Let’s start with the good news. The flashing red light resulting from a speed-of-light run on the US banking system, or what economists broadly refer to as financial contagion, is behind us.
Yet it is too early for policymakers to declare mission accomplished. Instead, red has become a flashing yellow due to the slower-moving economic contagion whose main transmission channel, that of curtailed credit extension to the economy, increases the risk not just of recession but also of stagflation.
Poor risk management and inadequate business diversification were at the root of the bank failures. They were exposed for all to see by two factors: first, a mishandled interest rate cycle that saw the US Federal Reserve start raising rates way too late and then be forced into a highly concentrated set of hikes; and second, as remarked to Congress by vice-chair Michael Barr in an unusual episode of frankness and humility from the current Fed, lapses in supervision and regulation.