The Fed’s Dilemma: Raise Rates During a Banking Crisis?

A momentous Fed decision

The failures of Silicon Valley Bank and three other lenders over the past 11 days has put the Fed in a difficult position as it prepares to deliver on Wednesday one of the most consequential decisions on interest rates of the Jay Powell era.

The central bank chief was already under fire for being too slow to tighten rates and bring inflation under control without pushing the economy into recession. Now, a banking crisis hands the central bank a third crucial challenge: how to steer the banking sector out of the predicament and restore confidence in the sector.

The bad news: There may be as many as nearly 190 lenders at risk of failure, a new academic study calculates. Investors are acting as though First Republic, which saw its shares plummet by 47 percent on Monday, is high on that list.

The cautious camp wants the Fed to pump the brakes on rate increases. Higher rates risk further destabilizing small and midsize banks, Goldman Sachs economists wrote in a note previewing Wednesday’s rate decision. Nomura economists argued last week that the Fed ought to cut rates, “to reduce the risk of further bank runs.”

Weighing in on the debate were the billionaires Bill Ackman and Elon Musk. Mr. Ackman wants the Fed to hit pause because of the turmoil in banks, while Mr. Musk tweeted that the “Fed needs to drop the rate by at least 50bps.”

The consensus is for a 0.25 percent increase. A chorus of economists, including Larry Summers, the former Treasury secretary, say the banking sector instability should not sidetrack the Fed in its inflation-fighting campaign. Others argue that instability in the banking sector will have a disinflationary effect as lenders take fewer risks with their capital reserves, but don’t think that the Fed should stop raising rates. Meanwhile, Treasury Secretary Janet Yellen plans to tell an industry group on Tuesday that the banking system is stabilizing, and that the government could backstop more deposits if needed.

The markets will be focused on any positive news about bank deposits. “After the fears of deposit outflows are put to rest,” Gerard Cassidy, a banking analyst for RBC Capital Markets, writes in an investor note, “we believe bank stock prices will start to recover.”

The Fed’s credibility as a crisis-fighter may be on the line. Mohamed El-Erian, the chief economic adviser at Allianz and a sharp critic of the Fed’s management of inflation, writes in The Financial Times that the Fed’s hands are largely tied. Anything less than an increase of the prime borrowing rate, he argues, would “set up more policy flip-flops that fail to deliver a soft landing while amplifying unsettling financial volatility.”


Amazon plans to lay off another 9,000 workers. The cuts add to the 18,000 layoffs announced in recent months, and represent less than 3 percent of the company’s corporate work force. Some of the company’s most profitable units will be affected, including cloud computing, advertising and the Twitch livestreaming platform.

The U.N. says the world has less than a decade to stop global warming. A new report said that global average temperatures were estimated to rise 1.5 degrees Celsius, a critical threshold for global warming, sometime in the early 2030s, and urged governments to accelerate efforts to shift away from fossil fuels.

Starbucks’ new C.E.O. takes over from Howard Schultz nearly two weeks early. Laxman Narasimhan, who formerly ran the consumer goods giant Reckitt, had been set to start on April 1. He is expected to address the coffee company’s annual shareholder meeting on Thursday.

The French government narrowly survives a no-confidence vote. The result ensured that President Emmanuel Macron’s bill to raise the legal retirement age to 64 from 62 became law, but it did little to quell protests amid widespread anger at the pension overhaul.

Searching for a new lifeline for First Republic

Shares in First Republic, the embattled lender, were up in premarket trading, but only after losing nearly half of their market value on Monday. The bank and its advisers, including JPMorgan Chase’s Jamie Dimon, are studying options to save the lender and stem panic among banking investors.

Some of them would be drastic. One option, according to The Wall Street Journal, is converting some of the $30 billion that JPMorgan and other big banks deposited at First Republic last week into capital. Others could include an outright sale of the lender or another infusion of private capital.

Any plan would have to come quickly: First Republic has lost some $70 billion in deposits in recent weeks, and its continuing troubles are unlikely to assure those whose money remains at the bank.

The outlook for other lenders appears to be improving:

Shares in PacWest are up in premarket trading, as the bank continues to negotiate a potential capital infusion from investors.

Charles Schwab, the brokerage and bank whose shares tumbled in the early days of the banking panic, said it had collected nearly $17 billion in new assets last week.

Across the Atlantic, shares in lenders like Commerzbank and Deutsche Bank of Germany and BNP Paribas and Société Générale of France were up as well.

All isn’t well in Switzerland, however. Tens of thousands of jobs at Credit Suisse are expected to be cut as part of the lender’s sale to UBS, while the country’s political opposition criticized the rescue deal over its cost and likely layoffs.

There’s also fallout from Swiss regulators’ decision to wipe out $17 billion worth of Credit Suisse debt while ensuring a tiny payout for shareholders. Investors in those securities — known as additional Tier 1 bonds — are threatening legal action over the move.

But other investors criticized the outrage over the Swiss move. “Put on your big boy pants and look in the mirror,” tweeted Jeff Gundlach, ​​the billionaire fund manager. “Learn how to manage risk!”

Rethinking banking regulation

After the collapse of Silicon Valley Bank, policymakers are reviewing the rules for financial institutions. Experts say that any new regulations should focus on two questions.

What makes a bank systemically important? Banks become subject to stricter capital requirements once they have $250 billion in assets, a threshold that was lifted from $50 billion in 2018. Last week, lawmakers proposed reversing those changes.

But Silicon Valley was hit by a bank run when customers withdrew their money partly because information was spreading so quickly online, spurring panic. “We have to think about interconnections and how information flows get amplified,” said Eswar Prasad, a trade policy professor at Cornell University.

Should the depositors’ insurance cap be higher? All depositors at Silicon Valley Bank and Signature Bank, including those with assets exceeding the $250,000 maximum for Federal Deposit Insurance Corporation insurance, have been covered. Regulators are reportedly studying ways to temporarily expand the cap in emergencies, and some lawmakers want to permanently raise it.

But that could have unintended consequences. “Once everyone is insured, you create a problem for the economy,” said Amit Seru, a finance professor at Stanford whose new research suggests that many banks may be facing situations similar to Silicon Valley.

Mr. Seru is a co-author of a study that tracked bank asset values as interest rates rose and found that their total market value was $2 trillion lower than suggested by book value. This was because many of them fund assets that mature over a long period using short-term liabilities, such as customer deposits.

If rates rise, the banks can be caught out when depositors suddenly withdraw their cash — as happened with Silicon Valley Bank. This suggests that many banks are already taking unnecessary risks and extending insurance may only encourage more such behavior. “It’s going to create huge moral hazard problems in the sector,” he said.

The UBS banker who’s lived through crises before

As Swiss government leaders assembled in Bern, Switzerland, on Sunday to announce that UBS would buy Credit Suisse at a fire sale price, sitting with them up on the dais was an Irishman who spoke on behalf of the surviving Swiss bank.

That was Colm Kelleher, 65, UBS’s chairman and a key figure in the extraordinary events of the past week. The fall of Credit Suisse was only the latest banking crisis that he has grappled with up close during his 34-year career in the industry.

Mr. Kelleher had a front-row seat in the 2008 financial crisis, as Morgan Stanley’s C.F.O. when the bank sought to survive after Lehman Brothers foundered. The challenge then was for Morgan Stanley to find enough capital to stay afloat. The answer that Mr. Kelleher and others hit upon was an injection of more than $8 billion from Mitsubishi UFJ Financial Group of Japan. (An option that didn’t pan out was a merger with Wachovia.)

He alluded to that experience during Sunday’s news conference. “Having been chief financial officer during the last global financial crisis, I’m well aware of the importance of a solid balance sheet, especially in challenging times like these,” he said. “And UBS will remain rock solid.”

Mr. Kelleher will now oversee Switzerland’s sole remaining banking giant, including a hugely valuable wealth-management arm and, soon, a dominant domestic retail bank. But he and other UBS executives intend to largely run down Credit Suisse’s troubled investment bank.

It’s the latest achievement in a career spent ascending the financial industry establishment. Mr. Kelleher joined Morgan Stanley in 1989 and rose rapidly. (He said in 2020 that he had narrowly avoided jumping to Credit Suisse in 2001, along with John Mack, then his boss.)

After serving as C.F.O., Mr. Kelleher became co-president of Morgan Stanley’s securities business, later taking over the unit. Mr. Kelleher eventually became Morgan Stanley’s president, before stepping down in 2019.

In 2021, he was unexpectedly chosen as UBS’s chairman, in part because of his investment banking experience. That background eventually proved helpful as UBS was pressed by Swiss officials into buying Credit Suisse.



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