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Dr. Krishnamurthy Subramanian

Dr. Krishnamurthy Subramanian

Mar 14, 2023
10 tweets

🧵on why Silicon Valley Bank fiasco could be the Canary in the Coal Mine (despite the program that the Fed brought out). See graphic👇explaining the phenomenon. The nature of deposits (specifically startups putting their deposits in SVB) is not as material to the phenomenon. /1

Any bank that has gotten much more deposits than it could lend, & so invested heavily in securities faces unrealized losses on its securities portfolio & is therefore v vulnerable. Question then: What about the program that the Fed came up with /2
Fed program was brought to stop panic leading to bank runs. While it may help, the crisis (looming bank failures) has not blown over. Why do I say so? Two reasons: 1. The program essentially pushes the "can down the road" by 1-yr in the hope the policy rate would be ↓ then /3
2. Will watch how bad a situation can the program handle. Program is: Banks can borrow from the Fed by putting up their securities as collateral. Crucially, collateral gets valued at face value of $100 NOT the marked down value. Also, borrowing upto 1 yr. /4
What is the Fed betting on thru this program. If policy rates r ↓ next year, the unrealized loss now will get recouped=> unrealized loss will be ↓ next year than now. So troubled banks will be in a more comfortable situation. /5
Is Fed's hope a reasonable one? Yes & No! Yes: Due to the inverted yield curve (i.e. borrowing rates for 10 yr < rate for 1 yr for ex.). If expectations captured by the yield curve are right (A BIG IF), rates next yr will be lower than now. /6
Is Fed's hope a reasonable one? Yes & No! No: bcos inflation (even in latest print) is stubborn. If Fed continued to focus on controlling inflation, even more rate hikes will be required. So, rates next year may be ↑ than now. If Fed's punt is wrong, then trouble wud be ↑↑ /7
Also, the program is essentially a transfer of money from Fed (and thereby taxpayers) to the banks. Penal int rate is only 0.1%. Even good banks will exploit the available "arbitrage." Question is: When does the taxpayer, i.e. U.S. Congress, say "enough is enough"? /8
Last, what about banks hedging? i.e. some banks would hv "insured" their int. rate risk? If the most insolvent banks hv hedged the most, good. But if the best banks hv hedged this risk - quite likely - risk of bank failures remains unaltered. Interesting times, wait & watch!/9
The inescapable conclusion, however, is that fiscal profligacy during Covid is costing the U.S. now. Long-term pain for short-term gain. India chose the reverse : short-term pain for long-term gain. End🧵
Dr. Krishnamurthy Subramanian
Executive Director IMF, 17th Chief Economic Adviser (2018-21), Professor ISB (on leave), @IMFNews @ISBedu @IITKanpur @IIM_Calcutta @UChicago. RT≠Endorsement.
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