Regulatory failures, but no need to panic

In that not-yet-distant period of low interest rates, some experts predicted: The Interest charges can no longer rise sharply because our financial system could no longer withstand such an increase. Was this assessment wrong? Five months ago, higher interest rates got British pension funds in trouble. At that time, the Bank of England stabilized the situation.

Now American west coast banks have gotten into serious difficulties, which Washington is calling into action. The stock markets are characterized by nervousness; Pessimists fear a new severe financial crisis, which nobody really needed in the already complicated political and economic world situation.

The crux of rising interest rates lies in the price losses that it brings to bonds and other fixed-income securities issued during the low-interest phase. These securities are mainly held by central and commercial banks and other financial institutions such as insurance companies, pension funds and investment funds. The price losses do not lead to disaster if investors simply hold their paper until maturity. Because at the end of the term, bonds and other fixed-income securities are repaid at the nominal value of 100 percent. Then there is no loss.

The banking system is better equipped with reserves

Disaster threatens when investors cannot hold their paper and instead have to sell it at a loss in price. The British pension funds had entered into risky futures transactions in order to generate additional profits. When deals went awry and back payments became due, their only option was to quickly sell government bonds. Lightly regulated compared to many of the big banks and risky, Silicon Valley Bank had to sell bonds at hefty losses as its customers called in their deposits ahead of the weekend to remain solvent. Central banks are also threatened with losses on their bond holdings due to rising interest rates. But unlike commercial banks, they can also withstand very high losses because they print their money themselves.

From this repeated flash of lightning on the financial markets, it is not possible to conclude with certainty that a storm is imminent. Overall, the international banking system is better equipped with reserves than before the financial crisis of 2008 and 2009. Most banks are also regulated much more strictly than before the financial crisis. This is especially true for the big houses.

However, during the Trump presidency, the regulations for medium-sized American banks were partially abolished. Among other things, the CEO of the Silicon Valley Bank had advocated this. After the relaxation of regulations, the business of the American regional banks had increased significantly. Their share prices are now under particularly severe pressure. Washington has announced that it will tighten regulation for these banks again.

Keep a Cool Head

Regional American banking crises are not an unknown phenomenon. In the 1980s and 1990s, several hundred houses were liquidated during the crisis in the so-called savings banks; the damage to the taxpayer amounted to more than $100 billion. However, this regional crisis did not result in a global crisis.

Everyone involved needs to keep a cool head now. The participants in the financial markets would like to see the fullest possible bailout from Washington, and they will not hesitate to paint a serious crisis on the wall should this bailout fail to materialize. If Washington gives in to the demands, there will be an immediate calming of the situation and significant price gains on the stock exchange. Economic history research by the economist Moritz Schularick shows how the willingness of the state to save every market participant leads to even more risky behavior in the future with the danger of even greater crises. That can’t be a solution.

Central banks shouldn’t let themselves be put under too much pressure either. Your interest rate policy must continue to be geared primarily to securing monetary stability. The rising interest rates may punish dubious business models of individual houses; the fate of the Silicon Valley Bank is likely to be shared by other houses in the years to come. But market exits of individual houses do not endanger the entire financial system.

Private investors should therefore also keep a cool head. Falling stock prices are more of a reason to buy stocks, rather than panicking about selling your holdings and regretting them later.