Collateral Damage: Why Banks Are Bearing the Brunt of Central Banks' Short-Sightedness

Over the past week, financial markets have been gripped by turmoil as a result of decisions made by central banks, who are responsible for overseeing the monetary policy of their respective countries. While central banks are supposed to be the guardians of a nation’s finances, their recent actions have shown a lack of analysis, regulation, oversight, and foresight.

Central bankers have not only raised interest rates, suppressed demand, and lowered wages, but they have also used high rates to risk and even precipitate bank failures and global financial instability. By deliberately tightening monetary policy into heavily indebted economies with falling real incomes, they have shown that their effective preference is for class war over financial stability.

The recent decision by the European Central Bank (ECB) to lift all three of their key rates by a whopping 50 basis points in the midst of US financial instability is a perfect example of this. The ECB seemed to be careless of the impact on employment and workers’ wages, as well as the risks higher rates posed to European banks like Credit Suisse.

But why are banks and the financial system “collateral damage” in this class war?

One reason is that banks have long gorged on government and corporate bonds issued at very low rates of interest. Investors, such as Silicon Valley billionaires, asset managers, hedge funds, private equity firms, and others, acquired these assets and used them as sound collateral to leverage higher borrowing. As a result, private debt ballooned.

Central bankers did little to discourage such borrowing by toughening up on regulation and supervision. Instead, after more than a decade of “easy money,” increased borrowing, and rising debts, they tightened the monetary policy noose.

When central banks raise interest rates, new government and corporate bonds are issued at higher rates, which increase the yield on newly issued bonds. The returns on these bonds are even more valuable if fewer new bonds enter the market, creating a scarcity of profitable rents. The new, higher-rated bonds are then more valuable to investors than the multitude of bonds issued under the low rate regime, causing the prices of low-interest bonds to fall.

This shift in value does not matter if bonds are held to maturity, and there is no pressure to sell. With time, future rates might fall, and bond prices rise. However, if bonds have been used as collateral, lenders will notice that the borrower’s collateral has fallen in value and demand more collateral to shore up outstanding debts. There will then be a scramble to sell or mobilize more capital to satisfy creditors.

The Silicon Valley Bank (SVB) ignored changes to the value of assets (bonds) triggered by higher rates, rising with greater rapidity than before. So did the Federal Reserve, for that matter. Nor did they seem to understand the financial implications of falling asset values held by the bank and its indebted investors. Until a group of Silicon Valley “founders,” led by Peter Thiel, noticed the risks and used their WhatsApp groups to spread panic among a select group of venture capitalists, who then instantly transferred money out of the bank, triggering a “digital run” on the SVB.

The first “frictionless” bank, as it was often referred to, quickly became a major victim of the class war being waged by central bankers.

In conclusion, the obsession of central banks with holding down wages has consequences for financial stability, as evidenced by the recent turmoil in the financial markets. By risking bank failures and global financial instability, central bankers are engaging in a class war that prioritizes inflation over all other indicators. Banks and the financial system have become collateral damage in this war, with private debt ballooning and lenders demanding more collateral to shore up outstanding debts as the value of bonds falls. As the financial world reels from the fallout of these actions, it is clear that more robust regulation and oversight are needed to prevent future crises.

Furthermore, the lack of understanding and foresight demonstrated by central banks highlights the need for greater transparency and communication with the public. The decisions made by these institutions have a profound impact on the lives of ordinary citizens, yet their actions are often shrouded in technical jargon and obscure policy statements.

If central banks are truly committed to the well-being of their nations, they must recognize that their policies have real-world consequences and take responsibility for the impact of their decisions. This means engaging with the public in a meaningful way, explaining the rationale behind their policies, and taking steps to mitigate the risks posed by their actions.