As I wrote yesterday, the world now stands on the brink of a full-blown banking crisis, following Friday’s collapse of California-based Silicon Valley Bank (SVB).
Few Britons will have heard of it, but this is now the second-largest banking failure in US history, with SVB holding assets totalling $202billion (£168bn). Only Washington Mutual, which crashed in 2008, was worth more at $300billion.
Stock markets will be all over the shop on Monday, as investors wait to see how far the crisis will spread.
SVB wasn’t the only US bank to go under last week, crypto bank Silvergate Capital collapsed a few days before.
Last November, crypto-currency exchange FTX, run by supposed web guru Sam Bankman-Fried, went down in flames owing £27billion.
In September, the fallout from former Chancellor Kwasi Kwarteng’s mini-Budget would have destroyed our pensions if the Bank of England hadn’t stepped in.
So why is this happening now?
The answer is that we are paying the price for decades of free and easy money, which saw central bankers respond to every financial problem by slashing interest rates ever lower, and pumping out yet more monetary stimulus.
The policy was originally called the Greenspan put, named after former US Federal Reserve chair Alan Greenspan, who reacted to the 1987 stock market crash by throwing cheap money at markets.
Investors hailed the man as a financial genius. Of course they did. Greenspan gave them whatever they asked for, and more. Who doesn’t like free cash?
Having seen this policy work once, central bankers weren’t going to stop. They threw more money at stock markets after the dot.com crash in 2000, the financial crisis in 2008 and again during the pandemic.
Politicians learned fast and piled on the stimulus, too. US President Joe Biden has lavished markets with trillions of dollars, fuelling today’s inflation nightmare.
For years, I moaned this was only building up problems for the future, as cheap money inflated asset values everywhere, but particularly house prices.
We should have had a correction after the financial crisis, but the Bank of England averted that by slashing base rates to 0.5 percent in March 2009.
So prices flew even higher.
The same happened in 2020, during the pandemic. Another blast of low interest rates and monetary stimulus, and prices rocketed again.
Central bankers and politicians could get away with this while inflation was below its target rate of two percent, but it was only building up problems for the future.
Back in the day, the average house cost about four to five times earnings. Today, it costs nine times earnings, rising to a staggering 12 times in London.
This has squeezed young buyers out of the market, leading to generation rent, a disgruntled wave of younger people who may never own a home.
The Treasury rushed to their aid with schemes such as Help to Buy, which drove prices higher still. I can’t imagine a worse use of taxpayer money than inflating the already insane UK housing market.
READ MORE: House prices crash all over the world. UK may be next
With inflation stuck in double digits, central bankers can no longer keep on kicking the same old can down the road. They have to face up the monster they have created.
Housing markets are falling everywhere, but slashing interest rates to save homeowners will trigger an inflationary spiral.
Which is why they have to keep hiking them. In the US, the key Fed funds rate is now 4.75 percent.
Soon it could hit six percent.
The Bank of England has increased base rate from 0.1 percent in December 2021 (0.1 percent – what were they thinking!!!) to four percent today.
Markets expect the BoE to increase bank rate to 4.25 percent on March 23, but it will have to go even higher unless we get lucky and inflation starts falling sharpish.
If base rate hits six percent over here, too, then mortgage rates will fly to seven or eight percent and it’s finally game over for the housing market.
Around 1.4million homeowners will see their fixed-rate deals expire this year, and will face the mother of all payment shocks if that happens.
We’re not there yet. As I said, we might get lucky.
But years of near-zero interest rates have left central bankers stuck between a rock and a hard place. If they hike interest rates to crush inflation, they will destroy the housing market.
If they cut rates to save the housing market, inflation will let destroy everything else.
If prices do crash, central bankers can now do nothing to stop them.
On top of this, they now have to juggle a potential banking crisis.
That’s the problem with repeatedly putting off tough decisions. They only get tougher when you are finally forced to face up to them, as we might be next week.
Hold tight.
