Squirrel!

By Regitze Ladekarl, FRM

For those still holding their breath: yes, the headline inflation rate did come down, and yes, we are back on ramp to interest rate cuts soon, and yes, soon is firming up to mean September.

And soon needs to be soon because there are debt burdens starting to throw their weight around and it isn’t healthy. In the wake of the Big Sell-Off, someone dared to whisper it could have been a Minsky Moment, and we definitely do not need that kind of negativity in our lives.

This week, Bloomberg did a Quick Take on Minsky—close, but not to be confused with Mitski, who is by the way headlining Sunday at the All Points East Festival in London this weekend—and we will try to give you an even quicker take.

A Minsky Moment is a sudden, major collapse of asset values after a longer period of stability and (debt-financed) growth. It basically describes that because everything is going swimmingly, we borrow to swim faster and lull ourselves into thinking there is no risk and then have a rude awakening. Sound familiar?

The Minsky Moment was coined by Paul McCulley (PIMCO) in 1998 to describe the Russian Financial Crisis, and later the GFC in 2008, and it refers to the theories of the economist Hyman Phillip Minsky (1919-1996) who dabbled in financial market fragility and speculative euphoria. Again, sound familiar?

The combination of an ever more credit-driven economy and an ever-shortening attention span (squirrel!) is obviously not ideal. Debt-financed growth does carry a non-zero probability of loss and if we freak out* when growth slows down because we forgot that growth could do that, we make it worse. So, we try to soften the systemic impact of such freak-outs, for example by requiring banks to hold reserves to absorb loss.

Another funny story about that—not funny as in haha, but funny as in ironic—was also reported by Bloomberg this week.

As you know, the Fed wears the hat as bank of the banks. In many ways its balance sheet therefore looks like a bank’s, too, loans and securities—their monetary policy instruments-on one side, deposits and debt on the other side.

As we have talked about (a lot), the higher-for-longer rates aren’t that great for banks because higher rates lower the value of securities (the yield versus price tug) and ups the rate it has to pay on deposits. And if the two sides of the balance sheet moved too much in opposite directions, there is an imminent risk of depositors pulling out their savings and causing a run on the bank.

So, at one end of the Fed, they hike rates to curb spending (and inflation) and encourage savings. At the other end of the Fed, the banks deposit their reserves because since 2008 Fed has paid close to the policy rate to hold these.

That did not mean much when the Fed rate was a mere 0.25%, but now the Fed pays 5.4% on the $3.3 trillion reserves the banks have sitting there.

That is way more than the Fed is earning from the asset side of its balance sheet. Again, again, sound familiar?

Now, the Fed is backed by the Treasury, so it is not going to nosedive like SVB, but it used to be that the Fed was making money for the Treasury, and now not so much. Even with the Fed starting to cut rates soon, it is estimated to take until mid-2027 before they are back to black with the Treasury.

Cue Alanis Morisette…

Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.

This article is part of the FRG Risk Report, published weekly on the FRG blog. To read other entries of the Risk Report, visit frgrisk.com/category/risk-report/.