Deal, or No Deal?
The banking deposit crisis is receding, but the credit crunch is just starting. After 15 years of investment decisions dominated by the Fed Put (i.e., extremely low interest rates and pumping money into the economy, to rescue markets), the critical question investors currently have is whether the Fed will resume a low interest rate policy and QE in order to address a developing financial crisis. In other words, is the Fed Put still in place, or not?
For a very long time now, the seed of each financial crisis has been found in the ‘fix’ for the prior crisis. This time is no different. At some point, we’ll figure out that we have failed to actually fix anything; we have merely hidden the problems under mounds of money, postponing the inevitable reset.
As the next crisis likely approaches, we are all looking for clues as to how the Fed will respond. What has become clear is that after 15 years of very loose policy, the Fed strongly desires a return to normalcy, that is interest rates and economic growth within historical ranges. What is different this time around is that the inflation problem demands a return to interest rate normalcy. Any delay, only feeds inflation. Since the first attempt to turn off the money spigot and return interest rates to more normal levels in 2013, the Fed has repeatedly discovered that those efforts are invariably followed by some serious financial dislocations. The current episode is just the latest.
No matter how you slice it, the reality is that economies do not run like Swiss watches. At this point, it is abundantly clear that the more we adopt extreme policies, like zero interest rates and QE, in a futile attempt to coax our economy to run as smoothly as a Swiss watch, the more fragile our economy actually becomes. The lesson is that the pain that appeared to be avoided all these years, was not avoided at all, it was merely postponed. There are some ‘past due’ bills that still need to be paid.
We are at a crossroad with divergent goals (fighting inflation vs. saving the banks). Does the Fed cave; lower rates dramatically; and rescue financial markets again? Or does the Fed push the inflation fight at the expense of the economic growth and allow markets to flap in the wind? Wall Street wants to know. Deal? Or no deal?
A Credit Crunch, as Described by ChatGPT
We asked ChatGPT, the artificial intelligence chatbot, to explain how a credit crunch affects the economy. Here is the response. FYI, we added the bullet formatting.
A credit crunch is a situation in which lending institutions become reluctant to lend, and credit becomes difficult or impossible to obtain. This can occur for various reasons, such as a sudden increase in loan defaults, a decline in asset values, or a decrease in investor confidence.
The impact of a credit crunch on the economy can be significant. Here are some of the ways it can affect the economy:
- Reduced investment: Businesses that rely on borrowing to fund their operations may find it difficult to obtain credit during a credit crunch. This can lead to a decrease in investment, as businesses are unable to expand or invest in new projects.
- Reduced consumer spending: Consumers may also find it difficult to obtain credit during a credit crunch. This can lead to a decrease in consumer spending, as people are unable to finance purchases of goods and services.
- Economic contraction: The reduction in investment and consumer spending can lead to a contraction of the economy. This can result in lower GDP growth, higher unemployment, and lower tax revenues.
- Financial instability: A credit crunch can lead to financial instability, as banks and other financial institutions may struggle to meet their obligations. This can result in bank failures, bankruptcies, and a general loss of confidence in the financial system.
- Reduced access to housing: A credit crunch can make it difficult for people to obtain mortgages, which can result in a decrease in housing prices and reduced access to housing.
Overall, a credit crunch can have a significant impact on the economy, leading to reduced investment, consumer spending, and economic growth, as well as financial instability and reduced access to housing.
We could not have said it better ourselves. Small/regional banks, currently under stress as deposits flea, will soon be facing loan losses on commercial real estate. The likely result will be that a significant portion of our economy is facing much tighter financial conditions than they have seen since the subprime crisis got started. An upcoming recession seems baked in, and it could be a doozy, if the Fed says No Deal.
What We’re Reading
The FDIC Should Act Like a Real Insurer
Small Banks Are Losing to Big Banks. Their Customers Are About to Feel It.
Low Jobless Claims Show Labor Market Shrugs Off Economy’s Clouds
The bank collapses triggered by SVB have uncanny parallels to the savings and loan crisis of the 1980s
Americans Are Losing Faith in College Education, WSJ-NORC Poll Findscredit crunch, Economic Growth, Federal Reserve, GDP, Inflation, Interest Rates, Jerome Powell, Recession