Banking crisis spills to Europe

Credit Suisse, Switzerland’s 2nd largest bank, is the latest casualty, being forced into a sale to rival UBS over the weekend. Controversially, as part of the deal, ~$16bn of Credit Suisse bonds were wiped out, while stockholders received ~$3bn. The situation at Credit Suisse is different from the US regional bank runs that began 2 weeks ago. Credit Suisse is a global investment bank that is systemically important. Their issues go back several years and include taking big losses from the blow-up of Archegos and Greensill. The zeroing out of bonds, while giving value to equity, was met with a lot of outrage given generally, the pre-determined order of priority of claims in an event of this kind would have bondholders receiving value before stockholders. These particular bonds had a clause that dictated they would recover zero in the event of extraordinary governmental assistance. Ironically, these types of bonds were created after the global financial crisis to address prior funding issues. At the end of the week, Deutsche Bank began to show signs of stress in credit markets.

ELI5 (Explain it like I’m 5)

• Credit Suisse is Switzerland’s largest bank
• They have been under pressure for years, having been involved in multiple scandals
• Their situation is not like that of US regional banks
• However, they faced similar bank run dynamics of the US banks
• The Swiss government orchestrated for UBS to purchase them over the weekend for $3.25bn
• As part of the deal, ~$16bn of Credit Suisse bonds (investors, not depositors) were wiped out
• This was largely unexpected because, generally, bondholders are paid off before stockholders
• These particular bonds were unique in that they had a clause in them saying that in the event the government had to provide extraordinary assistance, they would be worth zero
• The panic started to creep into other European financials, including Deutsche Bank, by the end of the week

Bond market expects interest rate cuts

Despite several banks failing here and abroad over the last few weeks, the Federal Reserve (as well as the ECB, Swiss National Bank, and Bank of England) all raised interest rates this week. The central banks remain focused on inflation still being above levels they are comfortable with and believe they have the ability to deal with bank failures in other ways. Central Banks have found themselves in an extremely precarious position. On the one hand, inflation is still above their target levels, while the delayed effect of their prior interest rate increases is beginning to show unintended consequences in the banking system. While in the UK, inflation just printed at over 10%, inflation in the US has been showing clear signs of deceleration. Unofficial measures of inflation, such as Truflation, are actually showing US inflation running below 4%. It seems Central Banks are intent on being reactive instead of proactive, which is how we got here in the first place. Meanwhile, the bond market in the US has significantly repriced where it expects interest rates to go over the next 12 months, expecting 2 interest rate cuts instead of hikes by year-end.

ELI5

• Central Banks all raised rates again this week
• Even though the market was expecting it, this was still surprising in light of the multiple recent bank failures
• While inflation is still very hot in the UK, some unofficial readings in the US indicate significant recent cooling
• Central Banks don’t seem to want to be proactive ahead of potentially bigger problems
• Ironically, this is how we got here in the first place when they refused to hike interest rates in light of inflation
• Bond markets are trading in contrast to current Fed projections, indicating 2 interest rate cuts by year-end

Russia and China flex

While most focused on the continued bank failures, China’s Xi Jinping and Russia’s Vladimir Putin held a summit earlier in the week. While no one is privy to the full extent of their conversation, they ended the summit by releasing audio where Xi tells Putin that they are embarking on change the world has not seen in 100 years. China is intent on replacing the United States as the top global power, a role the United States has played since the world wars of the 20th century. Aligning with Russia provides them with a cheap source of energy, something they desperately need. For Russia, it provides a partner to help power its economy.  Allowing China to pay for its oil in Yuan instead of the US dollar provides a path to replace the US dollar as the world's global reserve currency.

ELI5

• China is intent on becoming the global world leader of the next century
• Some would say we have already been in a proxy war with China via Ukraine/Russia
• Most global commodities are priced in US dollars, so getting rid of US dollars helps take the United States out of the picture
• Russia agreeing to allow for payment for their oil in Yuan (Chinese currency) is a step in that direction

Crypto crackdown continues

The SEC sent a wells notice to Coinbase this week. This is done ahead of an enforcement action. It seems like they are honing in on the staking service they offer clients. Coinbase is the de-facto onramp to crypto in the United States. They worked with the SEC to go public in 2021. They have done everything in their power to work with regulators to ensure they are operating within the guidelines of their regulations. Our understanding is that the regulators have not reciprocated. Coinbase CEO, Brian Armstrong, vowed to fight this, hopefully bringing some much-needed clarity to regulations of this industry.

ELI5

• The SEC sent notice to Coinbase letting them know they are about to sue them
• Coinbase is a public company and worked with the SEC on their listing
• Coinbase has been very public about attempting to work with the SEC to make sure they are operating within the regulatory framework
• The SEC has not reciprocated
• This sets up a fight that may provide regulatory clarity

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