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    Federal Reserve and Global Central Banks Act to Shore Up Dollar Access

    America’s central bank and its counterparts around the world are rushing to cushion markets against the impact of bank problems.WASHINGTON — The Federal Reserve and other major global central banks on Sunday announced that they would work to make sure dollars remain readily available across the global financial system as bank blowups in America and banking issues in Europe create a strain.The Fed, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank announced that they would more frequently offer so-called swap operations — which help foreign banks to get weeklong access to U.S. dollar financing — through April. Instead of being weekly, the offerings will for now be daily.The point of the move is to try to prevent tumultuous conditions in markets as jittery investors react to the blowups of Silicon Valley Bank and Signature Bank in the United States and the arranged takeover of Credit Suisse by UBS in Europe. Upheaval in the financial sector can easily turn worse if investors struggle to move around their money — something that often happens because of a shortage of dollar funding in moments of stress. Swap lines can help to release those pressures.Still, the fact that the central banks are enhancing swap lines underlines how serious the fallout from the bank problems has become: Central banks typically pull out such programs amid acute problems, like in the 2008 financial crisis or the 2020 market meltdown at the onset of the coronavirus pandemic.The move was “a coordinated action to enhance the provision of liquidity,” according to the statement from the central banks.The move comes ahead of a big week for the Fed. The U.S. central bank is set to meet and announce its latest interest rate decision on Wednesday.Up until a few weeks ago, it seemed possible that the Fed could make a large half-point move at this meeting, as it tried to battle surprisingly stubborn inflation in an economy that had proved remarkably resilient.But with tumult coursing across the global banking system, investors now think that a large move is unlikely: They are betting on a smaller quarter-point move, or no move at all, as officials wait to digest how the financial system is handling the latest developments. Plus, turmoil in banking can lead to less lending, which could itself help to slow down the economy.The move was part of the Fed’s ongoing push to shore up stability in the global financial system. Just one week ago, the Fed and other regulators announced that Signature Bank had failed and moved to back up uninsured deposits at that firm and Silicon Valley Bank. The Fed also set up an emergency lending program to help banks to weather a tough period.That program allows banks to use bonds and other assets as collateral to obtain loans, and it values those securities at their original prices, not the prices at which they are currently trading in markets. For banks sitting on assets that are worth less after a year of steep Fed interest rate increases meant to combat rapid inflation, that could serve as a sort of relief valve, allowing them to raise cash without realizing big losses. More

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    Before Collapse of Silicon Valley Bank, the Fed Spotted Big Problems

    The bank was using an incorrect model as it assessed its own risks amid rising interest rates, and spent much of 2022 under a supervisory review.WASHINGTON — Silicon Valley Bank’s risky practices were on the Federal Reserve’s radar for more than a year — an awareness that proved insufficient to stop the bank’s demise.The Fed repeatedly warned the bank that it had problems, according to a person familiar with the matter.In 2021, a Fed review of the growing bank found serious weaknesses in how it was handling key risks. Supervisors at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six citations. Those warnings, known as “matters requiring attention” and “matters requiring immediate attention,” flagged that the firm was doing a bad job of ensuring that it would have enough easy-to-tap cash on hand in the event of trouble.But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was in a full supervisory review — getting a more careful look — and was ultimately rated deficient for governance and controls. It was placed under a set of restrictions that prevented it from growing through acquisitions. Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose.It became clear to the Fed that the firm was using bad models to determine how its business would fare as the central bank raised rates: Its leaders were assuming that higher interest revenue would substantially help their financial situation as rates went up, but that was out of step with reality.By early 2023, Silicon Valley Bank was in what the Fed calls a “horizontal review,” an assessment meant to gauge the strength of risk management. That checkup identified additional deficiencies — but at that point, the bank’s days were numbered. In early March, it faced a run and failed, sending shock-waves across the broader American banking system that ultimately led to a sweeping government intervention meant to prevent panic from spreading. On Sunday, Credit Suisse, which was caught up in the panic that followed Silicon Valley Bank’s demise, was taken over by UBS in a hastily arranged deal put together by the Swiss government.Major questions have been raised about why regulators failed to spot problems and take action early enough to prevent Silicon Valley Bank’s March 10 downfall. Many of the issues that contributed to its collapse seem obvious in hindsight: Measuring by value, about 97 percent of its deposits were uninsured by the federal government, which made customers more likely to run at the first sign of trouble. Many of the bank’s depositors were in the technology sector, which has recently hit tough times as higher interest rates have weighed on business.And Silicon Valley Bank also held a lot of long-term debt that had declined in market value as the Fed raised interest rates to fight inflation. As a result, it faced huge losses when it had to sell those securities to raise cash to meet a wave of withdrawals from customers.The Fed has initiated an investigation into what went wrong with the bank’s oversight, headed by Michael S. Barr, the Fed’s vice chair for supervision. The inquiry’s results are expected to be publicly released by May 1. Lawmakers are also digging into what went awry. The House Financial Services Committee has scheduled a hearing on recent bank collapses for March 29.Michael S. Barr’s review of the Silicon Valley Bank problems will focus on a few key questions.Manuel Balce Ceneta/Associated PressThe picture that is emerging is one of a bank whose leaders failed to plan for a realistic future and neglected looming financial and operational problems, even as they were raised by Fed supervisors. For instance, according to a person familiar with the matter, executives at the firm were told of cybersecurity problems both by internal employees and by the Fed — but ignored the concerns.The Federal Deposit Insurance Corporation, which has taken control of the firm, did not comment on its behalf.Still, the extent of known issues at the bank raises questions about whether Fed bank examiners or the Fed’s Board of Governors in Washington could have done more to force the institution to address weaknesses. Whatever intervention was staged was too little to save the bank, but why remains to be seen.“It’s a failure of supervision,” said Peter Conti-Brown, an expert in financial regulation and a Fed historian at the University of Pennsylvania. “The thing we don’t know is if it was a failure of supervisors.”Mr. Barr’s review of the Silicon Valley Bank collapse will focus on a few key questions, including why the problems identified by the Fed did not stop after the central bank issued its first set of matters requiring attention. The existence of those initial warnings was reported earlier by Bloomberg. It will also look at whether supervisors believed they had authority to escalate the issue, and if they raised the problems to the level of the Federal Reserve Board.The Fed’s report is expected to disclose information about Silicon Valley Bank that is usually kept private as part of the confidential bank oversight process. It will also include any recommendations for regulatory and supervisory fixes.The bank’s downfall and the chain reaction it set off is also likely to result in a broader push for stricter bank oversight. Mr. Barr was already performing a “holistic review” of Fed regulation, and the fact that a bank that was large but not enormous could create so many problems in the financial system is likely to inform the results.Typically, banks with fewer than $250 billion in assets are excluded from the most onerous parts of bank oversight — and that has been even more true since a “tailoring” law that passed in 2018 during the Trump administration and was put in place by the Fed in 2019. Those changes left smaller banks with less stringent rules.Silicon Valley Bank was still below that threshold, and its collapse underlined that even banks that are not large enough to be deemed globally systemic can cause sweeping problems in the American banking system.As a result, Fed officials could consider tighter rules for those big, but not huge, banks. Among them: Officials could ask whether banks with $100 billion to $250 billion in assets should have to hold more capital when the market price of their bond holdings drops — an “unrealized loss.” Such a tweak would most likely require a phase-in period, since it would be a substantial change.But as the Fed works to complete its review of what went wrong at Silicon Valley Bank and come up with next steps, it is facing intense political blowback for failing to arrest the problems.Supervisors at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six citations in 2021.Aaron Wojack for The New York TimesSome of the concerns center on the fact that the bank’s chief executive, Greg Becker, sat on the Federal Reserve Bank of San Francisco’s board of directors until March 10. While board members do not play a role in bank supervision, the optics of the situation are bad.“One of the most absurd aspects of the Silicon Valley bank failure is that its CEO was a director of the same body in charge of regulating it,” Senator Bernie Sanders, a Vermont independent, wrote on Twitter on Saturday, announcing that he would be “introducing a bill to end this conflict of interest by banning big bank CEOs from serving on Fed boards.”Other worries center on whether Jerome H. Powell, the Fed chair, allowed too much deregulation during the Trump administration. Randal K. Quarles, who was the Fed’s vice chair for supervision from 2017 to 2021, carried out a 2018 regulatory rollback law in an expansive way that some onlookers at the time warned would weaken the banking system.Mr. Powell typically defers to the Fed’s supervisory vice chair on regulatory matters, and he did not vote against those changes. Lael Brainard, then a Fed governor and now a top White House economic adviser, did vote against some of the tweaks — and flagged them as potentially dangerous in dissenting statements.“The crisis demonstrated clearly that the distress of even noncomplex large banking organizations generally manifests first in liquidity stress and quickly transmits contagion through the financial system,” she warned.Senator Elizabeth Warren, Democrat of Massachusetts, has asked for an independent review of what happened at Silicon Valley Bank and has urged that Mr. Powell not be involved in that effort.  He “bears direct responsibility for — and has a long record of failure involving” bank regulation, she wrote in a letter on Sunday.Maureen Farrell More

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    Biden Asks Congress for New Tools to Target Executives of Failed Banks

    The request is a response to the federal rescue of Silicon Valley Bank and Signature Bank, and it seeks to impose new fines and other penalties.WASHINGTON — President Biden asked Congress on Friday to pass legislation to give financial regulators broad new powers to claw back ill-gotten gains from the executives of failed banks and impose fines for failures.The proposal, a response to the federal rescue of depositors at Silicon Valley Bank and Signature Bank last week, would also seek to bar executives at failed banks from taking other jobs in the financial industry.The measures contained in Mr. Biden’s plan would build on existing regulatory powers held by the Federal Deposit Insurance Corporation. Administration officials were still weighing on Friday whether to ask Congress for further changes to financial regulation in the days to come.“Strengthening accountability is an important deterrent to prevent mismanagement in the future,” Mr. Biden said in a statement released by the White House.“When banks fail due to mismanagement and excessive risk taking, it should be easier for regulators to claw back compensation from executives, to impose civil penalties, and to ban executives from working in the banking industry again,” he said, adding that Congress would have to pass legislation to make that possible.“The law limits the administration’s authority to hold executives responsible,” he said.One plank of the proposal would broaden the F.D.I.C.’s ability to seek the return of compensation from executives of failed banks, in response to reports that the chief executive of Silicon Valley Bank sold $3 million in shares of the bank shortly before federal regulators took it over a week ago. Regulators’ current clawback powers are limited to the largest banks; Mr. Biden would expand them to cover banks the size of Signature and Silicon Valley Bank.In a contrast with top Silicon Valley Bank officials, a senior Signature Bank executive and one of its board members bought shares in the firm’s stock last Friday while it was experiencing a run, regulatory filings show. Signature’s chairman, Scott Shay, bought 5,000 shares of Signature stock while one of its directors, Michael Pappagallo, bought 1,500 shares.The president is also asking Congress to lower a legal bar that the F.D.I.C. must clear in order to bar an executive from a failed bank from working elsewhere in the financial industry. That ability currently applies only to executives who engage in “willful or continuing disregard for the safety and soundness” of their institutions. He is similarly seeking to broaden the agency’s ability to impose fines on executives whose actions contribute to the failure of their banks.The proposals face an uncertain future in Congress. Republicans control the House and have opposed other pushes by Mr. Biden to strengthen federal regulations. A 2018 law to roll back some of the regulations on banking that were approved after the 2008 financial crisis passed the House and Senate with bipartisan support.Senator Steve Daines, Republican of Montana, faulted Mr. Biden’s focus on regulation and indicated that he would not support any move to impose new rules on the banking sector.“What we don’t need is more onerous regulations on well-managed and sound Montana banks that didn’t fail,” Mr. Daines said in a statement on Friday evening.Democrats were far more vocal in supporting the call for new rules. The chair of the Senate Banking Committee, Sherrod Brown of Ohio, said in a statement emailed to reporters that regulators needed “stronger rules to rein in risky behavior and catch incompetence.”He added that in addition to executives who had failed at their duties, there should be a way to hold accountable the “regulators tasked with overseeing them.”In a letter to the chairs of the Securities and Exchange Commission, the F.D.I.C. and the Fed, Representative Maxine Waters, a Democrat from California, asked the regulators to use the “maximum extent” of their current powers to hold both banks’ senior executives and board directors accountable.She added that the Dodd-Frank law enacted after the 2008 financial crisis had given agencies more powers than they had yet used to tie executive compensation in the financial industry to successful risk management strategies.“While I am moving quickly to develop legislation on clawbacks and other matters arising from the collapse, it is critical that your agencies act now to investigate these bank failures and use the available enforcement tools you have to hold executives fully accountable for any wrongful activity,” she wrote. More

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    Banking Crisis Hangs Over Economy, Rekindling Recession Fear

    Borrowing could become tougher, a particular blow to small businesses — and a threat to the recovery’s staying power.The U.S. economic recovery has repeatedly defied predictions of an impending recession, withstanding supply-chain backlogs, labor shortages, global conflicts and the fastest increase in interest rates in decades.That resilience now faces a new test: a banking crisis that, at times over the past week, seemed poised to turn into a full-blown financial meltdown as oil prices plunged and investors poured money into U.S. government debt and other assets perceived as safe.Markets remained volatile on Friday — stocks had their worst day of the week — as leaders in Washington and on Wall Street sought to keep the crisis contained.Even if those efforts succeed — and veterans of previous crises cautioned that was a big “if” — economists said the episode would inevitably take a toll on hiring and investments as banks pulled back on lending, and businesses struggled to borrow money as a result. Some forecasters said the turmoil had already made a recession more likely.“There will be real and lasting economic repercussions from this, even if all the dust settles well,” said Jay Bryson, chief economist at Wells Fargo. “I would raise the probability of a recession given what’s happened in the last week.”At a minimum, the crisis has complicated the already delicate task facing officials at the Federal Reserve, who have been trying to slow the economy gradually in order to bring inflation to heel. That task is as urgent as ever: Government data on Tuesday showed that prices continued to rise at a rapid clip in February. But now policymakers must grapple with the risk that the Fed’s efforts to fight inflation could be destabilizing the financial system.They don’t have long to weigh their options: Fed officials will hold their next regularly scheduled meeting on Tuesday and Wednesday amid unusual uncertainty about what they will do. As recently as 10 days ago, investors expected the central bank to reaccelerate its campaign of interest rate increases in response to stronger-than-expected economic data. Now, Fed watchers are debating whether the meeting will end with rates unchanged.The failure of Silicon Valley Bank, the midsize California institution, set the latest turmoil in motion.Ian C. Bates for The New York TimesThe notion that the rapid increase in interest rates could threaten financial stability is hardly new. In recent months, economists have remarked often that it is surprising that the Fed has been able to raise rates so much, so fast without severe disruptions to a marketplace that has grown used to rock-bottom borrowing costs.What was less expected is where the first crack showed: small and midsize U.S. banks, in theory among the most closely monitored and tightly regulated pieces of the global financial system.“I was surprised where the problem came, but I wasn’t surprised there was a problem,” Kenneth Rogoff, a Harvard professor and leading scholar of financial crises, said in an interview. In an essay in early January, he warned of the risk of a “looming financial contagion” as governments and businesses struggled to adjust to an era of higher interest rates.He said he did not expect a repeat of 2008, when the collapse of the U.S. mortgage market quickly engulfed virtually the entire global financial system. Banks around the world are better capitalized and better regulated than they were back then, and the economy itself is stronger.“Usually to have a more systemic financial crisis, you need more than one shoe to drop,” Professor Rogoff said. “Think of higher real interest rates as one shoe, but you need another.”Still, he and other experts said it was alarming that such severe problems could go undetected so long at Silicon Valley Bank, the midsize California institution whose failure set in motion the latest turmoil. That raises questions about what other threats could be lurking, perhaps in less regulated corners of finance such as real estate or private equity.“If we’re not on top of that, then what about some of these other, more shadowy parts of the financial system?” said Anil Kashyap, a University of Chicago economist who studies financial crises. Already, there are hints that the crisis may not be limited to the United States. Credit Suisse said on Thursday that it would borrow up to $54 billion from the Swiss National Bank after investors dumped its stock as fears arose about its financial health. The 166-year-old lender has faced a long series of scandals and missteps, and its problems aren’t directly related to those of Silicon Valley Bank and other U.S. institutions. But economists said the violent market reaction was a sign that investors were growing concerned about the stability of the broader system.Tougher lending standards could be a blow to small businesses and affect overall supply in the economy.Casey Steffens for The New York TimesThe turmoil in the financial world comes just as the economic recovery, at least in the United States, seemed to be gaining momentum. Consumer spending, which fell in late 2022, rebounded early this year. The housing market, which slumped in 2022 as mortgage rates rose, had shown signs of stabilizing. And despite high-profile layoffs at large tech companies, job growth has stayed strong or even accelerated in recent months. By early March, forecasters were raising their estimates of economic growth and marking down the risks of a recession, at least this year.‌Now, many of them are reversing course. Mr. Bryson, of Wells Fargo, said he now put the probability of a recession this year at about 65 percent, up from about 55 percent before the recent bank failures. Even Goldman Sachs, among the most optimistic forecasters on Wall Street in recent months, said Thursday that the chances of a recession had risen ‌10 percentage points, to 35 percent, as a result of the crisis and the resulting uncertainty.The most immediate impact is likely to be on lending. Small and midsize banks could tighten their lending standards and issue fewer loans, either in a voluntary effort to shore up their finances or in response to heightened scrutiny from regulators. That could be a blow to residential and commercial developers, manufacturers and other businesses that rely on debt to finance their day-to-day operations.Janet L. Yellen, the Treasury secretary, said Thursday that the federal government was “monitoring very carefully” the health of the banking system and of credit conditions more broadly.“A more general problem that concerns us is the possibility that if banks are under stress, they might be reluctant to lend,” she told members of the Senate Finance Committee. That, she added, “could turn this into a source of significant downside economic risk.”Tighter credit is likely to be a particular challenge for small businesses, which typically don’t have ready access to other sources of financing, such as the corporate debt market, and which often rely on relationships with bankers who know their specific industry or local community. Some may be able to get loans from big banks, which have so far seemed largely immune from the problems facing smaller institutions. But they will almost certainly pay more to do so, and many businesses may not be able to obtain credit at all, forcing them to cut back on hiring, investing and spending.The housing market, which slumped in 2022 as mortgage rates rose, had shown signs of stabilizing before the banking crisis arose.Jennifer Pottheiser for The New York Times“It may be hard to replace those small and medium-size banks with other sources of capital,” said Michael Feroli, chief U.S. economist at J.P. Morgan. “That, in turn, could hinder growth.”Slower growth, of course, is exactly what the Fed has been trying to achieve by raising interest rates — and tighter credit is one of the main channels through which monetary policy is believed to work. If businesses and consumers pull back activity, either because borrowing becomes more expensive or because they are nervous about the economy, that could, in theory, help the Fed bring inflation under control.But Philipp Schnabl, a New York University economist who has studied the recent banking problems, said policymakers had been trying to rein in the economy by crimping demand for goods and services. A financial upheaval, by contrast, could result in a sudden loss of access to credit. That tighter bank lending could also affect overall supply in the economy, which is hard to address through Fed policy.“We have been raising rates to affect aggregate demand,” he said. “Now, you get this credit crunch, but that’s coming from financial stability concerns.”Still, the U.S. economy retains sources of strength that could help cushion the latest blows. Households, in the aggregate, have ample savings and rising incomes. Businesses, after years of strong profits, have relatively little debt. And despite the struggles of their smaller peers, the biggest U.S. banks are on much firmer financial footing than they were in 2008.“I still believe — not just hope — that the damage to the real economy from this is going to be pretty limited,” said Adam Posen, president of the Peterson Institute for International Economics. “I can tell a very compelling story of why this is scary, but it should be OK.”Alan Rappeport More

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    Fed poised to approve quarter-point rate hike next week, despite market turmoil

    The Federal Reserve likely will approve a quarter-percentage-point interest rate increase next week, according to market pricing and many Wall Street experts.
    A rate increase would come just over a week after other regulators rolled out an emergency lending facility to halt a crisis of confidence in the banking industry.
    “This might be one of those times where there’s a difference between what they should do and what I think they will do. They definitely should not tighten policy,” said Mark Zandi, chief economist at Moody’s Analytics.

    Even with turmoil in the banking industry and uncertainty ahead, the Federal Reserve likely will approve a quarter-percentage-point interest rate increase next week, according to market pricing and many Wall Street experts.
    Rate expectations have been on a rapidly swinging pendulum over the past two weeks, varying from a half-point hike to holding the line and even at one point some talk that the Fed could cut rates.

    However, a consensus has emerged that Fed Chairman Jerome Powell and his fellow central bankers will want to signal that while they are attuned to the financial sector upheaval, it’s important to continue the fight to bring down inflation.
    That likely will take the form of a 0.25 percentage point, or 25 basis point, increase, accompanied by assurances that there’s no preset path ahead. The outlook could change depending on market behavior in the coming days, but the indication is for the Fed to hike.

    U.S. Federal Reserve Chair Jerome Powell addresses reporters after the Fed raised its target interest rate by a quarter of a percentage point, during a news conference at the Federal Reserve Building in Washington, February 1, 2023.
    Jonathan Ernst | Reuters

    “They have to do something, otherwise they lose credibility,” said Doug Roberts, founder and chief investment strategist at Channel Capital Research. “They want to do 25, and the 25 sends a message. But it’s really going to depend on the comments afterwards, what Powell says in public. … I don’t think he’s going to do the 180-degree shift everybody’s talking about.”
    Markets largely agree that the Fed is going to hike.
    As of Friday afternoon, there was about a 75% chance of a quarter-point increase, according to CME Group data using Fed funds futures contracts as a guide. The other 25% was in the no-hike camp, anticipating that the policymakers might take a step back from the aggressive tightening campaign that began just over a year ago.

    Goldman Sachs is one of the most high-profile forecasters seeing no change in rates, as it expects central bankers in general “to adopt a more cautious short-term stance in order to avoid worsening market fears of further banking stress.”

    A question of stability

    Whichever way the Fed goes, it’s likely to face criticism.
    “This might be one of those times where there’s a difference between what they should do and what I think they will do. They definitely should not tighten policy,” said Mark Zandi, chief economist at Moody’s Analytics. “People are really on edge, and any little thing might push them over the edge, so I just don’t get it. Why can’t you just pivot here a little and focus on financial stability?”
    A rate increase would come just over a week after other regulators rolled out an emergency lending facility to halt a crisis of confidence in the banking industry.
    The shuttering of Silicon Valley Bank and Signature Bank, along with news of instability elsewhere, rocked financial markets and set off fears of more to come.
    Zandi, who has been forecasting no rate hike, said it’s highly unusual and dangerous to see monetary policy tightening under these conditions.
    “You’re not going to lose your battle against inflation with a pause here. But you could lose the financial system,” he said. “So I just don’t get the logic for tightening policy in the current environment.”
    Still, most of Wall Street thinks the Fed will proceed with its policy direction.

    Cuts still expected by year’s end

    In fact, Bank of America said the policy moves of last Sunday to backstop depositor cash and support liquidity-strapped banks allows the Fed the flexibility to hike.
    “The recent market turbulence stemming from distress in several regional banks certainly calls for more caution, but the robust action by policymakers to trigger systemic risk exceptions … is likely to limit fallout,” Bank of America economist Michael Gapen said in a client note. “That said, events remain fluid and other stress events could materialize between now and next Wednesday, leading the Fed to pause its rate hike cycle.”
    Indeed, more bank failures over the weekend could again throw policy for a loop.
    One important caveat to market expectations is that traders don’t think any further rate hikes will hold. Current pricing indicates rate cuts ahead, putting the Fed’s benchmark funds rate in a target range around 4% by year end. An increase Wednesday would put the range between 4.75%-5%.
    Citigroup also expects a quarter-point hike, reasoning that central banks “will turn attention back to the inflation fight which is likely to require further increases in policy rates,” the firm said in a note.
    The market, though, has not had the benefit of hearing from Fed speakers since the financial tumult began, so it will be harder to gauge how officials feel about the latest events and how they fit into the policy framework.
    The biggest concern is that the Fed’s moves to arrest inflation eventually will take the economy into at least a shallow recession. Zandi said a hike next week would raise those odds.
    “I think more rational heads will prevail, but it is possible that they are so focused on inflation that they are willing to take their chance with the financial system,” he said. “I thought we could make our way through this period without a recession, but it required some reasonably good policymaking by the Fed.
    “If they raise rates, that qualifies as a mistake, and I would call it an egregious mistake,” Zandi added. “The recession risks will go meaningfully higher at that point.”

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    One year after the first rate hike, the Fed stands at policy crossroads

    Exactly one year ago, on March 16, 2022, the Federal Open Market Committee enacted the first of what would be eight interest rate increases.
    The anniversary raises questions about what’s ahead as policymakers continue to grapple with a persistently high cost of living, on top of a banking crisis.

    U.S. Federal Reserve Chair Jerome Powell responds to a question from David Rubenstein (not pictured) during an on-stage discussion at a meeting of The Economic Club of Washington, at the Renaissance Hotel in Washington, D.C., U.S, February 7, 2023. REUTERS/Amanda Andrade-Rhoades
    Amanda Andrade-rhoades | Reuters

    The Federal Reserve is one year down its rate-hiking path, and in some ways it’s both closer and further away from its goals when it first set sail.
    Exactly one year ago, on March 16, 2022, the Federal Open Market Committee enacted the first of what would be eight interest rate increases. The goal: to arrest a stubborn inflation wave that central bank officials spent the better part of a year dismissing as “transitory.”

    In the year since, inflation as measured by the consumer price index has come down some, from an 8.5% annual rate then to 6% now and trending lower. While that’s progress, it still leaves the Fed well short of its 2% goal.
    And it raises questions about what’s ahead and what the ramifications will be as policymakers continue to grapple with a persistently high cost of living and a shocking banking crisis.

    “The Fed will acknowledge that they were late to the game, that inflation has been more persistent than they were expecting. So they probably should have tightened sooner,” said Gus Faucher, chief economist at PNC Financial Services Group. “That being said, given the fact the Fed has tightened as aggressively as they have, the economy is still very good.”
    There’s an argument for that point about growth. While 2022 was a lackluster year for the U.S. economy, 2023 is starting off, at least, on solid footing with a strong labor market. But recent days have shown the Fed has another problem on its hands besides inflation.
    All of that monetary policy tightening — 4.5 percentage points in rate increases, and a $573 billion quantitative tightening balance sheet roll-off — has been tied to significant dislocations that are rippling through the banking industry now, particularly hitting smaller institutions.

    Unless the contagion is stanched soon, the banking issue could overshadow the inflation fight.

    ‘Collateral damage’ from rate hikes

    “The chapters are now only beginning to get written” about ramifications from the past year’s policy moves, said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “There’s a lot of collateral damage when you not just raise rates after a long period at zero, but the speed at which you’re doing so creates a bull in a china shop.”
    “The bull was able to skate around, not knocking anything over, until recently,” he added. “But now it’s starting to knock things over.”
    Rising rates have hammered banks holding otherwise secure products like Treasurys, mortgage-backed securities and municipal bonds.

    Because prices fall when rates go up, the Fed hikes have cut into the market value of those fixed income holdings. In the case of Silicon Valley Bank, it was forced to sell billions on holdings at a substantial loss, contributing to a crisis of confidence that has now spread elsewhere.
    That leaves the Fed and Chairman Jerome Powell with a critical decision to make in six days, when the rate-setting FOMC releases its post-meeting statement. Does the Fed follow through on its oft-stated intention to keep raising rates until it’s satisfied inflation is coming down toward acceptable levels, or does it step back to assess the current financial situation before moving forward?

    Rate hike expected

    “If you’re waiting for inflation to go back to 2% and that’s what’s caused you to raise rates, you’re making a mistake,” said Joseph LaVorgna, chief economist at SMBC Nikko Securities. “If you’re on the Fed, you want to buy optionality. The easiest way to buy optionality is to just pause next week, stop QT and just wait and see how things play out.”
    Market pricing has whipsawed violently in recent days over what to expect from the Fed.
    As of Thursday afternoon, traders had gone back to expecting a 0.25 percentage point rate increase, pricing in an 80.5% chance of a move that would take the federal funds rate to a range of 4.75%-5%, according to CME Group data.
    With the banking industry in tumult, LaVorgna thinks that would be a bad idea at a time when confidence is waning.
    Since the rate increases started, depositors have pulled $464 billion from banks, according to Fed data. That’s a 2.6% decline after a massive surge in the early days of the Covid pandemic, but it could accelerate as the soundness of community banks comes into question.

    “They corrected one policy mistake with another,” said LaVorgna, who was chief economist for the National Economic Council under former President Donald Trump. “I don’t know if it was political, but they went from one extreme to the other, neither of which is good. I wish the Fed had a more honest appraisal of what they got wrong. But you typically don’t get that from government.”
    Indeed, there will be plenty to chew on when analysts and historians look back on the recent history of monetary policy.
    Warning signals on inflation began in the spring of 2021, but the Fed stuck to a belief that the increase was “transitory” until it was forced into action. Since July 2022, the yield curve also has been sending signals, warning of a growth slowdown as shorter-term yields exceed longer duration, a situation that also has caused acute problems for banks.
    Still, if regulators can solve the current liquidity problems and the economy can avoid a steep recession this year, the Fed’s missteps will have exacted only minimal damage.
    “With the experience of the past year, there are legitimate criticisms of Powell and the Fed,” PNC’s Faucher said. “Overall, they have responded appropriately, and the economy is in a good place considering where we were at this time in 2020.”

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    Low Rates Were Meant to Last. Without Them, Finance Is In for a Rough Ride.

    Economists expected inflation and rates to stay low for years. With Silicon Valley Bank’s implosion, Wall Street is starting to reckon with how wrong that prediction has proved.WASHINGTON — If a number defined the 2010s, it was 2 percent. Inflation, annual economic growth, and interest rates at their highest all hovered around that level — so persistently that economists, the Federal Reserve and Wall Street began to bet that the era of low-everything would last.That bet has gone bad. And with the implosion of Silicon Valley Bank, America is beginning to reckon with the consequences.Inflation surprised economists and policymakers by spiking after the onset of the coronavirus pandemic, and at 6 percent in February, it is proving difficult to stamp out. The Fed has lifted interest rates by 4.5 percentage points in just the past 12 months as it tries to slow the economy and wrestle price increases under control. The central bank’s decision next Wednesday could nudge rates even higher. And that jump in borrowing costs is catching some businesses, investors and households by surprise.Silicon Valley Bank is the most extreme example of an institution’s being caught off guard so far. The bank had amassed a big portfolio of long-term bonds, which pay more interest than shorter-term ones. But it wasn’t paying to sufficiently protect its assets against the possibility of an interest rate spike — and when rates jumped, it found the market value of its holdings seriously dented. The reason: Why would investors want those old bonds when they could buy new ones at more attractive rates?Those impending financial losses helped to spook investors, fueling a bank run that collapsed the institution and shot tremors across the American banking system.The bank’s mistake was a bad — and ultimately lethal — one. But it wasn’t wholly unique.Many banks are holding big portfolios of long-term bonds that are worth a lot less than their original value. U.S. banks were sitting on $620 billion in unrealized losses from securities that had dropped in price at the end of 2022, based on Federal Deposit Insurance Corporation data, with many regional banks facing big hits.Adding in other potential losses, including on mortgages that were extended when rates were low, economists at New York University have estimated that the total may be more like $1.75 trillion. Banks can offset that with higher earnings on deposits — but that doesn’t work if depositors pull their money out, as in Silicon Valley Bank’s case.“How worried should we be comes down to: How likely is it that the deposit franchise leaves?” said Alexi Savov, who wrote the analysis with his colleague Philipp Schnabl.Regulators are conscious of that potentially broad interest rate risk. The Fed unveiled an emergency loan program on Sunday night that will offer banks cash in exchange for their bonds, treating them as though they were still worth their original value in the process. The setup will allow banks to temporarily escape the squeeze they are feeling as interest rates rise.But even if the Fed succeeds at neutralizing the threat of bank runs tied to rising rates, it is likely that other vulnerabilities grew during decades of relatively low interest rates. That could trigger more problems at a time when borrowing costs are substantially higher.Impending financial losses helped to spook investors, fueling a bank run that collapsed Silicon Valley Bank and shot tremors across the U.S. banking system.Jason Henry for The New York Times“There’s an old saying: Whenever the Fed hits the brakes, someone goes through the windshield,” said Michael Feroli, chief economist at J.P. Morgan. “You just never know who it’s going to be.”America has gone through regular bouts of financial pain brought about by rising interest rates. A jump in rates has been blamed for helping to burst the bubble in technology stocks in the early 2000s, and for contributing to the decline in house prices that helped to set off the crash in 2008.Even more closely related to the current moment, a sharp rise in interest rates in the 1970s and 1980s caused acute problems in the savings and loan industry that ended only when the government intervened.There’s a simple logic behind the financial problems that arise from rising interest rates. When borrowing costs are very low, people and businesses need to take on more risk to earn money on their cash — and that typically means that they tie up their money for longer or they throw their cash behind risky ventures.When the Fed raises interest rates to cool the economy and control inflation, though, money moves toward the comparative safety of government bonds and other steady investments. They suddenly pay more, and they seem like a surer bet in a world where the central bank is trying to slow the economy.That helps to explain what is happening in the technology sector in 2023, for example. Investors have pulled back from tech company stocks, which tend to have values that are predicated on expectations for growth. Betting on prospective profits is suddenly less attractive in a higher-rate environment.A more challenging business and financial backdrop has quickly translated into a souring job market in technology. Companies have been making high-profile layoffs, with Meta announcing a fresh round just this week.That is more or less the way Fed rate moves are supposed to work: They diminish growth prospects and make access to financing tougher, curb business expansions, cost jobs and end up slowing demand throughout the economy. Slower demand makes for weaker inflation.But sometimes the pain does not play out in such an orderly and predictable way, as the trouble in the banking system makes clear.“This just teaches you that we really have these blind spots,” said Jeremy Stein, a former Fed governor who is now at Harvard. “You put more pressure on the pipes, and something is going to crack — but you never know where it is going to be.”The Fed was conscious that some banks could face trouble as rates rose meaningfully for the first time in years.“The industry’s lack of recent experience with rising and more volatile interest rates, coupled with material levels of market uncertainty, presents challenges for all banks,” Carl White, the senior vice president of the supervision, credit and learning division at the Federal Reserve Bank of St. Louis, wrote in a research note in November. That was true “regardless of size or complexity.”But it has been years since the central bank formally tested for a scenario of rising rates in big banks’ formal stress tests, which examine their expected health in the event of trouble. While smaller regional banks aren’t subject to those tests, the decision not to test for rate risk is evidence of a broader reality: Everyone, policymakers included, spent years assuming that rates would not go back up.When borrowing costs are very low, people and businesses need to take on more risk to earn money on their cash.John Taggart for The New York TimesIn their economic forecasts a year ago, even after months of accelerating inflation, Fed officials projected that interest rates would peak at 2.8 percent before falling back to 2.4 percent in the longer run.That owed to both recent experience and to the economy’s fundamentals: Inequality is high and the population is aging, two forces that mean there are lots of savings sloshing around the economy and looking for a safe place to park. Such forces tend to reduce interest rates.The pandemic’s downswing upended those forecasts, and it is not clear when rates will get back on the lower-for-longer track. While central bankers still anticipate that borrowing costs will hover around 2.5 percent in the long run, for now they have pledged to keep them high for a long time — until inflation is well on its way back down to 2 percent.Yet the fact that unexpectedly high interest rates are putting a squeeze on the financial system could complicate those plans. The Fed will release fresh economic forecasts alongside its rates decision next week, providing a snapshot of how its policymakers view the changing landscape.Central bankers had previously hinted that they might raise interest rates even higher than the roughly 5 percent that they had previously forecast this year as inflation shows staying power and the job market remains strong. Whether they will be able to stick with that plan in a world colored by financial upheaval is unclear. Officials may want to tread lightly at a time of uncertainty and the threat of financial chaos.“There’s sometimes this sense that the world works like engineering,” Skanda Amarnath, executive director of Employ America, said of the way central bankers think about monetary policy. “How the machine actually works is such a complex and fickle thing that you have to be paying attention.”And policymakers are likely to be attuned to other pockets of risk in the financial system as rates climb: Mr. Stein, for instance, had expected rate-related weakness to show up in bond funds and was surprised to see the pain surface in the banking system instead.“Whether it is stabler than we thought, or we just haven’t hit the air pocket yet, I don’t know,” he said.Joe Rennison More

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    European Central Bank hikes rates despite market mayhem, pledges support if needed

    Credit Suisse shares tumbled by as much as 30% in Wednesday intraday trade.
    The whole banking sector ended Wednesday’s session down by about 7%.
    Initial pressures on the banking sector emerged last week, when U.S. authorities deemed Silicon Valley Bank insolvent.

    Christine Lagarde, president of the European Central Bank (ECB), pauses during a rates decision news conference in Frankfurt, Germany, on Thursday, March 16, 2022.
    Alex Kraus | Bloomberg | Getty Images

    The European Central Bank on Thursday announced a further rate hike of 50 basis points, signaling it is ready to supply liquidity to banks if needed, amid recent turmoil in the banking sector.
    The ECB had signaled for several weeks that it would be raising rates again at its March meeting, as inflation across the 20-member region remains sharply above the targeted level. In February, preliminary data showed headline inflation of 8.5%, well above the central bank’s target of 2%.

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    Some market players questioned whether President Christine Lagarde would still go ahead with the move, given recent shocks in the banking sector. Credit Suisse shares tumbled by as much as 30% in Wednesday intraday trade, and the whole banking sector ended the Wednesday session down by about 7%.
    “Inflation is projected to remain too high for too long. Therefore, the Governing Council today decided to increase the three key ECB interest rates by 50 basis points,” the ECB said in a statement. One basis point is equal to 0.01%.
    This latest move brings the bank’s main rate to 3%. It was in negative territory before July last year.
    “The Governing Council is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area. The euro area banking sector is resilient, with strong capital and liquidity positions,” the central bank said in the same statement.
    Initial pressures on the banking sector emerged last week, when U.S. authorities deemed Silicon Valley Bank insolvent. The event threw international subsidiaries of the bank into collapse and raised concerns about whether central banks are increasing rates at too aggressive of a pace. Goldman Sachs quickly adjusted its rate expectations for the Federal Reserve, due to meet next week — the bank now anticipates a 25 basis point increase, after previously forecasting a 50 basis point hike.

    European officials were keen to stress that the situation in Europe is different from the one in the United States. Overall, there is less deposit concentration — SVB was an important lender to the tech and health-care sectors — deposit flows seem stable, and European banks are well capitalized since the regulatory transformation that followed the global financial crisis.
    Equity action Thursday showed some relief across the banking sector, after Credit Suisse said it will borrow up to $54 billion from the Swiss National Bank, the country’s central bank.

    ‘I was around in 2008’

    Lagarde was keen to stress that the recent market turmoil is different from what happened during the global financial crisis of 2008.
    “Given the reforms that have taken place, and I was around in 2008, so I have a clear recollection of what happened and what we had to do, we did reform the framework, we did agree on Basel III [a regulatory framework], we did increase the capital ratios … the banking sector is currently in a much, much stronger position,” Lagarde said during a news conference.
    “Added to which, if it was needed, we do have the tools, we do have the facilities that are available, and we also have a toolbox that also has other instruments that we always stand ready to activate, if and when needed,” she added, reiterating that the central bank is ready to step in, if required.

    Determined to bring down inflation

    The ECB on Thursday also revised its inflation expectations. It now sees headline inflation averaging 5.3% this year, followed by 2.9% in 2024. In December, the bank had projected a 6.3% inflation figure for 2023 and a 3.4% rate in 2024.
    Lagarde said the ECB remains committed to bringing down inflation.
    “We are determined to return inflation back to 2% in the medium term, that should not be doubted, the determination is intact,” she said.
    An open question remains: how quickly will the ECB proceed with further rate hikes? Until the recent market instability, expectations pointed to another 25 basis point increase in May, followed by the same move in June.
    Lagarde did not provide an indication about future decisions.
    “We know that we have a lot more ground to cover, but it is a big caveat, if our base line were to persist,” she said, highlighting that “the pace we will take will be entirely data dependent.”

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