What Rough Beast

The economic situation? I don't understand the question, and I won't respond to it

these are the fates. they don’t have my back. i would advise not getting killed by them. their swords trap the souls of their victims.

And what rough beast, its hour come round at last,

Slouches towards Bethlehem to be born?

William Butler Yeats, “The Second Coming”

Last month, I wrote a post about why I didn’t expect a recession in the US. Womp womp. Then Silicon Valley Bank happened, and now everyone is worried about a banking crisis. What’s the update?

The Bank-runs of Inisherin

Confidence Men

I used to think you were solvent. But maybe you didn’t use to be. Oh God. Maybe you never used to be.

To recap the financial situation, three banks failed last week, and the Fed bailed two of them out. Why did they fail? A bank run by idiots on a bank run by idiots, simply put. Those banks were very badly managed and badly exposed to interest rate risk. And they lost the trust of their clients. They key to the banking business is trust - trust in the solvency of your bank, and trust that others won’t lose trust and stampede to get their money out.

But now that the trust has completely fallen apart, what’s there to say? People are scared. One relationship falls apart like that, and now everyone is wondering - what if my bank is next? The Fed’s action make sense: it’s trying to get everyone to trust their bank again. That takes money, because it’s what people are scared their banks won’t have. But of course, money isn’t free.

At least the Fed said there won’t be a financial crisis on their watch. Or not. Nobody really understood what they said. So people are even more scared. Perhaps the Fed won’t actually save their bank. Nobody understands what “systemically important” means, and they’re not telling you. Committing to saving everyone means that you’ll get taken advantage of. But if you don’t, people are still scared. And the government already failed at reigning in the banks, so we’re in this whole mess already. You can’t stop rescuing a fella, because it isn’t nice.

One could say banks, and the tech industry behind the panic, abused that trust. Banks were irresponsible with their business practices - “ye’r all fecking insolvent”. And tech used their power, and money, and prestige, to push for pointless scams like cryptocurrency, that left common people who trusted successful companies to not rip them off. So there’s already been a big breach of trust here. Why would you trust the people who gave awards to Sam Bankman-Fried for ripping you off to not rip you off? And the banks can’t be trusted already, they got us into this mess to begin with.

Other banks are at risk now, and it’s not clear whether the government can or will save them. People are angry and they’re out for blood. First Republic Bank, one of the biggest risks out there, mostly services the richest people. Rescuing banks like that will take political courage. And the last time there was no courage to act, Lehman Brothers failed, and the global economy followed.

Some things there's no moving on from.

Things fall apart

Last time around, I said the economy was strong. The economy is still strong. But it might not be strong for much longer if people continue being scared. And it won’t be strong at all if banks start failing left and right.

The Fed has been raising interest rates since a year ago, because inflation is high. Many people say this is a bad idea, first because not all prices are going up for things the Fed controls, and because they don’t think it’s worth the cost. That’s not the argument to be had here. But the Fed has done much less than others - Latin America started earlier and went faster, and the kind of rules it used to follow would have required going much further.

Mike Konczal @mtkonczal

I don't understand why people focus on the headline job number as inflationary by itself - do the new workers not make anything? - instead of its influence on wages (and, by extension, spending). AHE number gets revised quite a bit, but downward trend is clear, now near trend.

The Fed is looking at some things right now. They’re looking at the labor market, and they’re not looking at it right - they want job openings down. But job openings just aren’t real - you wouldn’t measure how good the dating market is by how many people are on Tinder, you’d look at dates and matches. And yet the Fed is doing the former. Unemployment isn’t up. Employment, especially for those in their prime age, isn’t down. And labor force participation isn’t down. Quits are down, and job changers have led wage growth. Hires aren’t down a lot. And layoffs are normal. The Fed wanted the labor market to go back to normal, and it’s going back to normal.

Mike Konczal @mtkonczal

Here's what the onion looks like, all of it a bit more discouraging than in previous months. Shelter still not decreasing, may cause reassessments of when that happens. Core goods not deflating even with used cars in sharp decline. Rest of core services up a tick. /4

Prices are not looking good, though. But they’re not looking good for good reasons. The Fed wanted core goods inflation to go down, and it has, but cars are holding up the situation. They wanted core services (without housing) to slow down, and they kinda have, it’s all over the place. And shelter is behind everyone else, but it’s going to get there - private measurements say it already has, and official ones just have to catch up. They can’t print more cars, and they’ve already cooled the labor market, so core services should be coming down. And housing is sensitive to rates, but they’ve already done it - it just needs to come down on official numbers.

Last time around, I compared the Fed to the orchestra conductor Lydia Tár. They both tell everyone when to make moves, and more importantly, they both control time. Time is the thing. The comparison might have been more apt. When I said there was no recession, the Fed was at the height of its powers - commanding all the players perfectly, everything added up. But now they’ve taken a tumble, and it’s all falling apart. One of the big influences on Tár was The Telltale Heart by Edgar Allan Poe. The story is about guilt. Lydia Tár is guilty, and the whole ending may be imaginary because of how guilty she feels.

Carl Quintanilla @carlquintanilla

APOLLO: “Quantifying the impact of tighter financial conditions plus tighter lending standards, we estimate that the events this past week correspond to a 1.5% increase in the Fed funds rate.” [Slok]

Could the Fed be guilty? There’s a lot going on, and by all accounts, it’s on them. So the question is what they do next. The risk, on rates, always was going too far. They might stop now. People are scared, and banks are scared. The vibes are all harshed up. Financial conditions are tighter than believed becuase of the situation, and now they’ll be even tighter. This could mean no more rate hikes. And financial conditions affect the labor market, which the Fed wants to cool down.

In a weird, ironic twist, the economy might be safe from recession because of this.

Soft, hard, in between

There have always been two big scenarios people talk about: soft landing and hard landing. In a soft landing, there’s no recession, and inflation goes down. It has costs, but they’re small. In a hard landing, there’s a recession. That’s really bad.

People are scared because financial turmoil might mean there’s gonna be a hard landing. And the economic fundamentals haven’t changed, but the vibes dominate - the Fed is more a conductor than a player. If banks start crashing, people will get scared, and that means they’ll cut back. When they start cutting back, others lose their jobs or their incomes, so they cut back too. And so on and so forth.

But if the Fed feels guilty, and they stop, it might not be a hard landing. It’s more a spectrum than a binary. There’s softer landings, and harder landings. In hindsight, stopping earlier would have made people less scared, and made the crisis less severe. But there was a crisis, and now everyone is reeling. It’s spread to Europe too - Credit Swisse got bought out by another bank, Detusche Bank is in trouble, and the ECB raised rates again. But if the Fed stops, people might calm down, and the economy might cool down. Rates take a while to pass through, and then’s the other factors mentioned above. So we might see.

What isn’t really in sight is a 2008-esque meltdown. The similarities are concerning: higher interest rates and a looming recession (perhaps) while the banking sector suffers. But the differences are big. The first is that the banks held illiquid assets with unclear prices, not Treasury bonds. Secondly, those assets were tied to mortgages, which were defaulting at near-record rates because of higher rates and a slowing economy. Third, rates were higher and inflation was lower and did not stem from an underlying hot economy - monetary policy was tighter. And in this regard, the recession started about a year before Lehman fell, though there was financial stress in the meantine - the two were inseparable. The recession will not affect banks as much, and their assets are not as arcane.

Time is the thing.

Conclusion

We’ve done enough so far. Pack it up. To quote a Best Picture Oscar Winner, “Please, be kind. Especially when we don't know what's going on.“ Might be good advice for Central Bankers.