The recent collapses of Silicon Valley Bank (SVB) and Signature Bank have reminded the Federal Reserve that when the Fed moves from a protracted period of monetary policy relaxation to one of fast monetary policy tightening, things tend to break in the financial sector.
Hopefully, the Fed has also learned from the SVB collapse that an extended period of free money gives individuals a false feeling of security and encourages them to take on excessive risk under the premise that the easy money times will endure forever.
The Federal Reserve has been steering the economy like a car focused on the rearview mirror rather than the road ahead, hiking interest rates at their fastest pace in four decades. Because of this, the Fed has disregarded the potential for disruptions in the financial industry and the economy resulting from such a policy move.
The 19FortyFive notes that several regional banks may soon be in danger owing to their enormous holdings of long-dated Treasury bonds and outsized investments in real commercial property, which are the most crucial information in this work.
When the number of defaulting property market developers rises, these institutions will likely be forced to write down a sizable portion of their portfolios, and the mainly unregulated portion of the financial system is likely to undergo far more severe issues than the banks have previously encountered.
Hedge funds, equity funds, pension funds, and insurance firms all fall under the category of “shadow banks.” They should be watched closely since they currently handle more credit than traditional banks. This occurred because the Federal Reserve decided to maintain zero interest rates and inject $5 trillion into the market.
As a result, these financial institutions lent excessive sums of money at historically low-interest rates to speculative borrowers, including highly leveraged corporations, developing market economies, and heavily indebted nations in the Eurozone. We hope the Fed is bracing for heightened financial market volatility this summer due to the looming debt limit showdown. There will be a harsh economic landing if the Fed keeps hiking interest rates in the face of impending financial turmoil.