Bloomberg Wall Street Week March 24th, 2023

the US economy really is. Through the eyes of the most influential voices Larry Summers, the former Treachery Secretary, Katherine Keening, CEO of n y Mon Sam's l Sherman N, founder of Equatic Group Investment in Bloomberg Wall Street Week with David Weston from Bloomberg Radio, walking and chewing gum at the same time, as central banks address the need for financial stability without giving up their battle with inflation. Welcome

to Bloomberg Wall Street Week Time David Weston. This week's special contribute to Larry Summers takes us through the FED decision and what the banking crisis could mean for the real economy. They need to recognize that regulation lost its way over the last year or two. A ruined Sundarajan NYU sort out the reel from the fanciful and chat GPT.

The more people who use the system early on, the better it becomes and a special Wall Street Week roundtable on the banking breakdown, with Larry Summers joining former FED Governor Dan Trulo and stephaniely Flanders of Bloomberg Economics. We know first that there was a significant supervisory failure somewhere along the way. Central banks already had their hands full fighting inflation, but then a second front opened up with

the banking crisis. They quickly spread from Silicon Valley to Zurich, where officials began the week announcing that UBS would take over credit suis, a move praised by ECB President Christine lagard I wilcome the swift action and the decisions taken by the Swiss authorities. The actions are instrumental for restoring orderly market conditions and ensuring financial stability. But it was a shotgun wedding that left holders of so called Coco

bonds of credit suites out in the coal. Seventeen billion dollars of them are now rendered worthless, all of which put pressure on the FED to explain how we would pursue price stability and financial stability at the same time, and Wednesday we got our answer. Inflation remains too high and the labor market continues to be very tight. We remain committed to bring inflation back down to our two percent goal and to keep longer term inflation expectations well anchored.

We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound. My colleagues and I understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down

to our two percent goal. And while global Wall Street was consumed with the stability of the banks and how the central banks would respond, the rest of the world went on as President G of China paid a visit to Moscow for a visit with his good friend Vladimir Putin. She is there to present himself as a responsible stakeholder and a peacemaker to try to further boaster China's reputation on the global stage. Congress some of the CEO of TikTok the Capitol Hill for a grilling over his social media.

Female would also like to talk about national security concerns that you have raised that we take very very seriously.

At the end of this challenging week, equities actually held up remarkably well, with the SMP five hundred up one point four percent the NAZAC up one and two thirds percent, while much of the action was over in bonds, where the yield in a ten year started the week just over three point four percent spiked up well over three point six to end a week back down at three point three seven, just a handful of basis points from where it all started. Tell us sort all of this out.

We welcome now Dennis de Busher, his founder and president of twenty two V Research, and SONALDA Said, chief investment officer for fixed income at Franklin Templeton. So welcome both of you. Great to have you here. So now I'm gonna start with you, because the action really was largely in bonds. You're our fixed income person. Well, how do you explain how the bond market reacted to the news this week? So, you know, I wish it was an equity market equity week, but it is a bond market week.

Clearly i'd see other type of volatility we're seeing in the treasury yield curve. It is very interesting. There is a certain amount, in my mind, disonance the bond market is asking pleading with the Fed to cut rates. However, if I look at what is being priced in by the bond market, the number of rate cuts being priced in, it just doesn't make sense. It only makes sense if you're anticipating a really drastic recession triggered by a massive

banking crisis. But if that's the case, then the remainder of the bondmark it doesn't make much sense. I'm talking about credit markets, for example, we haven't seen spreads blowout. All the action really seems to be driven off market participants being unhappy with the FED not essentially doing what we've seen the FED do frankly since the global financial crisis, which has used overwhelming posts at the first sign of

wobbles in any particular piece of the financial sector. So, Dennis, is the equity market basically having a big debate with the bond market right now because the bond markets are saying we're going to have cuts this week this year, even though Jay Palla keeps saying we're not going to have, guys, but the bond market seems to think it is. If really we were, wouldn't that signal something really bad going on?

And shouldn't that be hurting equities? Right? Now he would say theoretically that it should be a pretty big drag on equities. I think one of the reasons why equities aren't reacting is because a lot of what's happening in the bond market could be a hedge against a really bad outcome, and at the end of the day, unless the near term adomic data is falling off a cliff, what it clearly is not doing. Lower rates are not going to be terrible for equities until it becomes very

obvious that you're going to see significant earning degradation. And so there's some chance that the banking system gets or people have a lot more confidence in the banking system, and if that happens, then deposit risk goes away or is significantly reduced. You don't have this drastic tightening of

financial conditions or lending standards. And if that were to happen, then the economy can weather it and maybe even with a lower rate outlook, and that combination at least stabilizes dequities until they have a little bit more information, because again, the earnings outlook is not terrible to start the year, and that's a really important point. So now the news was not just about what the Fed did or what

j Powe said this week. We also have this overhang of some confusion, even some fear in parts of the banking industry, was that reflecting the market? Did the bonds react to all of that that was going on there

some extent. But the reality is, you know, if we you know, you started off talking about the banking crisis, I would almost take issue with the idea that there is a crisis as such, because I would really distinguish what we are seeing today in banks from what we saw when we had a true banking crisis, a financial crisis, say two thousand and seven. Eight. We have to recognize that what we're looking at our banks, which buy and large,

are extremely solvent. If you look at banks like SVP, for example, problem was the most fundamental mismatch of duration. We're not looking at deep, strange, unvaluable securities where you can't figure out how much their work. You're looking at government treasuries. You're looking at US treasuries. You're looking at mortgage bonds, where we know the value of the asset

by the minute. So I think that's one thing to keep in mind every time I hear about the banking crisis and how this is spreading and there's something catastrophic waiting. I would I actually argue that what we heard from j Powell, indeed what we heard from Janet Yellin is broadly on point. If they see banks having runs, and remember in banking where in the business people are in the business and banking of borrowing short and lending long deposits,

fund loans, it's what banking is. I just think that what they are doing, which is trying to separate out what to do about the banks from interest rates, up to a point, this is a very sensible thing to do. So Dennis said, whether the banks are in a crisis or not, I guess it matters whether they think they're in a crisis. You could go into a crisis because it really affects their willingness to lend to some corporations, and that could really affect equities. That is what the

problem is for equities over time. And what we don't know is how much of that fighting of lending standards will actually show up over time. No one really knows. Tightening of lending standards is going to be quote unquote off the screen, So you're not going to be able to pick it up in the typical type of financial conditions in the sees that we are normally look at,

you know, on a Bloomberg screen. So it's a really unknown But you know, we did a search today of Google trends FDIC insurance and after a giant spike up, it's come down aggressively. So the broader public is probably not so focused on this as much anymore. I realize we all are on Wall Street, and there's a lot of people in California that are. And so if you get past that risk, which is the deposit flight risk, yes,

banks will have tighter lending standards. That might mean that the FED doesn't have to tighten as much on a go forward basis. In aggregate, you still have the same outcome slowing economy, lower inflation, but it doesn't mean a recession in the next six months. And if you don't have a recession in the next six months, then you have the case for eight equities to at least be stable and to have a significan get bounced back in

some of the more cyclical areas of the market. So now the side, oh sorry, go ahead, So now please now, I was just going to just say to Dennis that in fact, that's exactly I've seen so much of talk about how j Powell talked about raising rates just two days you know that rates needed to go up a lot more two days before sv BE broke, and then we saw that when we saw the new SEPs the top peak rate is still where it was in December.

So essentially what we're seeing is a substitution of higher rates which would have contracted demand for loans more yes, with fighter lending standards, as you said, which constrains the supply of credit. So overall, I do think it's too premature to assume that we're going to see this massive meltdown of the economy on the back of what we've seen in the past two weeks. So now the side and Denis be sure, we'll stay with us because we're a turn from what happened this week to what it

means of medium and long term. That's gonna have next on Wall Street Weet on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. I think we have a lot of individual investors who are on the internet buying and selling stocks almost every single day, and as a consequence, their behavior is somewhat different than the traditional institution, and quite frankly, I think the institutions these days are behaving a little bit foolish as well.

That was Roger mcnabe, a much younger Roger McBey then with Integral Capital Partners on Wall Street week back in February of nineteen ninety nine, when the number one moving the country was Message in a Bottle starring Kevin Coster and Robin Ry, and the number one song, well, that was Angel of Mine by Monica so Alacie of Franklin Templeton and Dennis de Buscher of twenty two V Research are still with us. So Dennis, let's go back to where you left us. Basically depends at the time horizon.

We were talking about what happened this week. But when you look six months out, twelve months out, if you're an equity investor at this point, given all the uncertainty're facing, what do you do you plan for lower inflation and stocks that benefit from lower inflation? Very simply, we spend a lot of time trying to figure out what the Fed is trying to accomplish, and this is an open secret. They want lower aggregate demand to lower inflation. They're going

to accomplish that goal one way or the other. Maybe the bank's timing of lending standard does it form. If that doesn't do it for them, they're going to tighten a lot. They're going to type more to make that happen. And so the net result of that is companies that benefit from lower inflation are going to outfl form. And as we see it, the things that will probably do the best of that backdrop are your early cyclicals on a relative basis, that's tech, communications, and discretionary, So that's

an area we'd be focused on. Then the main question is as the economy slows, is it a recession or not. If it's a recession, then more your defensive sectors work. That gets you to the stables, utilities, etc. If it's a mild recession, I think you want to fade defenses, and I think you really need to start thinking about the next cycle, which to me is the most interesting conversation. Are we in and I know you talk to Larry Summers.

Are we in a lower savings economy that's going to have consistently higher nominal GDP growth, consistently higher inflation and pressure affect. That's never really going back to two, but letting inflation run a little bit above target and over that longer term, right, you know, the defenses are going to be extremely unattractive if you're gonna have a two year great ramp put to book these levels for a

persistent period of time. It's just possible in a lower economy. Dennis, I want to sneak Sonil in here because I want to ask you the same question as a fixed income Unfortunately, we have just a short period of time. What do you do when you're investing as a fixed income investor? So right now is staying up in quality. We've been relatively neutral duration because I think we're going to get a lot more volatility. I do think ten year rates are going to go back up before we actually stopped

coming down. Because right now market and FED are playing a game of chicken. I happen to think the Fed's going to win, and so eventually we get higher yields and then I think we set ourselves up for a pretty good period for fixed income. We're already there as we move into slowdown, which allows the FED to cut some time next to that is terrific. Thank you, so much to both you, as Sonaldasai of Franklin Templeton and

Dennis the Busher of twenty two V Research. FED chair pal this week said he didn't yet know exactly what went wrong with Silicon Valley Bank, but the vice chair bar was conducting an investigation to find out. We convened our own expert roundtable to discuss what we know at this point, what we don't know, and what changes it should be on the table to make sure we don't

repeat what we saw over the last two weeks. Here's former treasure Secretary Larry Summers, former FED board member Jan Trullo, and Stephanie Flanders Bloomberg Executive editor for Economics and Government. I trust that the largest banks truly are in the much better capital and liquidity position that Jay Powell referred to yesterday during the press conference. We know first that there was a significant supervisory failure somewhere along the way.

Was that failure in San Francisco Fed's inability to identify problems of growth and maturity mismatches and the like early on? Was it the failure of the second San Francisco FED team to which did identify some problems to follow up in a sufficiently robust way. Was it a supervisory failure because of the light touch approach to supervision that the Federal Reserve Board had put in place over the last four or five years. But I think in the most

immediate sense, this is clearly a supervisory failure. Other factors may be uncovered as the FED Zone investigation proceeds. Larry, Let's put you back at the Treasury, or for that matter, at the White House. If you were looking at this situation, what questions would you be asking to make sure you understood the possible ramifications of what we've seen so far in a broader financial context. Before I answer that hypothetical,

let me put a question to my friend Dan. Dan, I've heard it said, and I don't know that even in twenty twenty two, the FED stress tests that were applied to the largest banks did not include an analysis of the stress from a major interest rate hike. If that's true, that seems kind of bizarre from the point of view of the world of early twenty twenty two, when it certainly many people, certainly me on David's show, were emphasizing that there was likely to need to be

very substantial increases in interest rates. Can you say something and if the stress tests weren't considering increases in interest rates, then perhaps the exempting of Silicon Valley Bank from the stress tests was not central to understanding the problem. Can

you say something about interest rate hikes and FED stress tests? Sure? So, First off, I think, Larry, I agree with the statement you made towards the end of your question, which is, actually, if Silicon Valley had been in last year's stress test for real rather than its stress rehearsal, I don't think it would have made much difference, for precisely the reason you say that they weren't stressing the things that were the SVB vulnerabilities with respect to stress testing generally, over again,

over the last five or six years, the stress test has become eminently predictable, but it follows the basic pattern of the scenario that was developed when we began doing the annual stress test. The scenario, of course includes a reduction in interest rates because of the hypothesis of a recession and the Fed's reaction, so to some degree, the

answer to your question is like supervision. Generally, the stress test has become less rigorous over time, and I think, more importantly it's become too predictable, and the whole purpose of a stress test is that you're trying to stress against the unanticipated, not the anticipated. It does our entire approach to deposits change, given what we're seeing in the fact is they're not as stick as we thought they were.

That's what I was alluding to earlier. I'd like to have a sense of exactly what the deposit profiles of this group of banks is as a whole, because in theory, at least, the supervisor should already have been distinguishing among different kinds of uninsured deposits, some of which I've always been understood to be eminently runnable, others of which have thought too were thought to be at least somewhat stickier

than insured retail deposits. If it turns out that those and this is what Stephanie I think was suggesting that those middle categories have changed, then you're going to need a change in regulation and not just in supervision. That was our Wall Street Week roundtable of Larry Summers, Dan Trulo, and Stephanie Flanders coming up. It was a week that called for courage, and we found it in a somewhat unlikely place. That's next on Wall Street Week on Bloomberg.

This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. This is Wall Street Week. I'm David Weston. We're joined once again by our very special contributor to Wall Street Week. He is Larry Summers of Harvard. So, Larry, we now have had another week of turmoil, continued turmoil in the banking sector. What are you looking for going

forward from our policy leaders in Washington? I think policy leaders need to be clear and decisive that depositors are not going to lose their money in large banks, in

medium sized banks, or in small banks. They can do that within their existing authorities simply by being clear that in the event of failures, given the highly fevered environment with respect to contagion right now, they are prepared to use systematic systemic risk exemptions to allow the FDIC to pay off depositors with assurance that those funds will come from the banking industry. I think by doing that they can contain a significant amount of the pressures that we're facing.

To provide confidence. I think they also need to increase the confidence they are providing in regulation. While it is true that the twenty eighteen Trump era legal changes were passed by the Congress were in almost every respect ill advised, and the important respects were driven by special interests pressure. It is also, i think clear that they are not the reason why we have had the problems we have had.

The problems we have had reflect problems of management and a number of financial institutions, and reflect major failures of the supervisory and regulatory paradigm as implemented by the Federal Reserve, in particular the failure to do a stress test in twenty twenty two when interest rate interest rates were clearly

on the upwards path. The failure to do any kind of stress tests about interest rate increases manifests a misunderstanding of what a major source of risk in the system was, and they need to signal an awareness of day shouldn't risk. They need to signal an awareness of solvency as well as liquidity issues in the regulatory paradigm going forward. Larry, we heard, of course from the Federal Reserve in particularly J. Powell news conference this week in which they did raise

the rates again twenty five basis points. We're a little more vague on where they go from here At the same time the chair said that this was an outlier. Silicon Valley Bank was an outlier. I guess my question to you is how confident are we actually the FED has our arms around the problem now now we know there is the problem to interest rate risk when it comes to SVB, How confident that we know that there

aren't other svbs out there. I think it's pretty clear looking at a variety of ratios that SVB and perhaps a couple of other banks were important respects outliers, but extreme examples tend often in life to point up digmatic issues.

And as I've been pointing out, a world of high interest rates with digital banking click of a finger ability both to move accounts out and to open new accounts is going to be a different kind of world in terms of risk, And it's going to be a different kind of world in terms of what banks can rely on in terms of the stickiness of deposits, and to what extent that's true is something we're likely to learn

in the next year or two. That's why I think it's appropriate, ahead of the curve to be sending clear signals of assurance with respect to bank deposits, because it is better to err on the side of overdoing it when you're talking about protecting against bank runs than it is to err on the side of under doing it. There are profound issues raised about the banking supervision here in the United States, and particularly with the stress tests.

There are also questions being raised over in Europe right now. They had the approach of those at one bonds or cocos that did not hold up so well for Credit Suite certainly, and now as the weekest progressed here, we've seen Deutsche Bank com under the siege. What questions are being raised about the European approach to protecting the banks.

I think it's important to recognize that, as Christine Legarde said, there are very important differences both between the way the terms of the Swiss banks are written at ones are written and the way the terms are written in other parts of Europe, and also to recognize that the ECB made clear that they're operating in a different paradigm than

the Swiss authorities were. But I think it's also clear that there's going to need to be some fairly systematic rethinking of these contingent capital instruments and how they work, and on what occasions they are going to be bailed in, and on what occasions they're not. Despite many years of legal discussion, it's clear that there were not sharp and

shared understandings in the marketplace. I suspect and hope that the European authorities, with the support of the United States and Secretary Yelling and Chair Powell, will send strong signals of support over the weekend for the European banking system, because given the scale of European institutions, there are potentially global consequences if problems spread from them. Larry, we have been understandably really focused on the banking situation, whether the

United States or in Europe. In the meantime, the war in Ukraine proceeds. You had an ed piece in the Washington Post specifically on Russian assets. Take us through what you think would be a good step forward on the economic front as opposed to the military front in Ukraine. I've been working with former World Bank President Robert Zellek on this and with noted policy academic Philip Zeliko, who's

a real legal expert. We are going to have to put billions of dollars, probably ultimately over a hundred billion dollars into Ukraine to win the war and then to win the peace. And the question is how that's going to be financed, And we believe there is both precedent, moral right and appropriateness to the financing coming from the

Russian reserve assets that we have frozen. And right now those assets are frozen, but there is not yet a willingness to deploy them to finance the ongoing support for the economy and the ongoing compensation for damage that Russia has caused to the Ukrainian economy. And we believe that there needs to be appropriate and creative lawyering, along with strong political leadership to get past that and to be

able to deploy those Russian reserves for that purpose. At a time when we are declaring that President Plutin is a war criminal, it seems to me almost inconceivable that we should be stopping short of using what are the currently immobilized assets of his state to deal with the damage that he and the Russians are causing. Larry, thank you so very much as our special contribute here in Wall Street Week. He's Larry Summers of Harvard coming up. It was a week that calls for courage, and we

found it in somewhat unlikely place. That's the next on Wall Street Week on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. Finally, one more thought. One man with courage is a majority, so said Thomas Jefferson.

And through the years we've seen some notable examples of a single person being a man or a woman standing up for what they believe in despite all the odds, like Army Secretary Joe Welch back in nineteen fifty four going toetete with Senator Joe McCarthy during the Red Scare untailed moment. Senator, I think I'll never really be you are crowding, are your right? Westman? Look you look down and don have you know damn about heat them dirt?

Or in the nineteen eighties, Johnson and Johnson CEO Jim Burke taking the bold and expensive decision to pull All Thailan all off the shelves across the country until he could be sure of the absolute safety of his product, and that brave student we saw stand up to the tanks in Tenement Square in nineteen eighty nine, never to

be seen again. Vice President Pence on January six, twenty twenty one, stood up to his book President Trump and a rampaging mob calling for him to be lynched as he insisted on doing his constitutional duty to certify the election of President Biden. President Trump is wrong. I had no right to overturn the election. The presidency belongs to

the American people and the American people alone. But one area where we haven't seen much courage in our dealing with our national debt, especially when it comes to how we're going to pay for all that we owe in Social Security and Medicare. Everyone agrees that what we are doing is not sustainable. There's artisan support for Social Security and Medicare. If anything, we need to shore those programs up.

They're running out of money. But when President Biden brought up the subject at the State of the Union address this year, he managed to get Republicans and Democrats to agree that we shouldn't do anything about the problem. Some

Republicans want medicare and so security sunset. I'm not saying it's a majority, and he was proud of it because we all apparently agree, So security Medicare is off the books now a right try not to do front all, right, forgot this week, though, we did get an example of real courage in addressing an aging population, as President mccron of France stood up to his parliament to implement pension reform. In France, President Emmanuel mccrone's government faces two confidence votes

as soon as today over his pension reform. Last week, McCrone used a constitutional provision to push through the plan to boost the minimum retirement age from sixty two to sixty four that led to violent protests. Mccron's government says that no confidence votes won't get a majority in parliament. Financial markets this week have called for more than a little bit of courage, Courage to face the truth, courage

not to overreact, courage to remain calm. And so we leave you this week with some further thoughts from John Mack, who led Morgan Stanley through the worst of it in the Great Financial Crisis, and it took to lead his organization through that time. I knew if I cracked, they all cracked. So I had to put on a face. What they didn't know. I was shut my office door and just trying to pull myself together. I couldn't show

the stress of fear that we were under. That doesn't for this episode of Wall Street Week, I'm David Weston. See you next week.