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Fed ‘made a terrible mistake’ keeping interest rates ‘so low for so long,’ editor says

The Financial Times Chair of Editorial Board Gillian Tett, Reuters Breakingviews Global Editor Peter Thal Larsen, and Tasty Trade ‘Truth or Skepticism’ Host Dylan Ratigan join Yahoo Finance Live to discuss the U.S. banking system, government bailouts, and the outlook for regulation.

Video transcript

BRAD SMITH: And let's continue our conversation on the financial fallout that began with the collapse of Silicon Valley Bank and the subsequent stabilization efforts put in place by banks and governments, both here and abroad. Joining us now for a global look, Gillian Tett, editorial board chair and editor at large for the US at the Financial Times; Dylan Ratigan, who is the host of Truth or Skepticism on Tasty Trade; and Peter Thal Larsen, who is the global editor at Reuters Breakingviews.

Thank you all for joining us this morning. Gillian, first, I want to begin with you. Earlier this week, we had State Street Global Advisors Michael Arone, who said he saw no reason to panic here, and particularly around the crisis word. I want to play this clip and get your reaction on the other side.


MICHAEL ARONE: I think that it's clear that government officials, central banks, and even the banking sector is doing everything they can to contain-- I even hesitate to call it a crisis-- but challenges within the regional bank sector. And Julie, just a moment ago, you were pointing out even today, if we look at those regional banks, a number of them are up so far this morning.

BRAD SMITH: And so there's been a lot of semantics about whether or not we should be calling this a crisis, but the reality here is that there is a magnitude of impacts and many still asking if there's an over-sensationalization, excuse me, of the turmoil warranted, considering those web of impacted parties. We'd love to get your perspective.

GILLIAN TETT: Well, the good news is that we are seeing some recovery in bank shares and signs, according to the US Treasury, that the outflow of deposits has slowed down overall, although we can't get a breakdown in terms of individual banks, and it's still very unclear what's happening at First Republic. The other bit of good news is that some kind of deal has been cobbled together in Switzerland, albeit very, very controversially.

The bad news, though, is that, as you've just heard, the reaction in the markets to this extraordinary attempted rescue of First Republic has not been as nearly as positive as the government had hoped. First Republic still is clearly very, very challenged. And the other bit of bad news is that there's still a sense that the interest rate problems that caused the issues originally at Silicon Valley Bank are still bubbling at many, many other regional banks.

And on top of that, there's a really big question, which is given that this has primarily been an interest rate risk linked crisis-- that's what's caused the liquidity problems at the banks-- are we now going to see this morph into a credit problem whereby we begin to see, unfortunately, some of the losses, some of the loans that banks have made, have problems?

JULIE HYMAN: And Peter, I want to bring you into this because as we look at the international banking system, the Credit Suisse, UBS situation seems to have stemmed the bleeding, so to speak, for now. You have that on top of some of the regional banks in the US still perhaps being troubled. Sort of, what's the global view on stability, on financial stability right now?

PETER THAL LARSEN: Well, I think there's a couple of things. I mean, part of it is just the weakest wildebeest at the back of the pack are getting eaten basically, right? I mean, Credit Suisse has had problems for a long time. Silicon Valley Bank was the one that had the greatest exposure in terms of unrealized losses on long dated securities. So those things tend to go first. The question, then, is really whether-- to what extent that spreads.

I think there's a couple of ways in which that could happen. One is in the US, obviously, this question over uninsured deposits and whether they're at risk, which the authorities are doing their utmost to try and calm people down on. The other point of contagion potentially is what happened in Switzerland over the weekend, which was the Swiss government's decision to write down to zero these additional capital bonds that Credit Suisse had issued, basically by changing the law over the weekend. And now, everybody asking the question across Europe and elsewhere, sort of, could that happen here as well?

So I think those are the immediate factors. And then but the underlying point in all of this is interest rates are rising, and we've had a decade and a half of ultra low interest rates. And now, the Credit Suisse and SVB situation show you that people are not prepared for that to happen. And so the consequences of that will continue to filter through.

BRAD SMITH: And so, Peter, as well, kind of thinking through where the contagion has actually led to already, as Dylan was mentioning a moment ago, some consolidation, or even after that consolidation what can be expected by clients of these banks to the service level agreement that they should be able to uphold their financial institutions, too, as well?

PETER THAL LARSEN: Well, I think it depends. I mean, Credit Suisse and SVB are very different. But one thing they had in common is that they-- in this case, it's the very wealthy clients, right? I mean, in Credit Suisse's case, millionaires and billionaires and SVB, obviously, had all these venture capital firms and startups depositing their money with it. So they were probably particularly susceptible to a run in a sort of an online, "people being very aware of what's going on" type of world.

I think the other question here, though, is that we've seen in both cases, despite all-- everything that happened after 2008 and all the regulations that were passed and so forth, we're still seeing essentially the authorities coming to the rescue. I mean, in the case of SVB, they stepped in and guaranteed the deposits. And in this case, the Credit Suisse, basically, UBS was ordered to buy Credit Suisse. And the Swiss government then changed all kinds of laws in order to allow that to happen quickly.

So we're still slightly in the set of the 2008 playbook, which is the government is ultimately there on the hook. And if that is the case, then I think that probably also changes the way people think about different governments and their ability to support their banking systems.

JULIE HYMAN: Yeah, on that front, Dylan, let's bring you into this. It's good to see you, by the way. It's been a while. As we mentioned, you're host of a podcast called Truth or Skepticism. So let's bring in some skepticism. You, in the past, have been critical of, particularly following the 2008 crisis, critical of the system, the regulatory framework. Do you think that was really a failure that led to maybe not just SVB, but also, in some ways, Credit Suisse?

DYLAN RATIGAN: Oh, yeah, I mean, it's not even a question. It's not an opinion. They chose to create two classes of banks in 2008, those that are too big to fail. There are four of them, and then they created everybody else. And that was their solution. They said, well, we're going to ratify-- Rahm Emanuel said in the meeting for Dodd-Frank, if you vote for this bill, you will never have to have another TARP vote again as long as you live because we can directly connect the Federal Reserve to the big banks and bail them out without anybody knowing. That was the law that was passed in 2008. And so you had two classes of bank.

Now you fast forward. The second class of banks pick them. We're using these names that are the ones now. Well, they fail. Well, guess what? They're also insured 100%. I think that the charade that every bank is not completely supported is not helpful because we're sort of pretending like, oh, capitalism, and, oh, you have your money. You fail your money. You lose your money. And no, not true. Not true.

The way it works is, if you work at a bank, you can create more risk two ways-- credit risk, which is what they did in '08-- you reduce your credit quality-- or duration risk, which Peter just referenced here, which is you go into longer dated investments and don't-- and in their case and in many cases, don't hedge. When you create more risk, whether through duration or credit risk, and you're a bank CEO, bank board member, bank executive, you pay yourself millions or tens of millions of dollars a year each year, and it lasts for three or four or five six, seven, eight, nine, 10 years.

And then at the end of that, because that is a terrible way to manage risk, when you fail, the government will bail you out. That's the global banking system. That's not a-- I don't care what the rules say. If you run a bank, the logical incentive is to manufacture risk and compensate yourself as much as possible until it finally blows up. The bank will then be bailed out. The equity might be dissolved, but there will never be compensation clawbacks.

And the consequence of this is have bankers that are incentivized to manufacture risk that can be transferred to the government, rather than provide a service, which is to facilitate the flow of credit and capital, the actual enterprises. Enterprise business, whether it's the startups of Silicon Valley or whether it's industrial manufacturing, we started with a glove manufacturer. We had a $50 million contract from the Pentagon. Can you imagine if we had to go to 50 different banks to try to manage all of our vendors because it's the depositor's responsibility to manage risk? It's laughable.

And so I think that this is a good opportunity. People want you to understand that the banking system is completely backstopped everywhere. That the implication that some are and some are not is useful for the more powerful. We want people to perceive First Republic to be vulnerable because other banks want to buy it for free.

So every time that it gets a little squirrelly, if you pretend to be capitalist for a few weeks, you're able to knock off the weak wildebeest, as Peter said. Buy them out for cheap, and then get-- then the buyer gets bailed out, whether it's UBS that takes the Credit Suisse book or whatever's going to happen with all of this. But I think we do ourselves a disservice to pretend that that's not the world we live in.

BRAD SMITH: And Gillian, I want to kind of pivot to you and perhaps even get your reaction to that, with the added thought of some economists saying that the banking sector turmoil has done the Fed's job for it. Do you believe that to be true?

GILLIAN TETT: Well, it's done the Fed's job for it in the sense that it's tightened financial conditions really quite considerably. And there are analysts out there reckoning that the financial tightening is equivalent to around 25, 50 basis points hike as it is. But the issue for the Fed right now is it is quite keen to separate out financial stability from the real economy insofar as it can. Of course, you never really can. But as Christine Lagarde of the European Central Bank said last week, there are different tasks for the Fed right now.

So I suspect what the Fed will do is essentially continue to raise rates to signal its fight against inflation. So use a policy rate tool to basically try and go after inflation, but use its balance sheet to essentially try and stave off the financial instability risks within that already.

It's going to be very, very difficult. I'm very strongly in the camp of those who think the Fed made a terrible mistake to keep interest rates so low for so long. The reason we're having these shocks now is because it's hard to overreact and jam on the brakes to essentially atone for the big mistake it made earlier. And I strongly agree with Peter that the fundamental problem, as I've written myself in numerous columns, is that most of the financial system has been geared to make a one-way bet on rates staying low forever. And they simply have not woken up yet to the risk. And the really big issue is that, yes, we start--

DYLAN RATIGAN: I would just argue they're aware of the risk, but-- I would argue, Gillian, they're aware of the risk, but they're expecting the bailout. In other words, there's ignorance, and then there's just like-- so these are not stupid people. These are people that benefited from the credit expansion in 2006, '07, '08, '09.

Then there was a massive overcompensation, which is the 0 rates, to compensate for their previous mess, which everybody agrees the Fed is out of control running 0 and getting all these-- and now, you know, First Republic has mortgages out in California for 2 and 1/2%. And their borrowing rates are 5 and 1/2% at the short end. That's not a shock, right? At some point, rates were going to go up. I'm arguing that the risk is egregiously mismanaged. There is going into 2006, '07, '08, 09--

GILLIAN TETT: With the government.

DYLAN RATIGAN: --with the credit with the ninja loans--


DYLAN RATIGAN: --or whether it's the leverage on short rates now because they know they're going to get bailed out.

JULIE HYMAN: Well, but and Gillian, is that the risk then of the FDIC making the guarantee more explicit and saying there's no limit. Let's just guarantee all deposits. Is that the risk, then, that you are encouraging further risk taking behavior?

GILLIAN TETT: Well, the only thing that's worse than moral hazard, which the system is riddled with right now, is that you have unpredictable moral hazard. And that's worth the moral hazard, because, yes, at the moment, we now, in retrospect, that the depositors at Silicon Valley Bank and Signature were rescued. Yes, Janet Yellen said yesterday that that rescue, that support, would extend to other regional banks if they fall into problems, too. But we don't actually know how far the FDIC's suport goes, whether it's going to cover all the banks.

And perhaps most critically of all, although we've seen the banks break first in relation to the interest rate cycle going up or interest rates going up, and we're seeing some protection for them, what's going to happen if, say, commercial real estate starts breaking big time, as we've heard earlier it may well start to do? What are we going to do about private equity, venture capital? What are we going to do about university foundations? There are many, many parts of the financial system right now which could also be hurt very badly by interest rates going up. And we just don't know whether the government's going to step in and provide that kind of moral hazard or support or bailout there as well.

So for investors, it's incredibly confusing because you can neither trust on free market mechanisms to set the price of things completely. We've seen with the Credit Suisse, UBS deal that the government stepped in and meddled there extremely extensively. So you can't really trust free market mechanisms. But you just don't know yet whether the government is actually going to come out and bail out the entire system or just select the systems--

DYLAN RATIGAN: Yeah, I mean--

JULIE HYMAN: Well, actually, Dylan, I want to let Peter get in.

DYLAN RATIGAN: I just-- I have to-- this is worst case scenario. What Gillian described, which is stochastic moral hazard, is the worst potential economic policy you can imagine.

JULIE HYMAN: Right, well--

GILLIAN TETT: Stochastic [INAUDIBLE] but yes.

JULIE HYMAN: So, Peter, I wanted to bring you in here for the last word because what Dylan and Gillian are talking about is, indeed, a worst case scenario, right? It's sort of a dire scenario. Do you think that's what's going to happen? Is that what we're headed into here? What do the next three to six months even look like?

PETER THAL LARSEN: I mean, it's very difficult to predict. But I think Gillian made the important point just now, which is that we're talking about the banking system, but I think we can all agree the banking system is-- I mean, it's not safe, but it's safer than it was in 2008. The 2008 banking system was at the heart of the problems. And I think the banking system, until now, has been a bit more of a shock absorber. And OK, we'll see how that goes and whether there are other things lurking on the balance sheets that come to light that make this a more serious problem for a bigger number of banks.

But what's happened since 2008, quite deliberately, the regulators designed it this way is that they've pushed a lot of risk out of the banking system and into financial markets, into things of funds, into private equity, into various other things, and hedge funds and so forth. And that was very deliberate because the idea was that those entities would not put consumers at risk in quite the same way.

But it hasn't quite worked that way, and we've seen a couple of times now, most notably in 2020 during the COVID pandemic, that the central banks had to come in and backstop financial market instruments in order to prevent fallout and prevent damage to the economy. And so I think that's the other big lurking risk here, is what other unexploded landmines are there out there that are beyond the reach of the financial regulators directly, but that they may have to come in and take care of if it turns into a real problem for the economy.

JULIE HYMAN: Yeah, I think that one thing we've learned throughout the past, what, 20 years plus of covering finance is, they'll find new ways to take on risks that we haven't necessarily foreseen. Thanks, guys. Really great to get your collective perspective here.


JULIE HYMAN: Dylan Ratigan, host of Truth or Skepticism on Tasty Trade, Peter Thal Larsen of Reuters Breakingviews, and Gillian Tett of the Financial Times. Thanks again, guys.