Crisis lessons for U.S. Federal Reserve as Powell waits to find out why banks collapsed

Crises are good teachers – for central bankers and for the rest of us.

Canadians who treat money as an immutable unit of earning, saving and spending have learned from years of inflation.

And anyone who thought banks were glorified instant teller machines learned a lesson over the past two weeks as they watched the contagion of the disintegrating Silicon Valley Bank (SVB) help bring down Swiss banking giant Credit Suisse.

Just over a year ago, the world’s most powerful central bank, US Federal Reserve chairman Jerome Powell, admitted that inflation surprised him. On Wednesday, Powell said he still needed to understand why and how the banks collapsed and how that affected inflation and the economy.

“We are committed to learning the lessons of this episode and how to prevent events like this from happening again,” Powell told reporters at the central bank’s monetary policy news conference.

And there is much more to be learned about the impact of the event and when the disruption will end. The Fed chair said that if banks rein in their own lending to try to prevent them from getting into trouble, ordinary people will feel the effects – including making it harder to get loans and slowing economic growth.

“Events in the banking system over the past two weeks could lead to tighter credit conditions for households and businesses, which will affect economic outcomes,” Powell said. “It is too early to determine the extent of the effect and therefore too early to tell how monetary policy should respond.”

Didn’t see it coming

One monetary policy response was for the central bank to cut rate hikes to a quarter instead of the half-point increase it had expected earlier this month.

Just a few days before the SVB collapsed, Powell had testified to Congress that the Fed should have raised rates higher and faster to combat inflation – clear evidence that he did not see the banking turmoil and its disruptive effects.

The change took the US central bank rate to a range of 4.75 to five percent. That compares with the Bank of Canada’s policy rate target of 4.5 percent. However, Canadians trying to obtain or renew a five-year mortgage may be affected because long-term Canadian debt is heavily influenced by US bond rates.

For Canadian and US long-term borrowers, a quarter increase is better than a half. But the implication of “tighter credit conditions” means that banks may be more confused about who to lend to.

While Powell echoed Treasury Secretary Janet Yellen’s recent comments that US banks are “safe and sound” and that depositors will not lose their savings, the Fed remains uncertain about how long the banking sector’s woes will last. He said there was a lack of precision about the negative impact on the economy.

In fact, in the discussion before Wednesday’s policy announcement, Powell said he and a panel of advisers had seriously considered following Canada’s lead and pausing interest rate hikes altogether.

Economists from at least one financial group, Japan’s Nomura, have suggested that the Fed will cut rates by half a percentage point.

Despite repeated signals from the financial market – based on bets on where interest rates will move next – that the Fed will reduce interest rates before the end of the year, Powell scoffed at the idea, saying the central bank has no plans to, and does not. forecast, rate reduction in 2023.

The impact on rates is still uncertain

But the short period after the unexpected disruption in the banking sector, the impact on interest rates remains uncertain.

“We don’t know,” Powell said.

When he said there had been fears of a takeover of Credit Suisse by its former Swiss competitor, UBS, it would not be good, that seems to have changed.

“I’d say it’s been good.” But then Powell paused before adding, “You’re far away.”

Asked by one reporter how the American public can have confidence in the banking system when signals about SVB’s failure were “missed” by regulators, Powell explained several things that make the bank’s case unique, including its rapid growth and taking a lot of risks.

But there are also technical considerations. Powell described the “unprecedentedly fast and massive bank run” as a large group of well-connected and technically adept depositors withdrew their money “faster than historical records would suggest,” he said.

Despite the fear of some bankers – including Scott Anderson, president and CEO of Utah-based Zions Bank – that the 2018 rollback in the regulation will demand blame and lead to new tighter rules, Powell insisted that the central bank should learn enough to understand. what happened and prevent recurrence.

“My only interest is to find out what went wrong … to make an assessment of the right policy that needs to be implemented to prevent it from happening again, and then implement that policy,” he said.