The banking crisis that started with Silicon Valley Banks failure on Friday and followed by the collapse of crypto-focused Signature Bank may not be over as it had seemed earlier this week.
There remains a threat, or contagion, to the broader financial system, according to Larry Fink, CEO of asset management giant BlackRock and one of the most influential voices in the financial world given his companys management of trillions of dollars in assets.
The regulatory response has so far been swift, and decisive actions have helped stave off contagion risks. But markets remain on edge, Fink said in a much-awaited Wednesday letter to stakeholders. Are the dominoes starting to fall?
The first domino dropped when the Federal reserve rapidly raised interest rates to fight inflation, according to the BlackRock chief. Since last year, the Federal Reserve has increased rates eight times, for a total of nearly 500 basis points, ending whats known as the era of easy money.
The SVB implosion could lead to a second domino to fall, due to an asset-liability imbalance. SVBs parent company had sold $21 billion worth of investments last week, resulting in an after-tax loss of $1.8 billion. It subsequently announced that it would raise $2.25 billion in fresh equity to beef up its balance sheet.
There could yet be a third domino to fall, Fink said.
He alluded to past periods when the financial system faced tight conditions and eventually led to flameouts. He gave the example of the Savings and Loan crisis in the 1980s when inflation and interest rates increased sharply and its impact unfolded like a slow rolling crisis over the next decade. The failure of over 3,000 savings and loans ultimately cost taxpayers $132 billion.
We dont know yet whether the consequences of easy money and regulatory changes will cascade throughout the U.S. regional banking sector (akin to the S&L crisis) with more seizures and shutdowns coming, Fink wrote. Its too early to know how widespread the damage is.
The next worry for investors is whether to expect an interest rate hike at the Federal Open Market Committee meeting next week. Inflation in the U.S. is still ragingin February, prices were up 6% compared to a year earlier, which was lower than a 6.4% year-over-year increase in January. But it was still well above the Feds 2% target.
There are wildly different viewpoints on whether the Fed will continue its rate hikes given the latest banking crisis. Banks like Goldman Sachs believe the Fed will delay a planned rate hike in March due to the SVB fallout, while others think that hitting the brakes on interest rate hikes now would send a negative signal to the market. Economist Mohamed El-Erian sees a more modest interest rate hike on the horizon instead of a total halt.
In his letter, Fink said that since inflation is still high, the Fed will continue increasing interest rates.
While the financial system is clearly stronger than it was in 2008, the monetary and fiscal tools available to policymakers and regulators to address the current crisis are limited, especially with a divided government in the United States, Fink said in reference to the trouble SVBs failure posed to the financial system at a time of heightened inflation.
BlackRock did not immediately return Fortunes request for comment.
