Weekly Update 3/28/2023
The Recession of ‘23
Is a Recession In 2023 Now Inevitable?
Fed’s Kashkari: “Stress in banking sector brings U.S closer to Recession”
First Citizens Bank Acquires SVB
Powell: “Banking system is sound”
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—Market Madness—
Brian Chesky, Co-Founder and CEO of Airbnb: Designing a 10-star Experience
A recession in 2023 is now inevitable. Layoffs in tech and finance will spread to other sectors
More than a year ago, I forecast a recession would begin in the second half of 2023. That was a no-brainer. Years of virtually zero interest rates ignited stock markets, bond markets, and housing bubbles. To deal with the spike in the inflation rate to 9% in June 2022, the Federal Reserve began to increase the Fed funds rate–the rate banks lend to each other overnight–expecting to cool demand for goods and services and thus bring the rate of inflation down to its target rate of 2%.
With inflation increasing at the fastest pace in more than 40 years, the Fed had to act to deal with the pain families were feeling as wage increases lagged the rise in the cost of living. In short, the wage-price spiral is a myth. More accurately, a price-wage spiral unfolds during inflationary cycles. In an effort to cool off the economy and get inflation to its target rate, the Federal Reserve began to increase the Fed funds rate rapidly throughout 2022. Rates increased from virtually zero in March of that year to a target range of 4.75-5.00 for March 2023.
Nevertheless, the latest CPI data reveal prices rose 6% in February 2023 compared with the same month the previous year–well above the new Fed funds target rate of 5%. Historically, the Fed would raise its funds rate above the inflation rate to break the back of inflation. In short, Jerome Powell is no Paul Volcker, who raised the Fed funds rate more than four decades ago to nearly 18%–well above the 12% inflation rate (see above). We will have to wait and see if the Fed will raise the Fed funds rate in coming months to bring the inflation rate down.
However, Chairman Powell has another concern besides tweaking the Fed funds rate to slay the inflation dragon, which he addressed during his Mar. 23 press conference after the Fed announced the new funds rate target. The collapse of Silicon Valley Bank and Signature Bank complicates the Fed’s task of “managing” the macroeconomy by moving the Fed funds rate up and down to dampen inflation (and inflation expectations) and boost economic activity when the economy eventually slides into a recession. Additionally, the Fed is responsible for ensuring financial stability when banks fail and preventing more bank runs throughout the country. Only time will tell if Chairman Powell’s assertion that the banking system is “sound” turns out to be true.
The truth of the matter is a combination of fractional reserve banking, easy money, and FDIC depositor insurance has created a moral hazard that promotes risky bank lending. Thus, when a rumor of a bank’s shaky financial condition gains traction, a run unfolds, revealing tenuous liquidity situations and weak balance sheets.
Fed’s Barr to Congress: SVB’s failure is ‘textbook case of mismanagement’
Less than three weeks after Silicon Valley Bank failed, Federal Reserve Vice Chair of Supervision Michael Barr will tell lawmakers Tuesday the collapse was a textbook case of mismanagement after what was the country’s 16th-largest lender fell into receivership in a matter of days.
Barr’s testimony will come just a day after First Citizens announced a deal to take over Silicon Valley Bank’s loans and deposits from the FDIC, which had been leading the bank since March 10. Barr notes the company grew “exceedingly quickly” during the pandemic, with deposits rising rapidly and these proceeds largely ending up funneled into longer-term securities like Treasury bonds and mortgage-backed securities.
“The bank did not effectively manage the interest rate risk of those securities or develop effective interest rate risk measurement tools, models, and metrics,” Barr will say.”At the same time, the bank failed to manage the risks of its liabilities. These liabilities were largely composed of deposits from venture capital firms and the tech sector, which were highly concentrated and could be volatile.”
“SVB’s failure demands a thorough review of what happened, including the Federal Reserve’s oversight of the bank,” Barr will tell lawmakers. “I am committed to ensuring that the Federal Reserve fully accounts for any supervisory or regulatory failings, and that we fully address what went wrong.” Barr’s key message that SVB’s failure sits with company management echoes what Fed Chair Jerome Powell said last week in a press conference, telling the media: “[At] a basic level, Silicon Valley Bank management failed badly, they grew the bank very quickly, they exposed the bank to significant liquidity risk and interest rate risk, [and] didn’t hedge that risk.”
FDIC Chair Martin Gruenberg, who is set to testify alongside Barr and Treasury undersecretary Nellie Liang on Tuesday, also said in testimony released Tuesday the failure of SVB and New York’s Signature Bank, which the FDIC seized on March 12, contain several common threads, including a high proportion of uninsured deposits, heavy losses on securities portfolios, and the risks banks with more than $100 billion in assets post to the financial system. Gruenberg said the FDIC will release a report on the agency’s oversight of Signature Bank, and a separate review of the deposit insurance program, by May 1.
—CRYPTO CULTURE—
Binance, CEO Sued By CFTC For Trading Violations; Bitcoin Price Stumbles
The Commodities Futures Trading Commission on Monday sued Binance, the world’s largest cryptocurrency exchange, along with founder and CEO Changpeng Zhao, for trading and derivatives rules violations. Bitcoin shed more than $1,000 on the latest U.S. government crackdown vs. cryptocurrency firms, but came off lows.
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Binance ‘Disregarded Federal Laws’
Binance, Zhao and former Chief Compliance Officer Samuel Lim solicited U.S. customers while failing to register and comply with regulatory requirements as part of its “ineffective compliance program,” according to the Northern District of Illinois court filing.
The exchange accepted margin, futures, options trading, swaps, and leveraged transactions for “commodities” including bitcoin, ethereum and litecoin in July 2019. Binance sought U.S. retail and institutional customers while ignoring regulatory requirements under the direction of Zhao, the filing states.
In August 2020, Binance earned $63 million in fees from derivatives transactions. And 16% of its accounts were held by U.S. customers. By May 2021, Binance’s monthly derivatives transaction revenue increased to $1.14 billion.
Binance never registered with the CFTC “in any capacity” according to the filing. The exchange “disregarded federal laws,” including those that require controls to prevent money laundering and terrorism financing, the agency alleges.
Zhao and Binance’s senior management team “actively facilitated violations of U.S. laws,” by “assisting and instructing” U.S. customers to evade compliance controls Binance purportedly implemented, the filing noted.