On Friday, former Treasury Secretary Larry Summers offered his take on the banking crisis and the Federal Reserve’s potential move next week.
On Big Bank Rescue Package: While discussing SVB Financial Group, the parent of the tainted Silicon Valley Bank, Summers said in a Bloomberg interview that bankruptcy appears to be the right move for a company that is insolvent and that the government is resolving the situation.
Discussing the assistance that big banks will provide to First Republic Bank (NYSE:FRC), Summers said JP Morgan Chase & Co. (NYSE:JPM) and a number of other banks had apparently been corralled by current Treasury Secretary Janet Yellen. He added that the government committed to putting money at par, which is above the market value of the securities, for a year. The banks, on the other hand, made a commitment for 120 days and can therefore get out well ahead of the government, he said. The interest rate applicable to those banks isn’t yet clear, Summers noted.
“The fact that everybody’s acting will make people a little more confident, but it made me nervous, “ he said. “It seemed a little corporatist and deal-based between the government and big banks to me.”
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On Fed Decision: Summers applauded the European Central Bank, which, under Christine Lagarde, raised interest rates by a half percentage point. Summers said that Lagarde showed that an anti-inflation monetary policy can be carried out even when there are financial strains and that different instruments can be used to respond to inflation and financial instability.
The former Treasury Secretary also called out Lagarde’s decision to end forward guidance. “I hope in many ways that will be a role model for the Fed,” he said, adding that the policy of standing behind depositors should be handled separately from monetary policy.
Based on the current fiscal situation, Summers said that a 25-basis point hike would be appropriate. He also said that the fed funds rate would come down.
In addition, the Fed should not allow “financial dominance,” Summer said. If the Fed were to slow down its interest-rate increase beyond what was appropriate, it would raise inflation expectations and contract the economy, the former Treasury official noted.
The Federal Open Market Committee, the Fed’s policy-setting arm, is set to meet for a two-day meeting beginning on Tuesday. Fed funds futures are pricing in a 38% probability of the Fed pausing at 4.50%-4.75% and a 62% probability of a 25 basis-point increase.
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