04.04.2023 – The stock market has recovered nicely after the recent banking panic. But is the danger really over? Today we leave the stage to a warner. He sees a gigantic capital destruction going on behind the scenes – and expects a credit crunch.
Everything seems to be back to normal. This is shown, for example, by the four-hour chart of the Dow Jones. But it is possible that this is only an illusion. At least that is the opinion of Daniel Lacalle Fernández, chief economist at the Spanish private bank Tressis.
According to Federal Reserve data, about $98 billion was withdrawn from banks’ accounts in the week after the Silicon Valley bank collapse. Most of the money went into money-market funds, it said. Money-market funds invest mainly in money-market paper and liquid securities with a short remaining term. The problem is that the money is no longer available for long-term corporate loans, which stimulate the economy. But the flight of capital from banks is not the only problem.
What will lead to the credit crunch, according to Lacalle, is the destruction of capital in the assets of other lenders. Specifically, he says, the upcoming revaluation of assets is dangerous. Lacalle estimates that the destruction of value in private equity and venture capital is 15 to 25 per cent. In addition, the real estate industry in the US and Europe is also facing a significant revaluation. The destruction of capital is taking place pretty much everywhere in the asset base of lenders, “from the allegedly low-risk part, sovereign bond portfolios, to the aggressively priced investments in volatile businesses and bull-market valuations of corporate and venture capital investments.” Lacalle says: “The slump in mark-to-market valuations of all asset classes from loans to investments is what will ultimately drive an inevitable credit contraction.”
Less money for everyone
The Tressis expert went on to say that the tech bubble was bursting and that start-ups would soon be left high and dry as private investors and venture capitalists kept their money together. But they shy away from revaluing their assets. This is because writing off losses will lead to higher borrowing costs and thus more difficult investment conditions.
We add: For example, the value of long-dated government bonds issued several years ago must now be corrected. This is because old bonds have suffered a severe loss in value in the course of the interest rate turnaround – investors withdrew money in order to invest the capital in newly issued bonds that yield more interest when they are issued. So those who have held long-dated bonds have to accept heavy write-downs and losses when they are sold – this was precisely the problem at Silicon Valley Bank. When it realised the losses on bonds, the bank run began.
Lacalle went on to say that the profitable part of the banks would probably have to make provisions for non-performing – ergo: bad – loans. Both the Federal Reserve and the European Central Bank had recognised this danger months ago. Governments are also likely to create new regulations requiring higher provisions after the recent bank collapses. For these reasons, money would also be withdrawn from the market.
The Spanish expert concludes: “Capital destruction tends to be forgotten in a world used to constant central bank easing, but it is likely to be the main source of strangling of credit to families and businesses as banks and private equity firms deal with the loss of value and weakening earnings and cash flow of investments made at elevated valuations and unreasonable prices.” We add: The whole thing would lead to a downward spiral on the stock markets and perhaps to a bitter banking crash. We are curious to see whether this scenario will come to pass – Bernstein Bank is keeping an eye on the matter for you!
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