What was going on with banks in April 2016: emergency meetings, a bail-in and the worst quarter since 2009

In the second week of April 2016 nearly every central banker and finance minister of consequence was in Washington. The Federal Reserve’s Board of Governors met twice behind closed doors under “expedited procedures”. Between those two meetings the president of the United States received the Fed chair at the White House, with the vice president in the room. The G-20’s finance ministers arrived on Tuesday; the World Bank and the International Monetary Fund convened on Thursday. Taken one at a time each event had a routine explanation. Taken together they made a week that deserved a record, and this is it.

The meeting that needed explaining

Presidents rarely meet the chair of the Federal Reserve, and when they do it is scheduled well in advance. Barack Obama’s previous meeting with Janet Yellen had been in November 2014. This one was announced on the Monday for the Monday, immediately after the Fed’s first closed session, and the vice president was added to it. The White House spent more effort explaining what the meeting was not than what it was: the two would “trade notes” on the longer-term outlook, press secretary Josh Earnest said, and the president had “the utmost respect for the independent nature of her role”.

The most generous reading is that it was preparation for the G-20. The less generous reading, and the one this site favoured at the time, is that an administration in an election year had every incentive to make sure a recession was neither declared nor visible, and that the Fed’s own credibility was tied to the same outcome. Neither reading required anyone to instruct anyone. Self-interest does not need a memo.

Two expedited meetings

The Fed’s notices for 11 and 12 April used the same formula: a closed meeting of the Board of Governors under expedited procedures, “as set forth in section 261b.7 of the Board’s Rules Regarding Public Observation of Meetings”. The first was listed as a review of the discount rate, the ordinary business that closed meetings usually cover. The second, called a day later, gave its purpose as “bank supervision”. After the first, the Board added only that the meeting had been closed under exemption 9(A)(i) of the Government in the Sunshine Act, because “the public interest did not require opening the meeting”.

Boards always find a reason a matter is not in the public interest, and they always word it generically. What was unusual was not the closed door but the sequence: two expedited sessions in two days, with a presidential meeting between them, in the week the banks reported.

The reporting season nobody wanted

American banks were expected to post their worst quarter since the start of the Great Recession. Energy loans were the immediate cause: Wells Fargo had become the largest lender to the oil patch on collateral assumptions that a price under 40 dollars a barrel made look reckless, and it was not alone. The Atlanta Fed’s GDPNow model had meanwhile revised its estimate of first-quarter growth down again, to 0.1 per cent annualised. That is not a recession, but it is the precipice of one, and it was the number the Fed was looking at when it met.

Austria: the first bail-in

The same week Austria became the first country to apply the European Union’s new bank-resolution rules to a failing lender. Heta Asset Resolution, the bad bank carved out of Hypo Alpe-Adria, had its senior creditors written down by 54 per cent by the Austrian regulator. The state of Carinthia, which had guaranteed the old bank’s debts, was left facing obligations several times its annual budget. For anyone who remembered 1931, an Austrian bank dragging a regional government toward insolvency had an uncomfortable precedent: the collapse of Creditanstalt in Vienna that year is generally credited with turning a recession into the Great Depression.

The bail-in rules had been designed after 2008 so that taxpayers would no longer rescue bondholders. Heta was the proof of concept, and the proof was that bondholders, many of them German insurers and banks, would fight.

Italy: 360 billion of bad loans

Italy’s finance minister called the country’s bankers to an emergency meeting to assemble what was openly described as a last-resort measure: a fund, soon named Atlante, to buy the shares nobody else would buy in the weakest banks and to take bad loans off their books. The arithmetic explained the urgency. Italian banks carried roughly 360 billion euros of non-performing loans against about 50 billion of capital. Under the bail-in rules Austria had just used, a rescue with public money was no longer available, and Italian bank bonds were held in large part by Italian households.

What it added up to

None of these events on its own was a crisis. The Fed holds closed meetings; presidents and Fed chairs do occasionally talk; Austria’s bad bank had been failing for years; Italy’s bad loans were the worst-kept secret in European finance. What the week showed was how thin the margin had become eight years after the last crisis. Growth in the largest economy was rounding to zero. The largest banks were reporting losses on the loans they had made in the recovery. Europe’s new resolution regime was being tested on its first patient and finding that the patient’s creditors were other banks. And the people with the authority to act were all in the same city, in rooms with the doors shut.

That is the picture worth keeping. It is not that something was hidden in April 2016. It is that everything was in plain sight, and each piece was explained on its own so that nobody had to look at the whole.