Raoul Pal believes the following about the banking crisis: The impending banking crisis and its consequences are causing alarm, as there is a fear that something may break. The goal is to slow the business cycle and thereby eliminate inflation.
Yet, historically, something breaks at the bottom of every business cycle due to rising interest rates and a declining economy. This is a common characteristic of the business cycle, similar to how there is a boom and a peak with excessive leverage and confidence. The current scenario is complicated by the world's huge debt, with the United States being the most indebted country in history in terms of GDP.
Banks have two levels of operation: deposits and investments. In a typical scenario, banks conduct business using a steep yield curve. They borrow money at a low interest rate and lend it at a higher interest rate, resulting in a longer investment period.
Yet, the yield curve has turned negative, implying that banks are losing money on a daily basis. To compensate, they manipulated the yield curve by giving a higher interest rate on deposits. However, this encourages customers to migrate their deposits to other banks that provide better interest rates, causing the deposit base to decline.
As a result, bets placed at the conclusion of the investment maturity go underwater, resulting in mark-to-market losses. These losses may normally be retained on the books, but with the collapse of the deposit base, banks must recognise these losses. This is the present problem with the banking crisis, and there is ongoing debate over how to resolve it.
To allay people's anxieties after banks like Silicon Valley Bank and Signature Bank failed, the government has proposed guaranteeing deposits in the banking system. This, however, does not solve the underlying issue, which is that interest rates are too high and banks are losing money.
Even with guaranteed deposits, customers will seek higher-yielding alternatives such as Treasury Direct. The only solution is to decrease interest rates dramatically, maybe by 300 basis points or more, and to conduct quantitative easing (QE).
Because they are the leading lenders in the commercial real estate industry, small and medium-sized banks confront an additional hurdle. Commercial real estate is becoming increasingly unoccupied as a result of the transition to remote employment, which will have a substantial impact on these banks. The real estate market may become illiquid, making it difficult to repurpose unoccupied assets for regulatory and practical reasons.
But, the situation can be remedied by following the lead of Mario Draghi, who enacted policies in Europe to confront a similar crisis in 2012-2013.
When living in Spain, I watched Draghi's tactic of accepting any distressed assets on banks' balance sheets, regardless of their nature, and using them as collateral to keep the banking system solvent. Rather than attempting to entirely restore the banking sector, this approach entails controlling its collapse over time.
Several small to regional banks will not recover due to their strong exposure to commercial real estate, and many have also been impacted by deposit outflows and submerged assets. To resolve this issue, interest rates must be cut promptly rather than attempting to safeguard deposits, which does not address the underlying issue. Finally, like in Japan in 2008, the solution is for central banks to take on the toxic assets themselves.
In short, Raoul Pal argues that the banking crisis is a complicated issue caused by rising debt levels, deteriorating economies, and negative yield curves. He proposes reducing interest rates and performing quantitative easing to address the issue. Pal also suggests following Mario Draghi's lead and accepting distressed assets as collateral to keep the banking system afloat. Finally, central banks may be forced to take up bad assets directly, as Japan did in 2008.
Source:
Money Talks, 21 March 2023, "My Final Thoughts on The Upcoming Banking Collapse" | Raoul Pal Latest Prediction",