MNI INTERVIEW: Credit Crunch Looms On Bank Runs-Ex-Fed’s Stein
Ex-Fed governor says tightening financial conditions to have impact on policy rate path.
The U.S. banking industry’s reckoning could lead to a credit crunch that helps to tame inflation, potentially allowing the Federal Reserve to hike interest rates less than it otherwise would, ex-Fed governor Jeremy Stein told MNI.
“It’s not implausible that we may have a decent bank credit crunch in the works, it’s hard to know exactly what the magnitude or the impact of that is going to be,” Stein said in an interview with MNI’s FedSpeak podcast Friday.
Fed rate hike expectations have swung wildly alongside market fears of contagion in the financial system. Before the turmoil at Silicon Valley Bank began last week, Fed Chair Jerome Powell opened the door to a 50 basis point hike at next week’s meeting. Now that prospect has all but vanished – and that’s ok given the change in conditions, said Stein.
“If one were to do 25 or even to pause, you can still message that as not sacrificing the monetary policy objective but just calibrating given we have a potentially large and at this point still hard to fathom bank credit tightening,” said Stein.
The FOMC will be walking a fine line between addressing issues of financial turmoil on the one hand while continuing to fight inflation that remains far above the central bank’s 2% target. (See: MNI INTERVIEW: Fed Should Pause, Assess Two-Way Risk-Rosengren and MNI INTERVIEW: Fed Set For Hawkish Pause On Turmoil-English)
“If I were sitting at the Fed I would want to be very clear on the proposition that we’re not going to back off on our commitment to bring inflation down in light of the financial stability issues,” he said. "The financial stuff has tightened financial conditions and that has implications for where we set the funds rate."
REGULATORY FAILURES
Stein, an expert on financial regulation, said bank supervisors clearly share some blame for the events at SVB, Signature Bank, and now First Republic.
“There’s clearly some blame for the regulators. There’ll be a process of trying to attribute what went wrong,” Stein said.
While some have blamed 2018 reforms that exempted banks the size of SVB from some of the more stringent stress tests for the crash, Stein suggested it was more of a lack of enforcement than inappropriate rules that created the problem.
“The stress tests as they were conducted on the bigger bank did not have an interest rate stress,” Stein said. “I wonder whether it’s the rule on the books or it’s the supervision process. A bank that size is going to have supervisors on site and you’ve got to wonder what went on.”
BIG BANKS ARE SAFE
The bailout of First Republic by major banks with a temporary line of credit was an effort to shore up confidence in the system rather than an expression of concern for the health of the nation’s largest banks, Stein said.
Still, the crisis of confidence in banks is going to raise their funding costs because they will now have to boost deposit rates to match the higher market rates competing for the same funds.
“Even if you temper the runs, and everybody ends up keeping their deposits, it’s going to be important to ask, at what rate?"
Because those so-called systemically important financial institutions were heavily regulated after the financial crisis of 2008, they are in a much better position to withstand the current market pressures, he said. They also have a much larger deposit base that allows them to sit on unrealized losses rather than having to book them.
“At this point I have little concern for the biggest banks, they’re very well capitalized,” Stein said. “Some of them do have fairly significant mark-to-market losses on their asset portfolio but they have significantly more stable deposit bases.”