America’s worst banking crisis since the collapse of Lehman Brothers is pushing the U.S. economy closer to a recession, a regional Federal Reserve president has warned. On Sunday, Minneapolis Fed boss Neel Kashkari predicted that the combination of depreciating long-dated securities held by banks—often Treasury and government agency bonds—as well as loans granted to the troubled office real estate market would likely trigger further losses in the financial sector. And yes, that has recession ramifications.
Capital markets have been freezing the banking sector’s perceived weaker regional lenders out of the credit system, he argued, starving them of access to liquidity and increasing the chances that economic activity would shrink, potentially to the point of a recession that, in the words of the Wall Street Journal’s Nick Timiraos, has been predicted to be about six months away for well over a year now.
“Not all of these stresses are behind us. I expect this process will take some time,” Kashkari told CBS: Face the Nation on Sunday. “Sometimes it takes longer for all the stresses to work their way out of the system.…we know that there are other banks that have some exposure.”
Kashkari, one of this year’s four rotating regional Fed presidents that casts a vote on the policy-setting Federal Open Market Committee (FOMC), is a veteran of financial crises. The native Ohioan first rose to prominence at the age of 35 after then-Treasury Secretary Hank Paulson handpicked him in October 2008 to administer the $700 billion in U.S. taxpayer money to bail out banks under the Troubled Asset Relief Program, or TARP. The two had worked together at Goldman Sachs, where Paulson was the CEO but barely knew the investment banker Kashkari, per the Washington Post. He stayed on at Treasury at the request of Obama appointee Timothy Geithner, and later ran unsuccessfully for California governor as a Republican, and also worked under the bond investing giant Pimco.
While Kashkari has argued repeatedly in the past for interest rate hikes, he now considers it too soon to make any forecast about the further path of interest rates with the crisis only two weeks old.
“We’ve seen the capital markets have largely been closed for the past two weeks. If those capital markets remain closed, because borrowers and lenders remain nervous, then that would tell me this is probably going to have a bigger imprint on the economy,” Kashkari explained.
On March 22, the FOMC attempted to please hawks and doves, hiking the fed funds rate to combat inflation but only by a quarter point, citing a tightening of credit conditions due to the onset of the crisis. While Chair Jay Powell said the committee did not currently foresee any rate cuts during the year, investors already have begun pricing in a 74% chance the Fed will cut rates by at least 1.25% by the end of 2023, according to CME Group.
SVB-linked losses could amount to nearly $2 trillion across the system
Silicon Valley Bank sparked the current crisis after clients pulled a grand total of $56 billion out of the lender within a matter of weeks, wiping out a third of its deposit base. Two days after SVB became the second-largest lender by assets to fail in U.S. history, it was followed by the third largest, NYC-based Signature Bank.
Investors are now afraid the sector suffers unrealized losses lurking in their hold-to-maturity bank book. The Federal Deposit Insurance Corporation has estimated this risk amounts to $620 billion across the entire industry. Others believe the losses could be as high as $1.7 trillion once you factor in loans.
“The losses from the interest rate increase are comparable to the total equity in the entire banking system,” researchers at New York University wrote on March 13.
Although Kashkari claimed that deposit outflows from regional lenders have slowed in recent days and the broader sector was sufficiently capitalized to withstand the current credit crunch, he speculated that this crisis “definitely brings us closer” to recession.