Banking Sector Turmoil and Past Shocks Heighten Recession Risks
The recent banking sector upheaval raises the probability of the already vulnerable U.S. economy entering a recession. The economic outlook now relies on two factors: private sector confidence and Federal Reserve interest rate policies, following federal actions to stabilize the banking system and investor-driven market volatility.
Shocks marked past recessions in 1990, 2001, 2008, and 2020, including Iraq's Kuwait invasion, 9/11 terrorist attacks, Lehman Brothers' collapse, and Covid-19. In the first three cases, the economy was already weak, and the shock solidified the downturn's inevitability.
Failures of Silicon Valley Bank and Signature Bank, along with challenges faced by Credit Suisse Group AG and First Republic Bank, pose a new risk that could impact bank lending and the willingness of businesses and households to spend. The robust job market remains the economy's stronghold.
Before Silicon Valley Bank's collapse, the economic outlook was uncertain. Major tech firms downsized after overextending during the Covid crisis. Fed interest-rate hikes stalled real estate and rattled stock investors. Corporate profits declined in many sectors, and consumer sentiment worsened during two years of rising living costs. Still, a resilient job market kept the economy growing, prompting analysts to question potential breaking points.
In January, most economists surveyed by The Wall Street Journal believed a 2023 recession was already underway. After Silicon Valley Bank's failure, those who thought the U.S. could avoid a recession became less certain. For example, Goldman Sachs recently increased its recession probability estimate from 25% to 35%.
Such moments often hinge on intangible human emotions while economists analyze data. Policymakers' primary goal last week was to halt panic that caused depositors in small and medium-sized banks to withdraw money in search of safer investments. When banks lose funds, they curtail lending, potentially causing a credit crunch that slows household and business borrowing, spending, and investing.
Market stability remains elusive. Stocks rebounded after the Federal Deposit Insurance Corp. guaranteed Silicon Valley Bank and Signature Bank's deposits but plummeted when concerns about bank stability extended to Europe and Credit Suisse. Stocks rose as Credit Suisse received Swiss National Bank support, and large U.S. banks assisted First Republic Bank. Confidence in banks and businesses, and households' assurance about profits and jobs will shape the outlook.
Credit Suisse's Uncertain Future and Possible Scenarios
The $54 billion bailout Credit Suisse received from the Swiss central bank aimed to alleviate the lender's difficulties. However, by Thursday's close, the bank's shares still traded 11% lower than the previous day's opening, with minimal decline in credit default swaps and bond yields.
If deposit withdrawals persist, options include abandoning the restructuring plan, spinning off the Swiss unit, a complete takeover, or, in a worst-case scenario, resolving the bank.
Credit Suisse executives aim to implement a restructuring plan that reallocates capital and resources from the unprofitable investment banking division to domestic, wealth, and asset management units. However, investors are skeptical, particularly about the lack of clarity on the bank's planned asset sales. Harris Associates, a longtime major shareholder, sold its entire position due to the "cumbersome and costly" plan to separate the investment bank.
On a call with JPMorgan clients, analyst Kian Abouhossein suggested Credit Suisse's most probable fate was a takeover by Zurich rival UBS. A merger between Switzerland's two largest banks has long been discussed but was stalled due to antitrust concerns. Credit Suisse's current predicament has revived merger speculation, as regulators might consider it the best way to stabilize the important financial institution.
If no buyer emerges, the Swiss National Bank might resort to drastic measures. In an extreme scenario, the central bank could guarantee deposits, assume full control, sell parts of the business, and wind down the rest. However, this move would be politically risky due to the impact on Swiss taxpayers and the disgrace of one of the country's largest companies collapsing.
Adapted from WSJ, Reuters, CNBC, NYT, Forbes