The recent failure of Silicon Valley Bank (SVB) has been attributed to a combination of excess deposits and losses on assets, even in traditionally safe securities like Treasury bonds. This situation, according to the article, was not due to a lack of liquidity in the banking system, but rather an overabundance of it. By the end of 2022, the US banking system held $18 trillion in domestic deposits, with an estimated $8 trillion exceeding FDIC insurance limits. These "destabilizing excess deposits" resulted from over a decade of quantitative easing (QE), where the Federal Reserve purchased $8 trillion in bonds, replacing them with bank reserves.
Quantitative easing, while intended to lower long-term interest rates and prevent a prolonged depression, has created significant vulnerabilities. The Fed's bond purchases pushed trillions of dollars in deposits into the banking system, backed by newly created reserves rather than bank loans. Despite this aggressive monetary expansion, the growth rate of US commercial bank loans averaged a mere 3.4% annually between 2008 and 2022. The article notes that these increased reserves and associated bank deposits earned nothing, pushing yield-starved investors into long-term securities, including Treasury bonds, leading to record valuations.
The consequences of this prolonged period of zero-interest rates and excessive liquidity are now surfacing. Investment losses emerged in early 2022 as inflation pressures forced the Fed to normalize rates. The article argues that sudden banking strains in the US and Europe, along with the British pension crisis and equity market losses, are symptoms of an unwinding bubble created by QE. The Bank of England's quantitative easing program, which peaked at a liability of £895 billion (36% of GDP), has left UK public finances highly sensitive to interest rate decisions. While the Asset Purchase Facility initially remitted £120 billion in profits to the Treasury, rising interest rates and falling gilt prices have led to nearly equivalent unrealized losses. The article highlights that a significant portion of commercial bank reserves, over £400 billion, could remain at the end of 2030, potentially incurring substantial payments to banks if interest rates remain elevated, such as £12 billion if the bank rate is 3%.
