End to era of easy money and race to contain the banking crisis

Policymakers are racing to ease growth strains and a loss of confidence in the global financial system after the collapse of Silicon Valley Bank and as UBS Group agreed to buy Credit Suisse Group in a government-brokered deal.
Over the weekend, the Federal Reserve and five other central banks announced co-ordinated action to boost liquidity in US dollar swap arrangements.
Central banks opened spigots wide to keep the global financial crisis of 2008 from triggering a depression, using low interest rates and other measures to try to stimulate business activity.
They kept rates low for years in the face of a notably anaemic recovery, then opened the faucets again when the pandemic struck: The Fed cut interest rates back to near zero and didn’t raise them until March 2022.
It helped fuel a period of extraordinary growth in US financial markets, save for the short, sharp pandemic drop in 2020.
The US stock market rose more than 580% after the financial crisis, accounting for price gains and dividend payments.
It also led to a massive increase in debt taken on by companies and countries.
From 2007 to 2020, government debt as a share of gross domestic product globally jumped to 98% from 58%, and non-financial corporate debt as a share of GDP surged to 97% from 77%, according to data compiled by Ed Altman, professor emeritus of finance at New York University’s Stern School of Business.
The unparalleled era of easy money came to a screeching halt in 2022, as central banks shifted gears to subdue inflation: The Fed raised its benchmark rate from near zero to 4% in a mere six months.
That speed led to worries that something in the financial system would break, as the tightening of credit revealed previously hidden vulnerabilities.
Those fears seemed to materialise in the failure of two US banks, and the buyout of global giant Credit Suisse.
The market turmoil that followed raised questions of whether chastened banks would pull back on lending in a way that could tip economies into recession.
It also left the Fed facing even greater difficulties in balancing its inflation fight against the damage aggressive monetary policy can cause.
Lending rules were tightened after the collapse of credit markets in 2008, especially for the largest banks, leading to bolstered confidence in the financial system’s resilience.
But no banks were unaffected by the interest-rate changes: At the end of 2022, according to the Federal Deposit Insurance Corp (FDIC), banks had suffered $620bn in losses on their holdings.
JPMorgan Chase has estimated the US economy faces a potential hit to gross domestic product of a half to a full percentage point from diminished credit growth in the aftermath of the latest banking-sector troubles.
The worst outcome would be a giant bank failure that would dry up the flow of credit and almost guarantee a recession.
Credit Suisse’s crisis came shortly after the failure of three US regional lenders and underscored how some less well-managed financial institutions have struggled since the era of rock-bottom interest rates came to an end.
Its demise may push other banks to lower their risk profile, which means issuing fewer of the loans that enable economies to grow. That would make it harder for central banks to keep raising benchmark rates to cool red-hot inflation without causing recessions.
Investors have been abandoning bets on more rate hikes and now see US rate cuts coming as early as the summer.
European Central Bank president Christine Lagarde said on March 16 that the financial market turmoil could hit credit conditions and dampen confidence. However, she said the banking sector is “in a much, much stronger position than where it was back in 2008.”