Does saving banks promote 'democratic capitalism'?
Banks in the developed countries are the citadel of private capitalism and central banks are supposedly their guardians and gatekeepers. Every time there is a shockwave going through one or a few banks, it threatens to be systemic. One would suppose that in such moments of crisis central banks will spring to action, rolling out the emergency measures in monetary policy or rolling back prevailing ones to prevent the trickle from becoming a flood. They often do but only after governments take the initiative, using fiscal policy. In other words, public exchequer is used first to build or strengthen the firewall around endangered banks. Irrespective of their market capitalisation, the banks in jeopardy are considered 'too big to fall'. The apprehension about the tremor in one or two banks setting off a chain reaction through contagion galvanises governments into action much before central banks are seized with the problem of insolvency in the financial eco- system.
Banks are the emblems of private capitalism guided by the bottom line of profit. If the fulcrum of the financial system underpinning the economy becomes shaky and starts rattling the whole edifice may come crashing down, plunging the country in recession or even depression with resultant unemployment and groundswell of discontent. No democratic government can brook that with non- chance. Lest such intervention appear as 'socialistic', apologists of governments lose no time in rationalising the rescue measures by anointing the economic system as 'stakeholder capitalism' or 'democratic capitalism'. The question whether capitalism can be democratised will be taken up later, after the context, recent bank failures in which it has become relevant, is discussed.
On March 10 Silicon Valley Bank (SVB) failed, marking the second largest bank failure in the United States (US) history and the largest since 2008 financial crisis. The bank slid into insolvency as its larger customers pulled their deposits rather than borrow at higher rates of interest. As the bank took huge losses selling off its bonds, more investors panicked and withdrew their money.
Seeking higher investment returns, in 2021 SVB began shifting its securities portfolio from short term to long term treasury bonds. The market value of these bonds decreased significantly through 2022 and into 2023 as the Federal Reserve raised interest rates to curb inflation, causing unrealised losses on the portfolio. Higher interest rates also raised borrowing costs throughout the economy and SVB clients started withdrawing deposits to meet their liquidity needs. To raise cash to pay withdrawals by depositors, SVB sold over US$21 billion worth of securities, borrowed US$15 billion and arranged to hold an emergency sell-off some of its treasury stock to raise US$2.35 billion. The announcement by the bank caused a bank run as customers withdrew US$42 billion by 9 March. On the morning of 10 March, the bank was seized by financial regulatory authorities and placed it under the receivership of Federal Deposit Insurance Corporation (FDIC). It was found that about 89 per cent of the bank's172 billion dollar in deposit liabilities exceeded the maximum insured by FDIC. Authorised by the Treasury Department, the FDIC announced that all depositors would have full access to their funds. Although some characterised the government response as a bailout, the plan did not entail rescuing the bank, its management and shareholders. Paying the depositors with the proceeds of selling the bank's assets avoided using taxpayer money, at least in the short- term.
The collapse of SVB had severe consequences for startup companies in the US and abroad as it was their major source of funding. In the United Kingdom (UK), the HSBC bank bought local the branch of SVB to prevent contagion, most probably at the behest of the Treasury. In America two other banks on the verge of collapse, Signature and First Republic, were saved by a consortium of major American banks who provided US$30 billion to beef up the capital reserves. Away in Europe, one of the oldest and largest banks, Credit Suisse collapsed on 20 March, forcing the government to broker a deal that saw rival UBS buy the bank for US$3.2 billion. Among the causes mentioned for the failure has been the refusal of Saudi National Bank, one of Credit Suisse's large shareholder, to invest further fund, sending the shares tumbling. According to banking source, Credit Suisse received a clean bill of health from regulators only a week before collapsing. In the case of Silicon Valley and the two other bank's debacle, lax supervision and irregular stress test have been highlighted as causes for their failure. Lowering of the threshold of stress test from US$40 to US$50 billion of bad loan for stress test, as required under the Frank-Dodd Act by President Trump, is also cited as a factor behind the bank collapses. Finally, the steep increases of policy rate by Fed, from near zero to 4.5 basis points, have also contributed to the collapse of the banks. So obsessed was the Fed with containing inflation that it forgot or minimised the possible impact on the stability of the financial system.
In Europe, shares of UBS plunged on 20 March after its weekend rescue of rival Credit Suisse igniting concerns among its investors about the benefits of the deal, even though their bank bought their rival for a fraction of market value in a package orchestrated by Swiss regulators. The deal stipulated that UBS will pay US$3.23 billion for Credit Suisse and assume up to US$5.4 billion in losses. According to Reuters, European bank bonds across European Union slumped on 20 March following the state- backed rescue of Credit Suisse by UBS as some bond holders raised concerns around broader bank capital and also bank shares. European regulators tried to stop a rout in the market for convertible bank bonds saying owners of this type of debt would only suffer losses after shareholders had been wiped out. Despite these desperate measures and assurances, the European banking index has shed around 18 per cent this month after the failures of several US banks (SVB, Signature, First Republic) prompting a wider sell-off in bank shares. The uncertain situation has also been reflected in the rising cost of insuring exposure to the debt of other banks in the credit default swaps (CDS) market.
UBS buyout of Credit Suisse and reassurances from financial authorities failed to calm investors spooked by the fears of fresh crisis and global bank shares and oil prices plummetted. Analysts apprehend that if banks face tighter regulation and pressure to further improve their capital ratios, many consumers and businesses will find it harder to borrow money and that could feed into weaker economic activity.
The US Federal Reserve (Fed) and other major central banks announced on March 19 that a co-ordinated approach to improve bank's access to liquidity will be made. There was no mention about the upward creeping policy rate designed to tame inflation within the band of 2 per cent. The banking crisis came ahead of the Fed's policy meeting that is going to be held in the last week of March, with speculation rife that it may pause its interest rate hikes to provide some stability to the market. The European Central Bank (ECB) has described the continent's financial system as resilient and with sufficient liquidity. But Prof Kenneth Rogoff is sceptical and has said, 'such reassurances have felt empty in the face of market panic afflicting bank shares'. He has pointed out, 'European banks are down by an average of 19 per cent in a fortnight while US banks are down by 17 per cent during the same period. Markets were not exactly calm -- but they had stabilized somewhat' (Financial Times, March 18, 2023)
President Biden has declared, again and again, soon after the SVB collapse, that the American banking system is safe and that depositors money will be delivered on demand. At the same time he sent the message to bankers and investors that there will be no bail out this time around. Instead, the Fed will lend at par value to banks that need liquidity. Losses will be borne by the banking system as a whole, he stressed. But as Martin Wolf has wondered, the question being raised is whether the losses incurred by banks are not being partially socialised, being paid by taxpayers ? 'Does anybody doubt that socialisation will become deeper if the crisis also does', he queried. (Financial Times, March 14, 2023). He is suggesting, there is little doubt about government intervention to rescue the banks because they are the bastions of capitalism, the artery of the economy. To rationalise this role of governments, the point about ' democratic capitalism' will be laboured, bringing it one notch higher than 'stakeholder capitalism' because democracy as an ethos is higher than stakeholders' interest. Martin Wolf in his afore-mentioned write-up has admitted the fragility of 'democratic capitalism' because it has failed in the case of banks. But he has stressed the validity and importance of the values enshrined in it. His solution is reforming and protecting the institutions that make the system tick. He believes the predators eating away at the vitals of the system are within the system itself, hinting at bank management and investors.
Democratic capitalism, as pointed out by Wolf and others in their attempt at putting a human face to the avaricious system, is a chimera, however seductive it may appear as rhetoric. It does not care for the consent of the majority. Nor is it inclined to promote their, unless there is a strong political will among policy makers. The policy makers' dilemma is that they need support from the majority to be in power. But they also need political funding from the rich few to traverse the road to power, which takes precedence over the other. Angus Deaton, the Nobel laureate, has written recently in one of his column under Project Syndicate: "The American Democratic capitalism only serves the interests of the minority. If there was any doubt this has become evident after the financial crisis of 2008. The less skilled and privileged have been left behind, even though they are the majority. They are lost in frustration and the political system embracing capitalism is not coming to their rescue any time soon ( Bonik Barta, February 10, 2023)" .
Capitalism promoted democracy because it needed support of political power. The separation between the two has been very effectively bridged by mutual interests. Every time there is a crisis involving an institution of capitalism, democracy in vogue can be relied on to do the needful. Banks are not only important institutions under the capitalism, they are its life blood. Plutocracy, masquerading as democracy, can allow it to languish only to its peril. It is no surprise, therefore, that in developed capitalist countries all banks are 'too big to fall'. Under one guise or another, governments have to throw the lifeline at the sinking banks. Democracy, bent to the interests of the wealthy few, and capitalism with various prefixes, are joined at the hips since the birth of the former. Capitalism, tempered by any adjective, will be beholden to its bottom line - profit. Gordon Gekko of the Wall Street will always have the last laugh, muttering, 'greed is good'.
[March 22, 2023, Dhaka]