WHAT LURKS BENEATH — Seven days ago, most of the political world had never heard of Silicon Valley Bank. Most American business owners hadn’t pondered whether cash sitting idle in their bank accounts would be safe. Few elected officials had devoted even a moment to worrying about a new banking crisis. And investors were still scratching their heads over why the fastest hiking of interest rates in recent history — courtesy of the Federal Reserve and its war on persistently high inflation — had failed to dent the underlying economy and its red-hot labor market. All of that has changed. The spectacular implosion of the lender exposed vulnerabilities lurking beneath the U.S. financial system. It also put down a marker to gauge whether a long-predicted recession is finally on its way. What’s next? Here are three things to watch. 1. More regulatory scrutiny — and risk aversion Some regulators have egg on their face after the SVB debacle — amid questions about whether they should have seen it coming. The rest want to avoid the same mistake on their watch. Every responsible bank supervisor in America is spending their week scrutinizing the institutions they oversee to ensure they don’t become part of the falling dominoes. Lawmakers will hold hearings and bleary-eyed government officials will promise to get tougher in their roles after quietly executing a sweeping rescue with almost no public debate. All of that means bankers themselves — particularly at firms watching their deposits flee to bigger, too-big-to-fail competitors — will start a retreat. They’ll rein in lending bit by bit, either to correct their self-made risks or guard against more aggressive oversight. The consequences of a credit crunch could take months to show up in real economic data. But we can be sure it’s now underway. Less available credit in the economy will translate into slower investment among small and medium businesses. Roller-coaster moves in stock and bond markets — some short-term government debt this week took its largest swings since the 1987 stock market crash — will spook some larger businesses and a wider swath of investors, too. Ultimately it’ll all translate into less spending. 2. Soft landing? Hard landing? The debate ends in 2023. There’s an old adage in economics: Expansions don’t die of old age. They get murdered, usually by the Fed — to kill inflation. The past six months have been consumed by a debate about how the underlying economy would react to a pummeling by the Fed. Will it be a “soft landing” — little damage from the rate hikes — or a “hard landing” with real pain for American households and businesses? The suspense will end this year. The most peculiar element of the Fed’s rapid rate hikes over the past year has been the result. Consumers and businesses are holding strong in just about every sector. That’s partly due to lingering savings from the surge in government spending in the pandemic (the one that likely worsened the inflation problem). It’s also due to persistently low unemployment and strong wage growth — due in part to many employers’ desires to hoard labor after years of worker shortages. A weaker economy, due to tighter lending and reduced credit, will likely solve the Fed’s inflation problems. 3. What else could go wrong? Beware the dreaded “perfect storm.” A single week of action has managed to merge into one moment the most searing debates across 15 years of economic policy: the role of the government in rescuing private businesses, bank regulation since the 2008 crisis, the perils of low interest rates and high interest rates, the risk of key sectors (like tech and housing) gorging themselves on cheap money, the prospect of worrying about today’s economic problems over tomorrow’s threats. Other potential trouble is always lurking under the surface — whether from the war in Europe or confrontations in Asia, or some other risk few people are imagining today. An economic environment on edge from existing vulnerabilities usually doesn’t react well to new ones. Now, the job for the economy’s overseers is to ensure the bank rescues of March 2023 don’t look like the easy part. Welcome to POLITICO Nightly. Reach out with news, tips and ideas at nightly@politico.com. Or contact tonight’s author at sreddy@politico.com or on Twitter at @Reddy.
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