Aftermath of the Fall of SVB and Credit Suisse on The Financial Market
Global markets have recently been divided by the Atlantic, with the West Coast busy dealing with Silicon Valley Bank's mess, and the East Coast busy cleaning up Credit Suisse's mess. Even though Credit Suisse's crisis may only be a micro-level individual crisis, the Swiss government chose to intervene forcefully at the first opportunity.
It should be noted that the protagonist of the Credit Suisse and UBS merger is neither UBS nor Credit Suisse, but the Swiss government. The so-called Swiss government is a regulatory layer composed of the central bank regulatory agency and the finance department, which can be regarded as a complete set of financial regulatory teams.
The acquiring party of Credit Suisse, UBS, can only be considered as the government's agent in this century-old transaction. The government used super-luxury configurations, of course, to have more powerful power. This merger began in the fog of this strong power.
Although the Credit Suisse crisis has been temporarily resolved, a larger crisis may be looming. On the first three days of the official merger, the chairman of UBS Group, received an order from the Swiss government requiring him to prepare to take over Credit Suisse. On Saturday night, the Swiss government notified the two banks to activate emergency rights and modified laws overnight, depriving shareholders of both companies of voting rights. This means that whether shareholders are informed or agree, the merger of Credit Suisse and UBS will still be settled.
The top three shareholders of Credit Suisse are from Saudi Arabia and Qatar. This group of Middle Eastern shareholders have strong objections to the voting rights and exit terms of the acquisition price because the acquisition price given by UBS is too low. However, they did not have a seat at the negotiating table, and the Swiss government ignored their strong reactions. Last year, 4 billion Swiss francs bought 9.9% of Credit Suisse's equity. The overall acquisition price of Credit Suisse is now set at 27.5 billion Swiss francs.
This story is not unique. China was also a victim. In November 2007, Ping An of China invested 24 billion yuan to acquire Fortis Group and became the largest shareholder. Immediately, a crisis ensued. Fortis Group's financial situation deteriorated sharply, and for the sake of their own interests, European governments forcibly divided and nationalized Fortis Bank. The Dutch government announced the nationalization of Fortis Group, and the governments of Belgium and Luxembourg directly sold their branches in both countries to Paris Bank, completely excluding the largest shareholder Ping An of China. Ping An not only did not participate, but also did not have the right to speak that the largest shareholder should have. When the crisis came, political factors interfered with economic order, which is not a new thing in Europe.
Returning to the Credit Suisse incident, last Saturday, Credit Suisse's management was still bargaining, but the Swiss government stated that if they did not sign, the government would use its power to remove the entire management team. In this way, Credit Suisse's management finally settled down. The Swiss regulator's action this time was completely helping one party to plunder the other, ignoring modern corporate governance and shareholder rights.
Facing UBS, Switzerland provided irresistible conditions. The Swiss National Bank provided liquidity support up to 100 billion Swiss francs, and the Swiss finance department provided loss guarantees up to 9 billion Swiss francs after UBS lost 5 billion. That is to say, UBS bears the losses within 5 billion, and the part of the loss reaching 50 billion but less than 140 billion is fully borne by the Swiss finance department. From this moment on, the Swiss government is essentially tied to UBS.
During the subprime crisis in 2008, the Swiss government bailed out UBS, which caused domestic opposition. This time, the Swiss government apparently learned from that lesson and immediately decided to fully write off the 16 billion Swiss francs of AT bonds that could have been converted into common shares of Credit Suisse without even making a gesture, spreading the losses to creditors around the world. This is a typical case of wanting someone's interest but not wanting to pay the principal.
According to the rules of the financial world, the priority of bond repayment is higher than that of equity. However, this time, the assets of AT bondholders ranked higher than shareholders. Overnight, the Swiss government helped its own capital plunder the world, which means that a significant part of the clearing rules in the modern financial system collapsed. The beginning of the Credit Suisse-UBS merger was also the beginning of the Swiss government's reputation being trampled on. However, this is essentially the overall risk of the global financial system, which is the inherent instability of the modern financial system, and this also confirms Minsky's theory.
The financial system dominated by central banks is inherently imperfect and fragile. Sometimes it has to break the rules and intervene with strong power to deprive voting rights in the market, force debt simplification, or even threaten to remove the entire management team. In this crisis, we see that the Swiss government adopted the pre-intervention and excessive rescue method to forcefully put public power above financial rules. From a certain perspective, this merger has already exceeded the normal market behavior and become a political game led by the government. The Credit Suisse crisis is actually more of a trust crisis caused by internal control.
In March 2021, supply chain finance company Greensill Capital filed for insolvency, and Credit Suisse's $1.2 billion investment became worthless. In the same month, the largest single-day loss in history occurred with the collapse of the Korean hedge fund “Must have the King”. Credit Suisse failed to stop losses in time, and ultimately lost CHF 4.4 billion, equivalent to $5 billion, making it the investment bank with the most severe losses among all those involved.
The data leak incident in 2022 directly hit Credit Suisse's Achilles' heel. If Credit Suisse's crisis was originally just a trust crisis for microfinance institutions in the market, the Swiss government's forced intervention is likely to lead to a lack of trust in the global financial system. At least Credit Suisse's creditors, major shareholders in the Middle East, and even a considerable number of global wealthy individuals will greatly discount their trust in the Swiss authorities. More importantly, if the regulatory power can arbitrarily deprive shareholders of their rights and reduce the value of assets at will, will the market still trust government regulation?
The crisis of Luckin Coffee seems to have been resolved for now, but the situation seems to be evolving towards a more unstable and uncertain outcome. In the United States across the ocean, we can see a similar plot: Silicon Valley Bank collapsed, and high-net-worth individuals who were depositors mourned one after another. The result was that the US government quickly intervened and adopted a complete bailout strategy for all deposits of Silicon Valley Bank, completely breaking the upper limit rule of the deposit insurance system and changing the basic principles established by the banking industry for a long time.
The leader of this plan is the US Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation. It has the same formula and feeling as Credit Suisse's operation by Switzerland. The establishment of the upper limit in the deposit insurance system was originally to disperse the systemic risks of the banking system, make the participants of the banking system more diversified, and thus build a benign and sustainable financial ecosystem.
Once there is no upper limit on deposit insurance, high-net-worth individuals will no longer need to diversify their deposits, but choose to concentrate their deposits in the four major banks that are less likely to go bankrupt. The survival status of small and medium-sized regional banks will become even more severe. In the end, only a few giants that cannot fall will be left in the US banking ecosystem.
Once these giants encounter a crisis one day, they may be more ruthless in kidnapping depositors and governments, and even the entire financial system and real economy. The policy seems to protect depositors on the surface, but because of the regulatory destruction of the rules at will, the global banking industry is placed in greater risks.
After rescuing Silicon Valley Bank, the Federal Reserve reversed the direction of monetary policy and the balance sheet within a week. The long-term shrinking of the balance sheet for nearly a year only took half a month to expand back to half. Therefore, there is a strange phenomenon of raising interest rates while expanding the balance sheet. This time, the large-scale expansion in a short period of time mainly reflects in the discount window.
The window is actually divided into two types: expanding credit to banks whose finances have deteriorated and primary credit to banks whose finances are still healthy. In order to cope with the crisis, the Federal Reserve provided an expansion credit of $1.428 trillion, but at the same time, to avoid possible other bank failures, the Federal Reserve even provided the same amount of primary credit.
This credit scale has exceeded the level of the subprime crisis in 2008, which gives us reason to believe that there are still some banks in the market that seem to be operating normally, but are actually relying heavily on the support of the Federal Reserve. This is a cause for concern as it indicates that the banking system may not be as stable as it appears on the surface. The use of regular refinancing plans by banks to maintain liquidity may lead to a further expansion of the Federal Reserve's balance sheet.
This short-term expansion was mainly reflected in the discount window. The window is actually divided into two categories: expanding credit to banks with deteriorating finances and expanding credit to banks with relatively healthy finances. In order to cope with the crisis, the Federal Reserve provided $142.8 billion in expanding credit, but at the same time, in order to avoid possible other bank failures, the Federal Reserve also provided primary credit of the same scale. This credit scale has exceeded the level of the subprime crisis in 2008. This leads us to believe that there are still some banks in the market that appear to be operating normally but are actually struggling.
In the center of the whirlpool of the merger between UBS and Credit Suisse, the shadow of the US government is looming. The market rumors that the US regulatory authorities are pressuring Switzerland not to allow Credit Suisse to go bankrupt. If this is true, it only shows one thing: the US banking crisis is far from being as optimistic as Janet Yellen portrays it. Therefore, the United States does not allow Credit Suisse to have any problems again. In order to contain the current crisis, the Federal Reserve has even created a new tool called the Bank Term Funding Program. What does this mean? It means that the Federal Reserve can provide banks with mortgage loans for up to one year, and the collateral happens to be US Treasury bonds and MBS. These are all sold to commercial banks by the Federal Reserve when it shrinks its balance sheet, and the culprits that caused the liquidity crisis in commercial banks.
A discerning person can see at a glance that this new tool is specially designed to address the current crisis, and the continued use of the Federal Reserve's periodic financing plan will surely continue to increase the size of its balance sheet. This can be seen as the Fed's version of medical insurance for banks. However, the Fed is currently in a difficult situation, where inflation forces it to raise interest rates while the crisis forces it to expand its balance sheet. In the latest resolution, the Fed raised interest rates by 25 basis points, bringing the federal funds rate to its highest level since 2008. Why did the Fed choose to expand its balance sheet rather than cut interest rates? Inflation is only one aspect of the reason.
The more fundamental reason is the Fed's obsession with dynamic inconsistency, which means that the Fed is accustomed to using unexpected policy expectations based on asymmetric information to achieve better short-term results. In the latest statement, the Fed also mentioned that if necessary, the exchange market will adjust its stance. The Fed's attention to short-term effects may be influenced by Keynesianism.
However, Keynes did not remind the Fed that some decisions could lead to faster death. The Fed's path dependency during crises is to be unpredictable and go against market expectations. This means that Powell needs to have a split personality, saying hawkish things in public and cutting rates behind the scenes. This is the distorted combination of raising rates and expanding the balance sheet that we see. Of course, the Fed has another option, which is to increase its tolerance for inflation, which would allow monetary policy to naturally shift toward cutting interest rates. The cost is that the Fed would lose some of its remaining policy credibility, and the risk is that once the market perceives the Fed as being at a dead end, the consequences would be unimaginable.
This is like the 1992 British pound crisis when the UK government announced a rate hike to counteract the depreciation of its currency, and almost all currency market players participated in the currency sell-off, which the British government had initiated. Moreover, we have seen a trend of policy and statements becoming ineffective during the current round of US rescue efforts, and stock market crashes continue to occur.
Regardless of whether it is Switzerland or the United States, we have seen eager regulatory action, a larger regulatory lineup, and unlimited policy support. Now that firefighting is seen as the solution to crises, these firefighting efforts may breed more significant trust crises in the future. This is not just a lack of trust in a particular financial institution, but a lack of trust in the entire regulatory system and even the modern financial system.
Excessive government rescue and preemptive intervention have also led to frequent moral hazards in the financial industry. The Fed's frequent use of the lender of last resort function has provided potential risk incentives for the financial industry, as management continues to pursue profit maximization without supervising and reviewing the behavior of investors and creditors. This is like suddenly removing the laws of natural selection and survival of the fittest from the natural world. The entire financial ecosystem will quickly fall into an abyss of instability.
Under the Fed's leadership of the monetary tide, the rhythm of the financial cycle has become complex and chaotic. Under the previous round of quantitative easing policies, US commercial banks' debt scale reached $16 trillion, which will inevitably result in huge losses for commercial banks during a violent interest rate hike cycle. For financial institutions in the midst of a monetary onslaught, an excessive reaction to a crisis means stepping into thin air, while an inadequate reaction means asset failure. Since they will eventually die anyway, why not take a risk? As long as the music doesn't stop, Wall Street must continue to dance.