The Case For a Stagflation Stress Test.
By Viral Acharya
Bank runs happen slowly at first, then fast. The recent failures of Silicon Valley Bank and Signature Bank seem no different. Their rapid asset growth over the past three years, mostly in long-term bonds, was fueled by unsecured deposits tied to their undiversified base of loan clients. While the unprecedented scale of Federal Reserve and government stimulus following the pandemic clearly contributed to the explosion of bank deposits, the promise of low-for-long rates led to a search for yield and bank investment in long-term bonds. Effectively, banks seem to have manufactured tail risk again, this time not by underwriting risky mortgages but by taking on interest rate risk.
Regional banks tend to always come under strain when rates rise and local economies are hit. But the business models of many large global banks have also been found wanting as the era of easy money is coming to an end. Regulators have managed to arrest depositor runs for the time being by implicitly extending guarantees to uninsured deposits that no longer have sufficient private bank capital backing them.
Nevertheless, market uncertainty remains high. Investor expectations of the economy have switched within a couple of months from soft landing to no landing to a possible hard landing. Credit conditions are tightening in response, both at banks and in capital markets.
Read the full The Hill article.
Viral Acharya is the C.V. Starr Professor of Economics