Why global financial turmoil continues and how it could affect you

Can we talk about financial contagion without going on?

Regulators and public officials are desperate for reassurance, but for Canadians trying to understand how a series of unrelated global bank failures could affect them, like the 10-year-old dog in a burning kitchen meme, it may not be the best plan. .

After last week’s market turmoil, worries continued over the weekend. A new report on Sunday revealed that money market funds have swelled by $286 billion in two weeks as people withdrew their deposits from banks. Also on Sunday, International Monetary Fund managing director Kristalina Georgieva warned a Beijing audience of the risks of global financial instability.

As shares in the global investment banking giant in Frankfurt Deutsche Bank fell 14 percent in early trading on Friday and US Treasury Secretary Janet Yellen held an emergency meeting in camera that was not scheduled from the Supervisory Board of Financial Stability, it is quite clear what it looks like. The isolated failure of one overextended California bank is still sending ripples around the world.

Last week, Yellen told depositors that US banks are safe and sound. While calming words are good, emergency meetings are not entirely reassuring.

The phenomenon of financial contagion is not new and has been widely studied.

“Financial contagion describes the cascading effect that an idiosyncratic shock initially to a small part of the financial system can spread to the whole system” sounds like a discussion about the collapse of Silicon Valley Bank (SVB) about two weeks ago and the events that followed. , but the quote comes from the 2013 Handbook of Safeguarding Global Financial Stability.

And while experts know that such a series of events is sometimes difficult to stop, financial experts who have been in the same financial system, quite reasonably, are eager to explain that the problem is limited to unique causes that can be overcome. .

Chances of crisis ‘fairly limited’

“So far, problems have been concentrated in US regional banks and one weaker entity in Europe,” said a report issued early Friday from Netherlands-based ING, whose shares also fell sharply on the day. “The European problem has been more or less dealt with by quick intervention by the Swiss government and the central bank.

“This makes the possibility of a broad systemic crisis quite limited,” said the report, titled Market Turmoil: Make Sure You Don’t Make Drama Out of the Crisis… But.

The difficult question to answer this summer is what causes contagion and the correct analogy to choose. Is it just a “weaker entity” or two that will stabilize quickly. Or is it like snow accumulating on top of a financial mountain built during a time of low interest rates and loose debt?

According to Jacqueline Best – a professor of political studies at the University of Ottawa who has studied periods of inflation and market instability before, and is currently conducting research as Visiting Professor Hallsworth at the University of Manchester in England – the fact that the true analogy is unknown. as the crisis begins perpetuates the contagion.

As someone who studied the financial crisis, he said he felt overwhelmed.

“It’s an exciting time, intellectually, for me, but it’s very worrying,” Best said, speaking by phone from Britain as European markets closed on Friday.

In a theoretical sense, he said, the contagious market rises and falls as a combination of psychological and real factors, connected to the concept of “animal spirits” proposed by John Maynard Keynes during the Great Depression after the market crash of 1929, as a period of enthusiasm replaced by fear.

Looking for a buried corpse?

In the current case, the flaws found at SVB and Credit Suisse mean that each is looking for similar flaws elsewhere.

It is a well-known concept that rising markets can cover up a lot of unrecognized creative accounting, risk-taking and outright fraud that is only revealed when falling markets require people to get paid.

It is a concept that shows the tides that have been swimming naked. But Best has a more macabre analogy.

“If we don’t know enough about where the bodies are buried, then you can have a crisis from sector to sector, institution to institution, country to country,” he said.

“Self-sufficient market dynamics can be quite rational,” Best said. “When you see that others are selling or withdrawing large amounts of deposits, it is rational to do the same as soon as possible.”

Another real type of contagion is the unintended impact of solving one problem on another. Last week, US Federal Reserve chairman Jerome Powell warned of the effects of “tighter credit conditions,” the most extreme of which he called a credit crunch where no one is willing to lend.

The dominoes fell

Another unexpected impact has been caused by financial tools intended to prevent bank failures.

Few Canadians knew that AT1 existed before last week. Now a special bond meant to help distressed banks is causing its own cascade effect after Credit Suisse turned its US$17 billion from AT1 into worthless paper.

It is hard to imagine in advance the chain of events that will lead to the next domino fall. It may be harder for Canadians to think about how the global crisis might affect them.

Canadians love to complain about the banks, but Best points out that Canada’s big, well-regulated banks have been bulwarks against previous crises, including in 2008.

“We’re doing better than many, many other major economies,” he said. “But that said, it’s also quite miserable.”

We are part of a global system, and if global finance deteriorates, there may be dead bodies buried in Canadian institutions if the economy goes into a deeper recession, which could affect politics, business, budgets, jobs and real estate.

“Where I get particularly concerned because of the vulnerability of Canadians right now with huge debt and so on. It is quite clear that of course in a more significant recession, we could potentially be worse this time around,” Best said.

Not only does ING tell you in its report that a broad systemic crisis is unlikely. But instead of saying, “It’s okay,” just being a little bit scared and a little bit cautious might be a good strategy for the country and for Canadians.