Kim Gwang-seok is an adjunct professor at Hanyang University. [박해윤 기자]
“The bankruptcy of Silicon Valley Bank (SVB) in the United States and the sale of Credit Suisse (CS), a global investment bank, are the result of current insolvencies across the global financial industry. It is not a problem unique to the two banks. All banks around the world faced the homework of ‘rising interest rates’ and suffered losses in existing investment assets. In the case of GMB, as large customer deposit withdrawals increased, they had no choice but to accept losses and sell their bonds. (Deposit withdrawal happened on a large scale) even and we cannot stand it.”
Recently, the world has been shaken by the instability of the financial market. The unrest that started with the bankruptcy of SVB on March 10 (local time) has progressed to the bankruptcy of Signature Bank, the liquidity crisis of CS, and the rumors of the bankruptcy of First Republic, the 14th largest bank in the United States. On March 16, 11 major US banks, including JP Morgan Chase, Bank of America, Morgan Stanley, and Goldman Sachs, backed 30 billion dollars (about 38.838 trillion won) to First Republic Bank, and began evolve, but there is uncertainty in the market Hardly. never subsides.
Many experts say that it is unlikely that this crisis will turn into a global financial crisis. Is it really like that? Currently, he is researching the real economy as head of economic research at the Korea Economic Research Institute, and he asked economist Kwang-seok Kim, an adjunct professor at Hanyang University, about the current situation.
Bankruptcy when unrealized losses occur
How exactly should we look at the bankruptcy of the GMB, which became the starting point of the current crisis?
“It’s a counterattack from high interest rates. When people save, banks lend some of it to households or businesses, and part of it is invested in securities (buying government bonds, debentures, stocks, etc. for profit). Especially when interest rates are low, bond prices rise, so many banks invested in bonds in 2020-2021, and SVB also bought a lot of US Treasuries. However, since last year, the Federal Reserve (Federal Reserve Board) has suddenly raised interest rates, saying it would hold high inflation, and problems began to arise. Bonds tend to fall in price when interest rates rise. As a result, all banks, including GMB, incurred unrealized losses (losses incurred when the market value of their holdings fell below their acquisition cost). However, it is unrealized literally unrealized, so there is nothing wrong with holding the bond as it is. SVB began to have problems due to the peculiarity of its main customers being start-ups or venture companies. Following the economic recession caused by high interest rates, the inflow of investments to companies decreased and liquidity became insufficient, so companies began to withdraw their existing deposits, and SVB had to respond to this by selling the bonds of the government even while bearing losses. This situation eventually led to bankruptcy.”
What is the background that brought CS to the brink of bankruptcy?
“It is also a counterattack from high interest rates. CS is different from banks in Korea. While domestic banks derive their main source of revenue from the difference between deposit and deposit interest rates, CS, an investment bank, basically does the business of deposits and loans, but also engages in investment and asset management businesses. Therefore, CS also invested in stocks and bonds as part of its investment business, but as interest rates rose in 2022, maximum losses were made. The vicious cycle continued, with stock prices falling because the fundamentals were not strong and credit ratings falling as asset ratings fell. In such a situation, the GMB crisis happened, and there was also a bank run in CS with signs of insolvency.”
Is there any way to prevent a series of crises and bankruptcies in banks?
“Since the problem that all banks are having at the moment has arisen from the structural cause of high interest rates, we just need to lower interest rates again and return to the period of low interest rates. Stock prices and bond prices will then rise again, and the current unrealized losses may turn into unrealized gains. However, this is only a theoretical assumption, and in reality, it is difficult to lower interest rates in a short period of time as inflation is still not caught. Then the only option is to compensate the unrealized loss with money so that the crisis does not come because it is not a loss if it is not realized. I don’t know if the current situation will lead to a financial crisis, but with these financial problems, at least a few small regional banks could go bankrupt at any time.”
Fed Chairman Powell Is Not Wrong
It is noted that Fed Chairman Jerome Powell missed the right time to raise interest rates by misjudging the issue of inflation.
“In 2021, the Fed thought there would be no inflation, and the opposing school argued that there would be. In conclusion, the people who said that inflation would come were right, but it is correct to say that nobody was right because there was no ‘war’ on the basis of the school. Who would have predicted the start of the Russian-Ukrainian war in 2021? But since no one expected the war to start, a global supply chain bottleneck occurred and the prices of all commodities, including crude oil, skyrocketed. Of course, high inflation in the 3-4% range could have come, but if there was no variable called war, it would not have reached the high level of 9%.
What does it mean that the Fed chairman’s logic is correct?
“If you look at the economic situation in 2021, there weren’t many reasons for inflation. Nevertheless, the Fed planned to start with tapering (less quantitative easing) to prepare for inflation and go to the key rate hike stance. Now, as a result, there are a lot of negative stories about the Fed not reacting preemptively to the interest rate hike, but even if it had, there would have been a lot of gossip. If the zero (0) interest rate was introduced to stimulate the economy and the rate was raised while the economy was not properly stimulated, the economy would have fallen again.”
How do you expect the current financial market uncertainty to play out?
“There are two possible scenarios at the moment. First of all, the current financial instability will only end with financial insolvency. In this case, the recession is accelerating. This is because banks tend to focus on safety rather than profitability in order to avoid the risk of insolvency, and take a passive approach to lending. Then, interest rates on loans rise further, and companies cannot start new investments, which leads to job losses and slow consumption.
The second is that one bank after another goes bankrupt, leading to a financial crisis. It cannot be said that there is no room for that, but if this happens, as it did in 2008 in response to the financial crisis, the Fed will convene an emergency meeting and carry out a ‘big cut’ (lowering the base rate by this). 0.5%c) and raise interest rates to zero Inflation is not a big problem when a financial crisis comes, just as we avoid it once an earthquake comes. Also, when there is a financial crisis, it is inevitable that prices will be held. If an interest rate cut is made on such a large scale, asset values, which have weakened in the meantime, could increase again. The cycle repeats itself all the time.”
Which scenario is more likely to come to pass?
“Certainly, there is the possibility of a financial crisis. However, if the bank collapses, the pillars and foundation of the economy will collapse, so they will try to prevent the bankruptcy of the SVB with full deposit guarantees and prevent the First Republic Bank crisis with money or systems somehow, just as 11 stepped from big banks on to stop it. Moreover, since President Joe Biden is about to be re-elected, special measures will be taken to avoid being pushed further into a crisis situation. The first scenario has a 90% chance and the second has a 10% chance.”
There are concerns about the contraction of Korea’s real economy
If the second scenario unfolds, what signs can we see?
“If the news suddenly says ‘the Federal Reserve of the United States has called an emergency meeting’ or ‘a major cut in interest rates’ comes out, it must be seen that a financial crisis has already occurred. From now on, we have to keep our ears open and see if there are any further bankruptcies.”
Will disruptions in the US financial market lead to disruptions in the Korean financial market and economy?
“During the global financial crisis of 2008, the global economic growth rate was -0.073%. At that time, the Korean economy grew by 0.8%. This means that the US financial crisis has not spread to us. Of course, the real economy was not good. This is because when the US economy struggles, new investment from the US will shrink and affect the Korean economy. I believe that the US financial crisis may cause a recession in Korea, but as mentioned earlier, the US will take more extensive measures such as the Inflation Reduction Act (IRA) and the Semiconductor Support Act before the re-election of the President Biden. A very small share of securities investment is held by domestic banks. It is relatively safe at this stage.”
On March 23 (local time), after the regular meeting of the Federal Open Market Committee (FOMC), the Fed took a baby step (a 0.25% increase in the base rate). In what sense can I interpret it?
“Before the FOMC, the market outlook was half freeze and half baby step. However, if the Fed does not raise interest rates this time, it will lose confidence once again. (If we stop raising interest rates now, when inflation is not clear), there may be criticisms as to why the interest rates have been raised so far, but this is because the Fed itself admits the financial insolvency caused by the increase in the interest rate. . Instead, by keeping the final rate at the end of this year at 5.1%, the same as suggested in December last year, he indicated that it would be lower than the market expected.”
What will happen to the world economy, including the United States, and the Korean economy in the future?
“The economic downturn is serious and protracted. Looking back, the year 2022 was unprecedented in history, such as high inflation and an increase in interest rates, but it was not a crisis. And now, with the counterattack of high interest rates and high prices, difficult times have arrived. In the past, recessions lasted for three to four years, but I don’t think it will be that long this time. Whether interest rates are cut due to inflation or a financial crisis and interest rates are lowered, interest rates are expected to normalize.”
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Donga Weekly No. 1382 (p12~14)
