Something Wicked This Way Comes
Another US Bank has succumbed to events.
Republic First of Pennsylvania will not be the last US Bank failure in 2024.
You didn’t read that incorrectly — this bank is different to First Republic… who failed last year.
Recall that last year Silicon Valley Bank & Signature Bank disintegrated, too.
We’ve been documenting why the markets are in trouble - this article dives into the monetary and fiscal dangers:
Things have devolved rapidly since that piece was published in March 2024.
The Federal Reserve's emergency program (BTFP), designed to help banks weather losses from declining bond values, has expired. This leaves many banks with substantial unrealized losses vulnerable to collapse, as demonstrated by the failure of Republic First.
The problem is systemic: huge losses from bonds plague the whole banking sector. These losses originated when the Fed's actions to fight inflation inadvertently drove down bond prices, hurting banks that had invested heavily in those bonds.
The BTFP temporarily masked the problem by allowing banks to borrow money using their depreciated bonds as collateral at inflated values. With its expiration, the underlying issues reemerge.
Most alarming is the Federal Reserve's own insolvency.
Its nearly $1 trillion in unrealized losses renders it technically bankrupt.
This casts severe doubt on the Fed's ability to perform its role as a safety net for the banking system.
The looming cascade of staggering losses – in the banking sector, the Fed, and the US government itself – threatens the US dollar's position as the world's reserve currency.
…and that doesn’t take into account the perilous commercial real estate debt situation.
A major crisis in the CRE debt market would be a devastating blow on top of the issues outlined so far, creating a perfect storm for the US financial system.
Here's how that process would play out:
Compounding Losses: Many banks already hold substantial CRE loans on their books. A collapse in CRE values would lead to widespread defaults on these loans, adding massive losses to banks' already strained balance sheets. This could push already insolvent banks over the edge, triggering a new wave of failures.
Contagion Risk: The interconnectedness of the financial system means trouble in the CRE market wouldn't stay isolated. Banks facing CRE losses would likely curtail lending in other areas, tightening credit availability and stifling economic activity. Investors holding commercial mortgage-backed securities (CMBS) would also suffer, potentially leading to panic selling and a broader liquidity crisis.
Exacerbating the Fed's Dilemma: The Fed would be stuck between a rock and a hard place. A CRE crisis would demand more aggressive action to stabilize the banking system. However, the Fed's own weakened balance sheet limits its ability to provide the necessary support. Attempts to intervene could further destabilize markets and damage faith in the Fed.
Accelerating the Decline of the Dollar: A major CRE crisis coupled with the existing banking woes would fuel further doubts about the stability of the US financial system. Investors may flee the dollar en masse, seeking safer assets elsewhere. This could lead to a sharp drop in the dollar's value with serious consequences for global trade and financial markets.
In short, a major CRE debt crisis would pile even more pressure on an already fragile banking system. The potential fallout from this combination threatens to far exceed the localized bank failures we've seen so far.
The massive unrealized losses on the Fed's balance sheet raise significant doubts about its ability to act as a lender of last resort in such a crisis. Its technical insolvency is an unprecedented situation that could damage faith in its ability to stabilize the financial system.
The Bottom Line: If the Fed and US government continue racking up unsustainable debt and losses, this could eventually erode confidence in the US dollar. The CRE markets are already a source of trouble, and if they begin to topple the FED can’t help. The dollar's status as the world's reserve currency could be jeopardized, triggering a global financial re-ordering.
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