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Renowned economist Dr. Nouriel Roubini recently penned an op-ed for MarketWatch in which he discussed the precarious situation faced by investors and banks. Dr. Roubini, who has held the position of Professor Emeritus at the Stern School of Business, New York University, since 2021, after serving as a Professor of Economics from 1995 to 2021, is also the CEO of Roubini Macro Associates, LLC, a New York-based global macroeconomic consulting firm, and the Co-Founder of Rosa & Roubini Associates, headquartered in London.
In his op-ed, Dr. Roubini highlighted that by the end of 2022, U.S. banks’ unrealized losses on securities reached $620 billion, approximately 28% of their total capital ($2.2 trillion). He also pointed out that the rise in interest rates has led to a decrease in the market value of banks’ other assets, and when accounting for these factors, U.S. banks’ unrealized losses actually amount to $1.75 trillion, or 80% of their capital.
According to Dr. Roubini, the “unrealized” nature of these losses stems from the current regulatory regime, which allows banks to value securities and loans at their face value rather than their true market value. He asserts that most U.S. banks are technically near insolvency, stating that “In fact, judging by the quality of their capital, most U.S. banks are technically near insolvency, and hundreds are already fully insolvent.”
Dr. Roubini explains that rising inflation reduces the true value of banks’ liabilities (deposits) by increasing their “deposit franchise,” an asset not on their balance sheet. He further states that this asset only exists if deposits remain with banks as rates rise. However, experiences from Silicon Valley Bank and other U.S. regional banks reveal that deposit stickiness is not guaranteed. If depositors withdraw their money, the deposit franchise evaporates, and unrealized losses on securities become realized as banks sell them to meet withdrawal demands, leading to bankruptcy.
Dr. Roubini also mentions the “deposit-franchise” argument, which assumes that most depositors will keep their money in accounts bearing near 0% interest instead of earning 4% or more in safe money-market funds. However, he asserts that depositors are not so complacent. The current flight of uninsured and even insured deposits is likely driven by both the pursuit of higher returns and concerns about deposit safety.
“In fact, judging by the quality of their capital, most U.S. banks are technically near insolvency, and hundreds are already fully insolvent.“Dr. Roubini @Nouriel
Dr. Roubini emphasizes that the interest-rate sensitivity of deposits has returned after being a non-factor for the past 15 years. He suggests that banks assumed a foreseeable duration risk to increase their net interest margins and criticizes regulators for not subjecting banks to stress tests to see how they would fare in a scenario of sharply rising interest rates.
Finally, Dr. Roubini argues that central banks face a trilemma due to recent adverse aggregate supply shocks, such as the COVID pandemic and the war in Ukraine. Achieving price stability through interest-rate hikes raises the risk of a hard landing but also the additional risk of severe financial instability. He warns that central banks may “wimp out” to avoid an economic and financial meltdown, setting the stage for a de-anchoring of inflation expectations over time. Dr. Roubini calls for everyone to prepare for the coming stagflationary debt crisis.
Dr. Roubini’s concerns are not limited to traditional banking institutions. Last month, he expressed his concerns about the risks associated with cryptocurrencies during a conversation with Stansberry Research’s Daniela Cambone. He emphasized that the crypto market is highly dangerous and riddled with frauds and criminals, pointing out that the entire crypto house of cards seems to be collapsing. Dr. Roubini suggested that crypto is not the place to be if someone seeks to preserve their wealth.
Dr. Roubini also mentioned the significant volatility of Bitcoin, noting that just over a year ago, its value was around $69,000, but it has since dropped to between $19,000 and $20,000, losing around 80% of its value. He added that other top-10 cryptocurrencies had experienced even more significant losses. Furthermore, Dr. Roubini highlighted the recent collapses of two major crypto banks, Silvergate and Signature Bank, which he claimed were involved in risky activities, putting depositor funds at risk.
What does this mean for traders? While Dr. Roubini’s warnings may seem dire, it is important to remember that trading carries high risk. It is always wise to do your own research and consult with a financial advisor before making any investment decisions. However, traders should be aware of the risks associated with traditional banking institutions and cryptocurrencies, and take appropriate measures to mitigate those risks.