Transcript:

This podcast is called Backdoor QE. The authorities recently put in place two important interventions to save the regional banking industry.

#1 – By ensuring all the deposits in the institutions concerned, the authorities are de facto artificially maintaining these banks alive. They are also sending a clear message that all deposits will be safe in all banks, a wise move with the backdrop of the current chaos, as it avoids disorderly money flows between institutions. This policy had already been implemented in 2008 in response to the great financial crisis for the same reasons.

#2 – Providing unsecured lending against marked maturity valued portfolios, on the other hand, was an original policy tool. It was put in place to provide access to liquidity to the banking sector. However, and as its name entails, part of the loan provided by the Federal Reserve, under this arrangement, is unsecured at today’s valuation of the portfolio pledged as collateral. In other words, this facility is a form of unsecured funding subsidy to the banks.

The tool was set to be limited in size. Everyone will appreciate that this facility must be considered extendable to the whole industry in the amounts eventually needed if the current banking crisis persists. Both tools have addressed the very immediate problem of bank runs, polluting bank asset and liability management on the one hand, and creating severe disorder in the industry on the other.

With all bank deposits now potentially secured and bank liquidity readily available, what then of the banking business model which relies on capital to operate and create value?

With bank equity prices collapsing, the last few days have shown access to capital to be problematic for the industry when faced with a backdrop of today’s uncertainty, which is understandable. Without a solid and secure capital base, new bank lending will be constrained. No new credit means no new revenue stream for the bank making a loan. The institution could then become a zombified, non viable concern.

An example of this phenomenon was the Japanese banks during the 1990s. The US economy is a capitalist system very dependent on credit. Without the expansion of credit because of zombified banks, economic activity could soon come to a standstill. Therefore, the next phase of intervention by the authorities will have to be to ensure access to sufficient capital to maintain the banking system afloat and operational. If the financial markets are not prepared to fund this capital need, then the Fed will have to step in under the form of some kind of backdoor QE.

This podcast is for information only. It should not be considered as investment advice. We would recommend seeking professional investment advice when allocating to any asset.