Maybe setting up a state-sanctioned banking cartel wasn’t such a good idea after all. From MN Gordon at economicprism.com:
“The bank is something more than men, I tell you. It’s the monster. Men made it, but they can’t control it.”
– John Steinbeck, The Grapes of Wrath
Borrowing short and lending long works mostly well most of the time. This is how modern banking works. You may be a customer at a bank. But you also supply the product.
In short, a bank will pay you a small percent for the deposits in your checking and savings accounts, which you can withdraw at any time. This is the borrowing short side of the operation.
The bank then takes your deposits and invests the money in some longer-term assets, such as loans and bonds that aren’t paid back for years. Say the bank earns 2 percent on its money while paying depositors a fraction of a percent. The bank pockets the spread, the net interest margin. Easy money.
However, when the Federal Reserve intervenes in the market and presses the federal funds rate to zero and holds it there for 2 years (March 2020 to March 2022), driving yields across the range of maturities to 5,000-year lows, something bad is bound to happen.
The experience for consumers over the last 24 months has been raging consumer price inflation. But that’s only a small part of the bad stuff that can happen.
Because as the Fed jacked up the federal funds rate starting in March 2022, to contain the consumer price inflation of its own making, the yield curve has inverted. Short term yields are higher than long term yields. And banks, having borrowed short to lend long, have negative carry.
Perhaps it would all works out for the banks if depositors stayed put. But in a world where you can score nearly 5 percent from Treasury Direct – with no brokerage fees – why keep excess deposits in the bank when you only get a fraction of a percent?