Unlike 2008, the trigger was not exotic financial products, but the safest assets there are, US Treasury and agency bonds — the very assets banks were encouraged to hold by the post-2008 regulations. Of course, the value of these bonds — many acquired during the period of rock-bottom interest rates — fell as interest rates rose. It is somewhat of a mystery that even though central banks had telegraphed historically large and fast rate hikes, management and regulators of these failed banks (and likely others) apparently ignored this basic bond math and the adverse implications for asset valuations and capital buffers.
Those keenly following economic data for signs of a recession in the US and globally were in for a surprise in recent weeks. Financial-sector stress came to the fore and dwarfed positive economic data. This illustrates two things: first, last year’s aggressive monetary policy rate hikes have created unintended consequences; and second, the financial sector is a key conduit for recessions. Let’s take these in turn.
The depth of the surprise is best illustrated by then-Fed Chair and now US Treasury Secretary Janet Yellen’s 2017 claim that we “would not witness another banking crisis in our lifetimes”. Ironically, the recent episode of developed market banking stress appears oddly similar to the run-up to the 2008 global financial crisis, with one big difference: the key source of vulnerability this time around arose from steps to make banks safer.
