When the tide goes out, you find out who’s been swimming naked.
Silicon Valley Bank has collapsed and been taken into receivership by the Federal Deposit Insurance Corporation. This second biggest bank failure in American history comes after the catastrophic implosion of FTX in November. These events recall the storied failures of Bear Stearns and Lehman Brothers in 2008. The geographic shift of the epicenter from Wall Street to Silicon Valley reflects a change in the locus of the most excessive leverage and speculation.
The quake is however felt around the world. Stocks sold off sharply, while bonds (eg Treasuries) had a smashing rally. In a dramatic demonstration that the bond market, not the central banks, is really in charge, a global rate cut has already taken place. Free of bureaucratic constraints and meeting calendars, the bond market slashed rates … not next quarter, not next month, not even tomorrow, but right now.
What next? We’ve long known that something like this was hiding beneath the facade of market calm. Years of central bank rate repression encouraged the buildup of leverage. Asset prices inflated, followed by consumer prices. Having failed to acknowledge inflation until forced to do so by its arrival in consumer prices, central banks, again led by the bond market, hiked rates. We also recognized that rates would rise until something breaks. Things are breaking.
Stock prices are still inflated, and that fact alone is enough to justify declines. All that’s been missing from this bubble is the pin to burst it. So it’s unlikely this selloff marks a bottom. This very well could be the kickoff to the second half of the bear market that began in November 2021.
The first half wasn’t a straight line down and the second half won’t be either. When it’s too obvious stocks are headed down shorts build up, creating the kindling for rallies. On a very short term basis, stocks became oversold today and Financology took advantage of the opportunity to narrow its bond:stock over:under-weight a bit, but is under no impression that there’s not considerably more downside ahead. The good news for the economy is that it will finally slay the consumer inflation dragon. The good news for investors is that it should once again bring stock prices into a range where they offer prospective returns commensurate with their risks. Meanwhile their bond allocations can earn both fat yields and likely capital appreciation.
12 thoughts on “Bank Failure”
Thanks Rick … your views are welcome. And yes, maybe I am too optimistic … I’m optimistic that the stock market will crash and offer decent value again;-)
From what I have seen so far, Silicon Valley Bank did not fail due to fraud or too much leverage, which was the problem in the 2008 crash. Instead, Silicon Valley Bank’s problem was one of duration mismatch. They had foolishly put a tremendous amount of deposits into U.S. Treasuries and agency debt, all of which is guaranteed by the federal government. How much the depositors get back is going to depend on when in the bond super bubble Silicon Valley Bank bought the bonds and the maturations.
For maturations of under 5 years, I suspect the depositors will be made whole. At 10 years, unless the bank bought at the tippy-top of the bond bubble, I suspect the depositors will be made whole. As far as I can tell, the vast majority of assets of the bank are all high-quality (government backed).
Less than 2% of assets were in venture capital or private equity investments, which may have included direct or indirect investments in cryptocurrencies.
Thanks Milton. You are correct that SVB over invested in long term Treasuries … a duration mismatch that heavily contributed to its downfall. My bigger picture view nevertheless is valid as well. SVB’s failure was due to the bubble the Fed blew when it went off the rails back in 2020. It was flooded with fast money; a fertile environment for mistakes. Take a look at a five year chart of its stock .. a picture worth a thousand words.
There was leverage too. Had the treasuries been owned on an unleveraged basis they could not have blown up the bank. They were bought with borrowed money. Deposits are liabilities and fractional reserve banking is inherently leveraged.
If it hadn’t been SVB it would have been somebody else. And it was … viz FTX. There is never just one cockroach!
Perhaps I misunderstand the term leverage when it comes to running a bank since, even without fractional reserve lending, it’s understood that practically every asset in a bank is funded from a deposit. I found it strange that Silicon Valley Bank seemed to take deposits and largely used those deposits to buy bonds instead of lending it out (which, with fractional reserve banking, does result in leverage.) As far as I know, for every $1 of deposits, they bought at most $1 worth of bonds; I understood leverage to mean that, if they engaged in it grossly, for every $1 of deposits, they would be buy $2, $3, $5, or $10 of bonds.
SVB didn’t need leverage to blow up thanks to the Federal Reserve’s stupidity and incompetence. [I am one of those people who felt that the Federal Reserve *never* should have engaged in even one dollar of quantitative easing. As I predicted over a decade ago, QE can never end without negative economic consequences. I said on iTulip a wealth “effect” would give rise to a poverty reality.] If SVB happened to buy a lot of 10-year Treasury bonds at the absolute top in Q2 2020, they are looking at about a 20% loss. Tucker Carlson ripped on SVB in a segment where he said something like, “As everybody knows, interest rates do not stay at [an artificial, Federal Reserve manipulated] zero forever.” Once interest rates came off the zero bound, bond holders who bought at the top had a mark to market loss.
Get a bank run in those conditions–which is what happened to SVB when some venture capital firms told their portfolio companies to withdraw their funds; i.e., “panic first”–and the bank goes bust.
I figured something bad eventually would happen with the decade-plus of incompetent monetary policy. I just didn’t think it would be a large bank going bust because it behaved so unbelievably stupidly. This kind of failure easily could have been avoided by someone with a freshman-level education in accounting or finance.
MK: “I said on iTulip a wealth “effect” would give rise to a poverty reality.”
Ha! You betcha. Personally I’m not as bothered by QE (provided it’s confined to Treasuries and gold) as by interest rate repression, but the Fed has used both to make a mess. We could criticize on multiple levels (and have), going at least as far back as Greenspan, and even to the central banking model itself. The current crisis is IMO mostly the responsibility of the Bernanke and Yellen Feds. Bernanke left the ugly legacy of the 2% “inflation target”. Even assuming the post GFC policies were supported though, Yellen failed to back off them once the crisis was clearly over, circa 2013. Had policy been normalized then it would still not have been too late to avoid blowing yet another bubble and inflicting deep economic damage. Yellen even set targets for beginning normalization, yet when they were reached, simply moved the goalposts.
Powell then compounded these errors with the 2020 insanity of promising ZIRP forever and printing by the trillions. Then once again failing to back off the monetary rocket fuel once the early 2020 deflationary crash was firmly in the rear view mirror. I give him good marks though for admitting the Fed erred and for connecting monetary policy with financial conditions in 2022.
He can still rescue his legacy with how he handles the fallout from current policy. At some point the inflation battle will have been at least temporarily won and the Fed will ease again. The test will be does it back off when the crisis is past? Or does it repeat past errors by inflating another bubble?
MK: “Perhaps I misunderstand the term leverage when it comes to running a bank since, even without fractional reserve lending, it’s understood that practically every asset in a bank is funded from a deposit. I found it strange that Silicon Valley Bank seemed to take deposits and largely used those deposits to buy bonds instead of lending it out (which, with fractional reserve banking, does result in leverage.) As far as I know, for every $1 of deposits, they bought at most $1 worth of bonds; I understood leverage to mean that, if they engaged in it grossly, for every $1 of deposits, they would be buy $2, $3, $5, or $10 of bonds.”
I could be using the term in an unconventional way. The bottom line is that if you can’t go bankrupt without using borrowed money. If you buy an asset and it falls in value, the value of you portfolio declines. Heck, I have a sizable position in treasuries myself. But if you use someone else’s money, and they expect it back, you can get in trouble fast.
Fractional reserve banking is when the bank only holds a fraction of deposits on hand, lending the rest of them out. That includes buying Treasury bonds … lending to the federal government.
If the bank holds all deposits on hand, it can’t get in trouble. All the depositors want their money back at once? No problem. Of course it’s much more profitable to lend them out, so banks lend them out. They accept risk when they do, though, as dramatically illustrated by SVB.
It’s still possible for banks to lend without engaging in fractional reserve. Money that has been lent to the bank for a specified time period, say, via a five year CD, can be lent out for shorter periods without doing anything fundamentally sketchy. But not demand deposits, which are by definition callable by the depositor on demand.
Here’s an article from the Financial Times that explains how the regulations that didn’t apply to Silicon Valley Bank caused the bank to come agutter. I am linking to a Twitter tweet because clicking through to the FT will allow people to read the article without having a subscription. 🙂
An account on Twitter (Raging Capital Ventures) foresaw the Silicon Valley Bank bust on January 18, 2023. They totally nailed it.
“The bank basically increased its security portfolio by 700% at a generational TOP in the bond market, buying $88 b of mostly 10+ year mortgages with an average yield of just 1.63% at Sept 30th. Oops!”
“$SIVB’s HTM securities had mark-to-market losses as of Q3 of $15.9 b…compared to just $11.5 b of tangible common equity!!”
Good article. We know things have been broken for a long time. Clinton, Greenspan, Bush, Obama, Trump, Biden, Bernake, Geithner, Paulson, Yellen, Powell, etc. —- they all had have their prints all over it. Ruinous to savers, the common American, prudence and good sense.
svb was gaming the system and not bothering to hedge, and thereby saving the cost of, interest rate risk. further there is evidence in earlier filings that they were aware of the availability of interest rate swaps which would have prevented this fiasco. they were greedy and deserve to be wiped out.