen lending and help the economy. In fact, the market expects the Fed to cut rates this year because of these bank runs.
But there are two problems with that: 1) If the Fed cuts rates at this stage, they’re giving up on inflation. And 2) if the Fed pivots to rate cuts, that’s a sure sign of a recession. Yahoo Finance is one of many places that have noted this:
The scale of the rate cuts now being priced into the financial markets suggests the central bank will be fighting a steep economic slowdown or recession that would batter corporate earnings. In other words, what looked like a bullish moment for stocks may not be so bullish at all.
“Rate cuts would actually be negative for the stock market,” said Todd Sohn, managing director of technical strategy at Strategas Securities. “It’s cuts that get stocks and especially growth corners of the market in trouble, with the most glaring recent examples being 2000 and 2008.”
Rate cuts mean something has gone seriously wrong. The WSJ Editorial Board summed up the problem well:
Mr. Powell is also betting that the banking ructions will aid the fight against inflation as financial conditions tighten beyond the level implied by the Fed’s monetary policies. This is possible because the coming credit crunch is likely to slow growth.
But it’s also risky. One danger is that the Fed’s lender-of-last-resort activities prove insufficient to control a larger panic if one develops, prompting pressure for a sudden easing no matter the inflation rate at the time. The Fed could be forced to ease before it has conquered inflation.
For now Mr. Powell is hoping he can both calm markets and break inflation. It’s a difficult act, but then the monetary mania followed by inflation and financial panic are problems of the central bank’s creation. That’s why it now has to thread this needle.
In 2008, when the collapse began in earnest, the Federal Reserve had no problem with inflation. It could lower rates and suffer no consequences. That is not true of our environment. There’s no way to know if a credit crunch would crush inflation enough to allow the Fed to cut rates.
Remember, the Fed wants unemployment to increase. Markets are betting on a Fed that responds rapidly to a crisis with rate cuts, which may not happen. Suppose the Fed believes recession, even a deep recession, is unavoidable. Why not simply kill inflation while you’re in that moment?
I don’t mean to sound gloomy for the sake of being negative. I’m trying to game out how this next year goes, as is everyone else. The banking run we’ve experienced has dramatically changed the calculation for all policymakers involved. And much like the early inflation reports everyone called transitory, we’re hoping that this banking scare is transitory too, while we continue fighting inflation.
If you’re looking for more on how to prepare for a credit crunch, CNBC offers some helpful tips.
More than that, though, I want you to notice something else. The business world is preparing hard for a recession, possible banking runs, and a credit crunch. If you watch or read business/financial news outlets, this reality matches other big concepts in that space.
In contrast, the possibility of a credit crunch and harsh recession from that has not crossed the mind of the political world. In college, I noticed that if you read financial news, you were often three to six months ahead of whatever the political world would discuss later. That is true right now.
The business world is talking as if a credit crunch is inevitable. The political world knows some banks failed, but Joe Biden and the White House already ran their story with Politico about how they saved the day. Everything is good again.
Here we are again, much like March 2021 when inflation was transitory. A credit crunch is a possibility but not acknowledged. The White House will not be able to say they were not warned. Nor will Congress. Furthermore, what people think will matter in the GOP primaries right now may not be the same come summer and fall.
Links of the week
Book Excerpt: DeSantis vs. ’60 Minutes’ – Gov. Ron DeSantis
Deflation, not inflation, is the new threat – Kelly Evans, CNBC
The ‘Sex Change’ I Had 40 Years Ago Was A Scam, Not Medicine – Walt Heyer, The Federalist
Federal Judge Blocks California Handgun Restrictions – Stephen Gutowski, The Reload
Biden vexxed by Harris’s failure to ‘rise to the occasion’ as VP: Report – Washington Examiner
For Five Straight Years, The Pulitzer Prizes Have Rewarded Misinformation – Mark Hemingway, The Federalist
Hunter Biden used FBI mole named ‘One-Eye’ to tip him off to China probes: tipster – Miranda Devine, NYPost
Twitter Thread(s) of the week
Satire of the week
Woman Consistently Only Uses 1 of Her 5,000 Mugs – Reductress
Dad Still Sending Farmville Requests – Waterford Whispers
Thanks for reading!