Bloomberg: The Banking System Can’t Function With 4% Rates: Zingales

Luigi Zingales, University of Chicago Booth School of Business Professor of Finance discusses the Fed’s interest rate role in the recent banking crisis
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Transcript

Luigi’s and Galas of the University of Chicago birth school calling for a independent commission to look into the FED writing a following in the last two years the FED has failed twice it has failed to see inflation coming and it has failed to see the banking Crisis coming too the nation needed to

Trustworthy fed to combat inflation the only way to recover this trust is through a transparent independent and authoritative commission whose findings are believable President Biden should appoint such a commission without delay Luigi I’m pleased to say joins us right now Luigi good morning good morning is

This the FED chair’s fault or is this an Institutional problem I think that that’s what we need to find out I fear that is an Institutional problem or just a a German problem and it’s easier to replace the chairman and to sort of rethink the institution but I

Think that is a very consensus institution so I think the failures were shared and something has gone wrong is that a polite way of saying there’s too much group think at the FED uh I think that definitely is the case um but uh but I think maybe maybe

There’s more maybe there are not enough economists and says this is a I think a low point on the board I think only half of a PhD so in economics now you don’t need to have a PhD in economics but helps in understanding a situation like

The one where now what are they getting wrong right now I think that they’re getting wrong how unstable the banking system is I think that they have this idea that deposits uh are sticky and I think that first of all we have never experienced in recent time a spread of 400 business points

Between what you get on the the money market and what you get on your deposit and second the word has changed the deposits are mobile uh they’re really a Google say a click away and so I think that if deposits move in search of better yields then banks have to realize

Their losses the idea of losses ultimatuity that can stay there and not have any impact I think is is sort of a fantasy well what do you think the FED should be doing I mean at a certain point this is really the consequence of banks not managing their assets well

Enough isn’t it or do you really think this really lies with the FED no I think that the FED has a huge responsibility of the fact that they should have understood that they couldn’t raise rates so fast because when you raise raise rate so fast you’re going to

Impose losses in the bond market and who’s going to Bear those losses insurance companies then you have to bail them out Banks then you have to bail them out so unless all the losses are among us uh investors uh individual investors then something happens and so that was an extra reason to intervene

Early on the inflation they said they were very complacent and said oh we have the tools we’re going to do it we let it go a little bit but don’t worry because we have the tools I think that their tools were not very sharp and they should have recognized that how much do

You think that the banking crisis that people talked about three weeks ago has abated has really uh sort of moved from some sort of acute phase into perhaps a chronic question around flows and with respect to credit creation but not necessarily a crisis I think he’s possible and hopeful that there’s not

Going to be an open crisis like we’ve seen in the past however clearly put a lot of softness in the banking sector at particularly Regional Banks which we need to remember those are the ones who land to small and medium Enterprises the large Banks tend to do syndicated loans

To Big firms but the bread and butter of the economy is with the regional Banks and and they are very soft and they see deposits flowing out and and they are not going to make loans because if they make laws and then deposits flow out they have to sell Securities and they

Have to make losses so I think that the first thing they do for sure is not make new loans and then probably they’re going to try to slowly divest their Securities when they can uh we we saw there was an article on the Ft showing that at the beginning of the year cash

Over assets in Banks were particularly low and they say this is the cause of the current crisis I said no no this is an effect of the fact the fact that we have a withdrawal of deposits and so Banks don’t wanna divest the Securities

At the loss so that what they do is they reduce the cash they have the deposits let’s touch on that you’ve been highly critical of the Federal Reserve I’ll be the last in line to defend the Federal Reserve so let me be clear about that

But we do need to talk about the role of the banks in all of this you’ve got any criticism for the way the banks have been run look I think that if you don’t expect some bankers to be stupid you have not learned the lesson and so say Greenspan

Said they were surprised yeah well surprised how little people were trying to uh do the right thing even if they had the right incentives so we learned that people make mistakes a resilient system is a system that can bear uh the mistakes of individual Bankers especially when these Bankers are not

The CEO of JP Morgan if I go and open an account this morning if we went out at least for an eye and I put a joint account as a surveillance account with that Tom’s name on it because we know what would happen to the cash but that’s

Another story they’d probably offer a zero percent one of the big names still we’ve got Barclays out in the last 24 hours saying that money market funds could go up another 1.5 trillion do you think the concern right now at the banks is return of capital or return on

Capital and can they prevent deposit flight by quite simply just putting out interest rates on deposits no they can’t they don’t have the uh return to do that if you look at the Silicon Valley Bank if they had increased their return on their uh deposits by uh I think 75 basis

Points they would have wiped out all the profits last year so I don’t think that they have a return on assets that justify a higher deposits that’s the conundrum if the problem was solved simply by increasing rates would be easy but they cannot afford to so you’re

Saying this banking system does not work with rates of four percent plus is that basically what you’re saying yes so does the FED have to cut interest rates and do we just have that tolerate inflation that first of all I think the inflation might not be as big of a

Problem if we get into a recession I think that a session would do the job now that was not the plan of the Fed was a soft Landing not crash in the banking sector but that’s the part that they should have seen but so let’s just put

This into perspective in terms of bad news being bad news which seems to be the new theme in markets right now how much is what you’re talking about underpinning that that there is an imminent tension that’s going to perhaps accelerate some sort of economic downturn because the banking system just

Is not going to function at these rates I think that that is the underlying bad news now this is tempered by the fact that this will come with a reduction in interest rates and as we know that compensates some of the problems so I think that the the real tension is the

Fed will not raise interest rate models would probably at some point cut them and is there going to be enough to trans form what is likely to be a hard Landing into a more soft Landing that’s the question I think that we are softening up and there will be a landing at this

Point in my way there is little doubt the question is how hard let’s finish where we started the changes you want to see the changes you want to see over time but I want to talk about the changes you want to see in the next couple of months what would you like to

See announced uh from the point of view of the fed from the the government from the Federal Reserve I think that a cu’s analysis of what are the softness in the banking sector and I think there was a regulatory failure and uh the the FED needs to own it and change and uh

And two I think that uh be honest about the fact that probably we need to soften up interest rates because the banking crisis is is coming and trying to find way to soften up this banking crisis especially I think for landing on this meal and small and medium businesses

Because those are the one affected the most you said be honest it implies that they know but they’re not saying it do you truly believe that I don’t know what you know you can be honest and be wrong and I think sometimes people believe their own uh

View of the world I think that I honestly did not understand the 25 business points increase uh last meeting I thought that was just a signal to say I want to reassure that things are not as bad as they they might have been uh was not determined by the objective

Situation in the gun but I’ve been wrong before I can be wrong now I just wonder whether there’s a role for regional Banks anymore which are such a Mainstay of lending I mean basically under your Paradigm not really now there is a very important role of regional Banks because we know that

Small businesses don’t borrow at a large distance they depend on on local banks and particularly uh also minorities depend dramatically on for example minority Banks I had students who went on the market this year showing how important is uh bank ownership in determine who gets uh the the loans so I

Think we cannot say we only go with a few large Banks because that means a complete change in the U.S economy this was so good you can promote your podcast what’s it called Capital isn’t what is working in capitalism and what isn’t nice where do I find that anywhere you

Get your podcast from there we go that’s perfect you were that good that he basically was like you know go for it you have won yourself an advertising second promo don’t you know get in trouble with corporate now I’ve given that away

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