At this point, it’s becoming increasingly obvious that we have a full blown banking crisis on our hands, and the measures taken to contain it are becoming increasingly exceptional. The latest failures to add to the tally include regional bank First Republic and Swiss giant Credit Suisse (CS). First Republic was the latest amongst the US regional banks to come under pressure since Silvergate and Silicon Valley Bank heralded the start of banking panic in the US. The FED has seen its balance sheet swell from additional lending made to banks through both its newly opened BTFP and the traditional discount window. Meanwhile, Credit Suisse’s troubles are not exactly new at this point, with their CDS premiums being elevated for months now and only able to borrow at ~4% over risk free rates when it tried to raise cash for its internal restructuring back in January.
That these two banks are, in retrospect, clear candidates for the latest fault lines to crack under pressure should not be a good reason for consolation. The collapse of Credit Suisse in particular is a sign that systemically important banks, also known as banks that are “too big to fail”, may not hold under their own strength. The Swiss government was forced to intervene and arrange an acquisition by UBS, with the latter being a largely reluctant party forced to clean up after its rival. UBS’ own equity took a significant hit from the news, while the Swiss government had to put up 9 billion to absorb potential losses. It is notable that the merger also went ahead without shareholder voting and with only the approval of the respective boards.
Another important detail of the Credit Suisse UBS merger is that Credit Suisse’ 17 billion USD worth of Additional Tier 1 (AT1), also known as Conditional Convertible (CoCo) bonds, were completely wiped out. This is in stark contrast to shareholders who will be paid 3.2 billion USD for their equity. That equity is paid out before bonds is distinctly unusual even if AT1 bonds have a clause for wipe outs in the event of government intervention. With the AT1 now seen as potential junior to even equity, expect liquidity in AT1 markets to evaporate, along with AT1’s ability to fulfill its role as a buffer between equity losses and bonds at a time when global markets are already incredibly fragile.
The serial collapse in the banking sector and the unusual actions taken by both the Swiss and FED, even if successful in containing the immediate fallout of these banking collapses, only serve to emphasize how significant the underlying problems are. Expect more institutions to fail and contagion to spread. Financial crises tend to emerge in the aftermath of usually negative market conditions following a loosening of financial regulations. 2008 followed from the 1999 repeal of Glass-Steagall, and current events can be traced in no small part to the repeal of parts of the Dodd-Frank act in 2018, itself designed to prevent a repeat of 2008. The similarity is both uncanny and uncomfortable. Expect more trouble on the horizon.
Equity and Crypto
In stark contrast to the banking sector, both tech stocks and crypto have performed well, with BTC breaking out over 28000. Tech has come to be seen as a safe haven, while crypto is seen as an alternative to traditional finance as at large. While a point has clearly been made about the weaknesses of traditional financial markets, the assumption that tech or crypto do not seem well grounded. While tech is no longer the growth filled hype bubble of 2001, with mature behemoths such as Google and Microsoft, it is worth noting that many of the NASDAQ’s largest components such as NFLX and AMZN do not have particularly strong cash flows. Cash-on-hand for the sector as a whole has come under pressure lately and it remains to be seen what would happen if these tech behemoths are forced to raise additional capital.
Concurrently, crypto has already shown itself to be far less decentralized or divorced from traditional finance than maximalists would propose. To argue that the current rally is a reflection of crypto’s superiority rather than primarily a massive squeeze of short positions is to forget FTX and Silvergate. Imagine for a moment if Binance collapses, unable to process withdrawals due to a loss in confidence in its liquidity, or if its partner banks are unable to process transactions due to their own issues that are unrelated to Binance. Another scenario would be if major holders of crypto are forced to liquidate their BTC holdings in order to cover their losses elsewhere. With the long/short ratio of BTC becoming increasingly long favored, BTC and crypto as a whole remain exposed and in danger for all their apparent strength.
Events of Note
The FOMC announcement on March 22 is the calendar event to watch. Prior to Credit Suisse’ collapse, my view was that we are likely to see a 25 bp increase despite pressure on the banking sector. Inflation remains more than double of the FED’s target, while the FEDs can rely on its lending facilities to maintain banking sector stability. With things as they are now, it is clear that current events have overtaken whatever projections the FEDs have made and will likely continue to do so regardless of their decision in the upcoming meeting. Even if we see no increase, don’t celebrate too early. Historically, market bottoms have followed FED pivots, rather than come before.
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