Monkey Business😜

A lot has happened in the past few days in the banking sector, worldwide. Too much to digest in too few days. Rising inflation and interest rates, bank runs, the collapse of SVB, Signature Bank, UBS, and Credit Suisse, the RBI, and so on. Predominantly, I would talk about the US banking crisis. What caused the crisis? What are its implications? FEDs and the US government hypocrisy, and in the second part, I would cover the Credit Suisse and UBS stories and the European banking crisis. So, without wasting a dollar, let's dive in. 

THE US BANKING CRISIS 

According to legendary hedge fund manager Mr. Ray Dalio, an economy goes through two major debt cycles: the long-term debt cycle and the short-term debt cycle. Following the 2000 market crash, the US economy became stagnant. A classic post-crisis effect In order to kick-start the economy, the Federal Reserve (the US central bank, aka the FED) decreased the FED fund rate by 0.50%. Throughout 2000 and 2001, the FED fund rate decreased by 4.75%. The FED fund rate is comparable to the Indian repo rate. Decreasing interest rates means decreasing the borrowing cost. Now, one has to understand the fact that the US economy is a spending economy. On the other hand, the Indian economy is a savings-dominated economy.

The demand for loans increased as the borrowing costs decreased sharply. The stock markets were still recouping their losses from the dot-com crash and hence were an unattractive investment. Real estate emerged as the lotus among mud for investment. People started investing heavily in the real estate market, and soon enough, the epitome of an illiquid asset had become a hot commodity. Investors, or rather mindless gamblers, were buying the assets only to sell them at a higher rate, crushing the cherished theory of greater fools. In response to the rise in temperature, the FED began raising the FED fund rate, or, in other words, the borrowing cost.Soon enough, the real estate markets collapsed as borrowers started defaulting on interest payments. The crash was so big that the same year, the US GDP contracted by 4.5%.

The US economy recovered by 2011 and resumed its upward trajectory until 2020.COVID forced all economies into a slowdown. To kick-start their economy, the FED again decreased interest rates, this time by 2.75%. They didn't stop there. The FED undertook a programme called "quantitative easing". The investment banking world has this urge to use some fancy jargon so as to sound complex. QE, or quantitative easing, means injecting cash into the system. The FED printed trillions of dollars and started buying debt securities so as to infuse cash into the system. They also passed the 2020 relief package, under which every American was compensated with some cash. Suddenly, the money supply in the economy increased, leading to an irrational rise in the stock markets.

Golden Rule: Always buy stocks when the central banks undertake QE. No matter how bad their fundamentals are, just buy stocks.

A sudden rise in the money supply led to sky-high inflation. To again tame down the inflation, guess what the FED did? Yes, they increased the interest rates. Now, over the years, this rising and falling interest rate has given birth to one of America's most horrifying debt cycles. On a net basis, an average American owes $250,000 (Rs 2.06 crore) today. Their net asset position is negative. Irrespective of countries, every time something happens to the economy, the middle class is the one that bears the lion's share of the loss. This is the situation in America today.

SVB CRISIS 

Recently, a popular bank among start-ups filed for bankruptcy in the US. The bank was Silicon Valley Bank. The news broke when the company declared a $1.7 billion loss in their investment division. Being a bank, this sort of loss in the investment division was unheard-of. On further investigation, the FED found out that the bank is on the verge of collapse. What went wrong? Let's find out. 

SVB was famous among the start-ups. Birds of a feather flock together. Every other start-up in the United States had put their money in SVB.After the horrific impact of the 2008 crisis on the American banks, SVB management decided to switch from being a lender to being an investor. They stopped giving loans and started investing the proceeds, which they were receiving in the form of deposits, into long-term US Treasury securities.

Bond interest rates and bond prices are inversely proportional. Increases in FED fund rates cause interest rates to rise, lowering bond prices. SVB started buying long-term treasuries after the 2008 crash when interest rates were between 1 and 2%. In 2022, inflation is on the rise in the United States, and the Federal Reserve decides to tighten the economy by raising interest rates. The FED increased the rates by 4.5%. This directly affects the bond market. Considering the inversely proportional theory, after the FED increased the FED fund rates, the interest rates went up, leading to a fall in bond prices.

Because of a stagnant economy, start-up funding stopped. This led to startups withdrawing their deposits from SVB. Turns out, SVB has invested their deposits in long-term securities and hence has no cash available to fund their depositors. In order to meet the demand, they booked a massive loss of $1.7 billion in their Treasury Department, which created news. SVB started defaulting on their deposits, thereby leading to a bank run. A bank run happens when everyone collectively starts taking out deposits. That's what the SVB crisis is about. SVB changed their business model, which changed their destiny completely. For more than 13 months, the bank did not have a chief risk officer. SVB was managing north of $200 billion without a chief risk officer. That's equivalent to driving a car without a brake. SVB management sold their shares months before the news came out. A perfect case of insider trading

Janet Yellen, Secretary of the United States Treasury, stated that they would not increase deposit insurance, which would have protected depositors in the event that Signature Bank failed. SVB has corporations as clients. The US would have been in a far better position today if they had concentrated their efforts on their own goddamn economy instead of trying to stabilise countries in the Middle East.

CREDIT SUISSE (more like Debit Suisse) AND UBS 

Credit Suisse, the bank that was on a ventilator for so long, finally took its last breath. For a long time, Credit Suisse has been involved in unethical business practises, whether it be accounting scandals, insider trading, or what have you. Credit Suisse investors have been pouring money into the bank for years, but they have consistently lost it. It wasn't any one particular event that choked Credit Suisse to death; it was a pile of assembled events that killed them. It looked like everything they touched was turning into ash. Take, for example, Archegos Capital, where they lost more than $5.5 billion.

But, better late than never, UBS acquired Credit Suisse for a mere $3.1 billion. Just so you know, they have $450 billion under management. Post-acquisition, UBS has emerged as the 2nd-largest bank, just behind J.P. Morgan. The merged entity has a whopping $5 trillion under management. Take a good look at that figure. If not for Credit Suisse, it surely is a great deal for UBS. UBS has asked the Swiss national bank to cover their losses up to $9 billion, and the Swiss government has agreed to write off the additional tier 1 debt that Credit Suisse had on their balance sheet. Even in the midst of the turmoil, UBS struck a masterpiece. Unlike the US, the European banking system is still under observation, as everyone is trying their best to somehow decrease the losses. Recently, the Swiss central bank infused $54 billion into the system. Indians, on the other hand, are enjoying this saga, but globalisation will not allow us to do so for long. Being interconnected, India might face some minor corrections, which I believe won't last for more than a month. I am expecting a new rally once the new financial year begins. Let's hope for the best.

HAPPY INVESTING.