The United States may see another fifty bank failures if the US government does take appropriate action to fix structural issues and the central bank fails to cut interest rates, former Lehman Brothers executive Lawrence McDonald told Sputnik.
On March 10, federal regulators seized Silicon Valley Bank (SVB) - the largest US bank to collapse since the 2008 financial crisis and the second largest implosion in the country's history.
Two days later, the New York-based Signature Bank was seized in the third largest bank collapse in US history, which forced the federal government to take emergency measures and guarantee deposits to stem the crisis, which many blame on rising interest rates.
The US banking crisis has already affected several states around the globe including in Europe.
Credit Suisse’s share price plunged nearly 30%, sparking concerns about a liquidity crunch. The incident followed the recent collapse of several US financial institutions, including Silicon Valley Bank (SVB).
Later on Wednesday, the US Federal Reserve is widely expected to raise interest rates for the ninth time since last March in its battle against inflation, despite the fact many point to rising interest rates as a primary cause of the banking crisis.
"Yeah, because it's just after the financial crisis, and this all goes back to Lehman," McDonald said when asked if more US banks may be expected to collapse. "So Lehman failed and then it forced this too big to fail system, and then now this interest rate shock to the regional banks is moving hundreds of billions of dollars out of regional banks into the big banks... So you could have another 50 bank failures and unless they fix the structural problem."
McDonald, who served as the vice president of distressed debt and convertible securities trading at Lehman Brothers, added that Washington may be forced to put forward a much larger backstop that covers deposits larger than $250,000.
Bloomberg reported on Tuesday that the US Treasury Department is reviewing whether federal regulators have sufficient emergency authority to insure deposits that exceed the current $250,000 limit for most accounts without approval from the US Congress.
NEXT EXPECTATION IN BANKING CRISIS, FED RESPONSE
The crisis has already affected countries in Europe with UBS moving to acquire and save distressed bank Credit Suisse which suffered a liquidity crisis in the wake of SVB's collapse.
McDonald also said the probability of a recession occurring in the United States is now certain following a banking crisis spurred by frequent interest hikes.
"There's a loss of confidence, financial conditions rips tighter, so the consumer is wounded," McDonald said. "This is in the process of wounding that [current US consumer] boom. The probability of recession is now I think certain."
McDonald said the Federal Reserve's strategy to hike interest rates to combat inflation is essentially creating "another fire." He expects the US banking crisis will cause further damage in the American economy, forcing the Federal Reserve to scale back on interest rate hikes and require Washington to further intervene to secure deposit guarantees.
"The Fed probably cuts rates by 100 basis points by year end, and then unemployment is really going to move here in the next five months, higher, and then we'll get some type of Washington policy response that's bigger and then they'll stabilize the system," McDonald said.
McDonald predicts the US government may spend up to $2 trillion to stabilize the US banking system.
Last week, US banks borrowed a record $153 billion from the Federal Reserve, up from $5 billion the week before.
"Deposits are leaving [regional banks], so the Feds gonna be forced to cut rates, because you've pushed up the Fed Funds rates so high," McDonald said. "[Federal Reserve Chairman Jerome] Powell was on the Hill 10 days ago telling us that the banking system was fine and he doesn't understand this like interest rate risk for the regional banks and it's unconscionable... he was either lying or didn't understand what he's done. It's one of the two."
GLOBAL IMPACT
McDonald said Russia and China should be more resilient to the impact of the US banking crisis, but Beijing will not be able to completely shield its economy from the fallout considering it is exposed to the European economy and US consumer.
"China is very exposed to the European economy and the US consumer, so China doesn't avoid this at all," McDonald said.
On the other hand, Russia benefits from the fallout because it increases the value of their hard assets, such as gold, McDonald said.
"They [Russia and China] benefit because they're hard asset countries, you know, they benefit from higher gold prices," McDonald said.
However, McDonald pointed out that Russia will be hurt by its oil industry as its current account is starting to roll over.
After Russia began its special military operation in Ukraine, the countries of the so-called collective West actively searched for ways to limit Moscow’s energy-related income, notably from oil and gas. The effort culminated in a $60 price cap imposed by the G7 member states and Australia on December 5.
Western sanctions may have weakened some global banks heading into the current shakeup, but it did not play any critical role in the current dilemma, McDonald said.
"Sanctions weaken some of the global banks, you would have had maybe some more assets, but I wouldn't say that's a game changer," McDonald said.
Europe, however, is the region most feeling the ripple effects from the United States.
"We're already seeing leveraged loans, high yield bonds, we're seeing a pretty sharp deterioration in credit conditions, and so equities are bouncing, which they always do on the policy responses," McDonald said. "So we had a big response in Europe. So the European banks have bounced sharply because there's this big merger between Credit Suisse and UBS. You want to use these rallies to sell to lighten on equities."
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