Treasury Secretary Janet Yellen has been doing her utmost to reassure the public that all is well with the banking system. However, her assurances do not seem to be preventing continued deposit flight from the regional banks. As if to underline this point, over the past week the regional banks resorted to the Federal Reserve’s new backstop facilities to the tune of close to $165 billion.

A principal source of the U.S. regional banks’ difficulties is the large losses that some of them have sustained on their long-dated U.S. Treasury bond holdings. Mistakenly believing that the era of low interest rates would last forever, these banks stretched for yield by lengthening the maturity of their bond holdings. They did so only to find out that the Fed was to increase interest rates at by far the fastest pace in the past 40 years to regain inflation control. Compounding their problems, troubled commercial property loans amount to around 28% of their overall balance sheet.

If there is a silver lining to the banking sector crisis, it is that it will help the Fed in its effort to cool the economy. It will do so by reducing the regional banks’ willingness to extend credit to both households and businesses out of fear that they might be next in line for deposit withdrawals.

[We wouldn’t need to push the Fed to act if the Biden administration adopted supply-side tax and regulatory policies to expand production, especially domestic production. The historic inflationary wave was caused primarily by massively loose monetary policy over the last 15 years, but especially in the pandemic. It was triggered, however, by supply-chain crises and a last flood of money to spark demand. The solution should have been to incentivize production through new tax and regulatory policies, especially in energy production. Instead, the Biden administration has stubbornly clung to its demand-side approach, which left only the Fed to fight inflation. This is the result. — Ed]