Interest rates, bank crises and your money

This is an audio transcript of the Money Clinic podcast episode: ‘Interest rates, bank crises and your money’

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Claer Barrett
Banks. They’re supposed to be boring, but lately they’ve been anything but . . .

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The collapse of the US-based Silicon Valley Bank . . .

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. . . anatomy of a collapse of a big bank . . .

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. . . and Silicon Valley Bank collapse . . .

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. . . regulators shut down Silicon Valley Bank, a big lender out in California.

Claer Barrett
California’s Silicon Valley Bank. SVB. A bank, I’m willing to bet, most outside of the tech world had never heard of before it went belly up. And then came the fallout. Because if there’s one thing about bank collapses, it’s that they have ripple effects across the financial industry.

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The troubled global banking sector . . .

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Banking fallout continues as the American government tries to orchestrate a rescue of First Republic Bank with the aid of . . .

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A major sell-off of shares in the Swiss banking giant Credit Suisse.

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The Swiss bank has seen its shares tumble this week with billions of dollars wiped off its market value.

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A historic moment for Credit Suisse and for global finance.

Claer Barrett
Welcome to Money Clinic, the weekly podcast from the Financial Times about personal finance and investing. I’m Claer Barrett, the FT’s consumer editor. The wild ride in bank shares that we’ve been seeing recently is down to rising interest rates. Central banks have been fighting inflation by putting up key rates, but those increases have happened very quickly and that’s put some financial institutions under stress. It means central banks now face a dilemma. How can they keep up the fight against inflation without causing more financial turmoil? So in this episode, we’re asking what’s next for interest rates? How worried should we be about the stability of the global financial system? And of course, what does it all mean for your investments?

I spoke to Money Clinic regular, the FT’s markets editor Katie Martin. And down the line from New York, the FT’s financial reporter and author of the Unhedged newsletter, Ethan Wu. Now, we recorded this episode at the end of last week before the UBS takeover of Credit Suisse had been finalised. But the themes of this episode relating to investing and your money still stand. I started by asking Ethan to give us a brief rundown of what happened with SVB.

Ethan Wu
Well, do you want the short story or the long story?

Claer Barrett
Start with the short one. (chuckles)

Ethan Wu
Well, the short one is that, you know, a bank has two sides. Money goes in and money goes out. And in this case, SVB, the money went out from both ends. That’s the short story. The long story has to do with interest rates. And so, you know, the main thing to understand about SVB is the S and the V — Silicon Valley, right? It’s taking deposits from Silicon Valley start-ups. So they have all of this cash from these companies. They got this influx of money. Those companies are highly interest-rate sensitive. They have funding because interest rates are at zero, because the Federal Reserve, the central bank of the US, lowered rates to stimulate the economy after the pandemic. So that’s on the money-coming-in side. On the other side of the bank, you know, a bank got a lot of money. You got to put it somewhere. Most banks usually like to lend that out, right? That’s the main business they’re in. But in the case of SVB, they got so much money so quickly that they decided, “You know what, we’re going to do something prudent, safe, conservative. We’re going to put it in US government bonds. The safest stuff there is.” The one problem (chuckles) with that plan is that US government bonds are also highly interest rate sensitive. When interest rates go up, the price of the bond goes down. So what you had in the last year or so is interest rates in the US going up the fastest they’ve gone up in decades. So SVB got pinched on both sides. Its depositors, all these tech firms who had all this money from the era of low interest rates, they started saying, “Oh, it’s looking tough out there. We’re going to need to, you know, start withdrawing our money.” On the other side, all the bonds SVB had, they were rapidly losing value. And so we got in a situation where people started getting concerned in Silicon Valley, “Hey, are they going to be able to pay us back? Given what’s happening to the bond side of their portfolio.” And you know, add one more thing into this, which is all the people in Silicon Valley are in the same group chats. They’re all talking to one another. They’re all reading the same sub stacks, they’re all reading Twitter. They all got panicked in a herd and they ran for the door and it was too late for SVB.

Claer Barrett
Yeah, I mean, the speed that it unravelled was just absolutely phenomenal. Well, Katie, we’ve survived (chuckles) the last seven days or so of reporting on this story.

Katie Martin
So far.

Claer Barrett
So far. (chuckles) There’s been a lot of ups and downs. But tell us briefly what the market reaction has been to all of this.

Katie Martin
Yes. It’s been pretty spectacular. I mean, at first, you know, SVB started to look like it was in the death throes. And all of the investors that we spoke to on this side of the pond were saying, “Don’t worry, don’t panic. This is just some little bank in the States. It’s got very specific problems. It’s got itself in quite the tangle over here.” Because as Ethan says, it was getting hit on both sides. “This is not systemic. There’s nothing to worry about here.” And then a couple of days later, suddenly the market decided there was something to worry about here and it accelerated pretty quickly. One thing was that regional bank stocks in the States, first of all, just got hosed. They had a really hard time because people were thinking, well, which bank is next? Which is going next? The thing that had a bigger impact for portfolios for everybody else was that the market decided, huh? We’ve always known that if the Fed slams on the brakes and starts jacking up interest rates, something’s going to go through the windshield. Here’s the thing that’s going through the windshield: it’s the US banking system. You know, panic. So US government bonds, which are supposed to be the safe place where you can go, the sort of safe hidey hole for investors. They rocketed higher. Firstly because people were looking for safety. Also because people were saying, “Ha, I don’t think the Fed can keep on hiking quite as aggressively as it has been doing over the past year anymore.” And so suddenly you had bond prices picking up. Now, the problem there is that pretty much every hedge fund on the street has been massively betting against government bonds because they made a fortune last year out of betting that the Fed would raise rates. And they thought in 2023, what’s changed? We’re going to keep that bet on. So it took a fairly small move in the opposite direction for this to accelerate incredibly quickly. Suddenly, we ended up with the biggest rally in US government bonds since 1987. If you look at the bond market alone, it tells you this past couple of weeks has been worse than ‘08. Worse than March 2020. Just a kind of generationally terrible week in the markets. Now, I think that’s exaggerated on the bond market side, that the stock market will tell you that it hasn’t been quite so bad, but it has been a really violent move.

Ethan Wu
And Claer, just to add on to Katie’s very comprehensive answer, I think when we talk about government bonds being safe, you know, that word kind of obscures a distinction that I think people are, you know, learning really matters here. So one type of risk you want to be safe from is credit risk. That’s the risk that people default, that you’re holding the bond, the debt of a company or government or whatever that goes under. Government bonds are entirely safe from that type of risk. You know, historically speaking, developed countries, they just don’t default. It doesn’t happen. There’s another type of risk, which is interest rate risk. Now, this is not your bond goes to zero. This is your bond loses 20 to 30 per cent of its value because rates have gone up really fast. Now, that’s in some ways less catastrophic because it’s not going to zero. So people have, I think, not thought as much about, you know, interest rate risk as, you know, a major threat to bonds or at least sort of maybe in the popular cautiousness of government bonds being the safe place to go. But when we talk about safe, we’re talking about safe from default, not safe from losses on value of the bond.

Claer Barrett
A very, very good point. And it wasn’t just SVB that has had problems in the past week. It’s also been very dramatic over on the European banking scene. Credit Suisse, lots of drama there, as well as other bank stocks around the world.

Ethan Wu
Yeah. And I think part of the, you know, quote unquote contagion, the jumping of distress from SVB to Credit Suisse and First Republic in the US and, you know, various other banks in the US and Europe is that, you know, people have been asking, what’s the link here? I think there is something to be said about, you know, fear when it takes over markets. It is an incredibly powerful force and it doesn’t need a rationale. If you’re scared, you’re scared. Right? And which isn’t to say that Credit Suisse doesn’t have problems, but Credit Suisse did not have the same problem that SVB did. Right? SVB had this kind of, again, dual interest rate sensitivity on both sides of the bank. Credit Suisse was just kind of a poorly run business that had, you know, a bunch of scandals in the last couple of years. But what they share in common, right, is management incompetence leading to worsening profits. And then in a climate of fear, when everyone’s scared of, you know, are people going to start withdrawing? Am I going to get my money back? Those profitability concerns can morph through the prism of fear into something more existential for the banks.

Claer Barrett
Mm-hmm. And certainly there have been some weird and unexpected movements (chuckles) elsewhere on the markets. The price of bitcoin actually surged 30 per cent last week. I mean, Katie, what’s all that’s about? (laughter).

Katie Martin
I mean . . . (laughter)

Ethan Wu
What is that about? (laughter)

Katie Martin
You tell me, Claer. The thing is with the crypto crowd is that if bitcoin is up one week, they’re telling you that’s because it’s a flight to safety. The next week they’re telling you people are looking for a new speculative asset. The next time they’re telling you it’s because they want an alternative to the dollar brackets question mark. So why is it up? I don’t really know. But I do know that had SVB been allowed to fail in the sense that it’s depositors have been left with nothing or they’d only been left as much as the federal insurance covers them for, then the crypto industry would have been in a lot of trouble because there’s this thing called a stablecoin, which is supposedly pegged one for one with the dollar, which is run by a company called Circle. It had a cool $3.3bn on deposit with SVB and you’re only insured up to 250K. Now, as it turns out, the regulatory response to all this and the rescue package that they came out with said that, “OK, all the depositors are made whole. Don’t worry, you can get your money back.”

Claer Barrett
Mmm. And they were very fast too.

Katie Martin
They were super fast to do that. But there’s a very real sense in which the authorities in the States have stepped in and bailed out the crypto market here, which I mean, beats me.

Claer Barrett
Mm-hmm. And I mean, certainly in the UK there were just over 3,000 UK fast-growing tech companies mostly who did bank with the UK arm of SVB, and that was taken over very rapidly by HSBC.

Katie Martin
Yes. HSBC paid a whole pound for that business. So that again, is effectively a rescue. And again, it’s a bit of a lesson in does it make sense for banks to be heavily concentrated on one industry or does it make more sense for them to be more of a full service bank like HSBC, where you can just spread that risk around so that if the tech industry hits a wall, it doesn’t take the bank down with it. If you could cope with my tangled analogy there.

Claer Barrett
OK. Well, this story obviously continues to run and run, so keep up with FT.com for the latest. Let’s just pause for breath a minute now, Katie and Ethan, and let’s talk now about what all of this is potentially going to do to the future direction of interest rates. Now, listeners will know that raising rates is the main tool that central banks around the world have to fight inflation. But they’re walking a tightrope. If they raise rates too far, too fast, there’s a risk that economies could be plunged into recession. And of course, there’s all of these hidden risks potentially buried in bank balance sheets that could emerge. Now, it’s easy to understand why interest rates matter on financial products like savings accounts. But Ethan, why do they matter so much to retail investors and the value of the investments that we hold in our portfolios?

Ethan Wu
Mm-hmm. Yes. So interest rates matter for basically every investing asset out there. And that’s because, you know, interest rates, I think, are best thought of as the price of money. Which means, you know, basically every asset when you if you’re a financial professional, you’ve got your spreadsheet out and you’re deciding how much you want to pay for a stock, a key input into your valuation of a stock or a bond or whatever it is, is going to be what the prevailing interest rate is, what you can get, you know, the return you can get on your money for no risk at all.

Claer Barrett
If I can get 4 per cent in my cash Isa, why would I risk investing in something that I think is going to potentially yield me less than that?

Ethan Wu
Exactly. Yeah. No, when rates are high, equities better return quite a bit more or what’s the point? You know, So in general, when interest rates rise, stocks tend to do poorly. That’s not necessarily in iron law. And there’s, you know, plenty of wiggle room and variation around that. But that’s kind of a general relationship. You know, in the past year, it’s been quite bad for stocks and for bonds. It’s been, you know, really perilous investing climate for both retail investors and for the professionals. But I think now that interest rate increases are starting to level off inflation, you know, hasn’t been dealt with yet. But there are some hopeful signs that one might be optimistic about. I think that there’s a climate for savers where you can put your money away in a certificate of deposit for a year or two. If you need a short-term access to your funds, get four and a half per cent risk free. Don’t bother about “Is there going to be a recession? Will that hurt my equity portfolio?” Of course, if you’re a longer term investor, the best thing to do is almost always to buy and hold stocks for long periods of time. Right now is a decent entry point in global equities. They’re cheap by historical standards. US equities a little bit less so. Those are a little more expensive than historical standards. You know, if you’re a recent graduate or just getting into investing, it’s not the worst time to buy equities for the long run either.

Claer Barrett
No. And we always encourage people to take a long-term view, as regular listeners will know. Now, Katie, how else could rising interest rates impact our personal finances? I suppose the big question for lots of us sitting here who are lucky enough to own our own homes is what it will do to mortgage rates.

Katie Martin
I’ve got one year until I renew my mortgage. I’m really hoping this whole thing blows over by that (laughter), otherwise I’m going to be paying through the nose. Yeah, I mean, Brits in particular are very sensitive to this stuff because our mortgages roll over every couple of years as a rule, and the interest rate can kick up pretty severely in that period. So there’s a lot of people now who are rolling over mortgages that they’ve been paying reasonably happily without too much difficulty for a really long time that suddenly is getting some real sticker shock in terms of the price of renewing that debt. So that’s probably the main channel for Brits at the moment. The cost of borrowing has gone up enormously. Whether that is for a home or whether it is just any other standard loan. So a lot is hinging on central banks’ ability to get inflation down. And you know, these are the trade offs. You know, there are going to be fragilities in the financial system that are going to be things that go wrong if they’ve been hinging absolutely on interest rates staying low forever. So central banks have got to tread that line.

Claer Barrett
Mmm. Ethan, we’ve got some key events coming up, haven’t we, this week? The Fed meeting to decide interest rates. I mean, even quite recently, I think the FT’s front page splash on the 8th of March was that the Fed was going to go harder and raise interest rates further than the market was anticipating. I mean, so much changes and so few days.

Ethan Wu
It does. I did think what was interesting recently was the European Central Bank did stick with raising rates by half a percentage point, which I think tells us something. It tells us that central banks really are committed to stamping out inflation with interest rate hikes. Now, you know, part of the reporting on the ECB decision was that the bank was considering either half a percentage point or nothing at all. There was no consideration of slowing down. It’s either we’re going to pause to see how the financial system is doing or we’re going to, you know, stick on our campaign against inflation. Obviously, the stress in the financial sector complicates the picture for the banks. They now have to balance, you know, two risks that kind of point in opposite directions, right? One being financial stability, you know, one being combating inflation. Now, I think the UK example from last year, the gilts market crisis that the Bank of England had had to stamp out.

Claer Barrett
Mm-hmm. Yes, of course, talking about what happened after the disastrous mini-Budget where Liz Truss said that she was going to borrow huge sums of money for completely unfunded tax cuts and investors around the world were completely spooked and the cost of UK government borrowing went up because people thought Britain was much more risky and that completely repriced government bonds known as gilts and caused all kinds of issues everywhere from the stock market to the health of pension funds. A complete disaster.

Ethan Wu
Yeah, that’s right. Gilts being UK government bonds, just like in the US. Supposed to be the safest sort of debt in the UK. You know what happened in that situation was the Bank of England, it took a little break a couple of weeks, maybe a month, from tightening monetary policy to deal with the ructions in the gilt market. And it was successful because it has basically unlimited firepower to deal with financial market turmoil. Once it stamped that out, it pivoted back and said, “Hey guys, we’re going back to our inflation-fighting campaign.” You know, I think the ECB and the Fed are going to be looking at the Bank of England’s example of being able to separate the tools of financial stability and monetary policy. Financial stability is a near-term concern. You don’t have to, you know, deal with it forever. You have to deal with it in episodic periods when people get stressed out. And fighting inflation can be kind of a longer term priority that can be combated over time, even if you have to take these, you know, momentary breaks. But if things calm down, I would expect the central banks to go right back to raising rates because fundamentally, they have not won the inflation battle yet.

Katie Martin
Ethan’s absolutely right. And the really difficult thing for monetary policymakers now for, you know, the bigwigs sitting in central banks is they mustn’t look frightened. If you know, for example, had the European Central Bank said, “Look, we’re not going to do a half percentage point rate rise as we have indicated that we would. We’re going to go smaller or we’re going to do nothing at all.” Then the market would have thought, “Ha, well, if they’re worried about the European banking system, then maybe I should be more worried about the European banking system.” And so there’s going to be a very difficult communication job now, where it’s been it’s been difficult from the start that central banks don’t want to throw the baby out with the bathwater. They don’t want to break the system while they try and fix inflation. But at the same time, they really have to manage expectations and not look like they’re spooked. Otherwise this whole situation will get worse. So I really don’t envy them. I would be surprised if the Bank of England manages to get away with the next rate-setting meeting on the 23rd without being forced to say something about this whole situation. Thankfully, at the moment UK banks are not in the firing line of this and if we could all just keep it that way, then that would really help my stress levels.

Claer Barrett
(Chuckles) It certainly would, wouldn’t it? But Ethan, what the Fed decides on interest rates that really matters, whether you’re an investor sitting in the US, in the UK or even India, for example, it’s the most watched market.

Ethan Wu
Yeah, that’s right. Economically, the Fed sets the tempo for interest rates all across the world. But I think something important to say there is that the Fed tends not to make interest rate policy consciously for the rest of the world. They make it for the US. Right? These are US policymakers. They’re accountable to Congress. They talk to international central banks. But that’s not really their key constituency. So I think, you know, just like it’s been almost the entire interest rate cycle, the Fed’s going to be making decisions based on US inflation, US financial stability, not necessarily European financial stability or, you know, balance of payment crises in the developing world. It makes no decisions.

Claer Barrett
Now, I’m going to come to both of you to close. Obviously, this is a very fast-moving story. But starting with you, Ethan, what will you be watching in the days and weeks to come?

Ethan Wu
Mmm. One thing I’ve been watching is funding stress, essentially, you know, how much stress is out there? How much are banks having to borrow from the government to cover liquidity needs, to cover, you know, withdrawals from the bank. I’m on the lookout for if there’s going to be another failure or if authorities have really stemmed the bleeding and contain the fallout. I am hopeful at this juncture. I think there are reasons to think that we are not going to have a 2008 or even short of 2008-style meltdown, that this is a temporary stress that can be smoothed out. Now of course, as Katie referred to, when interest rates go up, things do tend to break. So in some ways, you know, it’s not surprising and we should expect more. But at least for now, in the interim, I think that keep an eye on the banking system, but I think there’s not necessarily reason to completely panic and sell everything and board up of your home.

Claer Barrett
Well, I’m relieved to hear that.

Ethan Wu
Yes.

Claer Barrett
And Katie, what will you be watching out for in the days and weeks to come?

Katie Martin
For what it’s worth, I am with Ethan on this. I’m not going out to buy guns and tin food. I don’t think, famous last words, I don’t think this is an ‘08 situation. It’s very difficult to see how it could be. So the thing I’m going to be really watching over the next few days is the government bond market to try and figure out how much of the move that we’ve seen over the past few days is an overreaction and how much of it is a realistic reflection of what central banks are likely to do next?

Claer Barrett
Brilliant. Well, thank you so much to Katie Martin, the FT’s markets editor, and Ethan Wu. You can sign up for the Unhedged newsletter that Ethan and another podcast favourite, Rob Armstrong, contribute to on FT.com. And of course, you can keep in touch with us at the FT Money team by emailing us money@ft.com. If there are any questions that you want us to answer about what’s going on in markets. And I have to say to both of you, I’ve learned so much from hearing you speak today. Thank you for sharing your thoughts with us.

Ethan Wu
Thanks so much, Claer.

Katie Martin
You’re welcome.

Claer Barrett
Come back again soon. That’s it for Money Clinic with me, Claer Barrett, this week and we hope you like what you’ve heard. If you did, spread the word and leave us a review. We’re always looking to chat with people about their money issues for the show. If you’re interested in being part of the future episode and are looking for some expert money advice, then email us money@ft.com. You can also take a peek at our website ft.com/money, grab a copy of the FT Weekend newspaper or follow me on Instagram. I’m @ClaerB.

Money Clinic was produced in London by Persis Love. Our sound engineer is Breen Turner and our editor is Manuela Saragosa. You heard original tune this week by Metaphor Music. And finally, our usual disclaimer: the Money Clinic podcast is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that, you’ll need to find an independent financial adviser. That’s all the small print for now. See you back here next week. Goodbye.