SVB Post Mortem

What caused the Silicon Valley Bank collapse? If you were expecting a detailed account of the trees, you won’t find it here. That’s been covered well elsewhere. We’re more interested in the forest … especially the parts not so well covered elsewhere.

Let’s start with head Fed regulator Michael Barr’s testimony before Congress. Chief among Mr Barr’s concerns was the lack of a “chief risk officer” at the bank. Aha! It just didn’t have the right organizational chart. Mr Barr’s obsession with bureaucracy is stupefying. Risk is a specialty to be considered only by a dedicated department, apart from the real business of making money? Who among us has not been advised that risk management is an integral part of our financial lives? We buy insurance, we diversify our investments. Yet while ordinary people are expected to manage risk, unless it’s part of their title, financial professionals are not?

Coming from a banking regulator, this mind set itself is a problem. Despite supervisors of the bank having highlighted deficiencies as early as November 2021, no action to remedy them was taken. Regardless of one’s view of regulation in general, it has to be acknowledged that there was a quid pro quo … FDIC insurance is extended on the condition that the insured institutions follow specified rules.

Just as concerning, but little remarked on, is the Federal Reserve’s action on March 26, 2020, when it reduced reserve requirements for depository institutions to zero:

“As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.”

Reserve Requirements

Like the slashing of its Fed funds target rate to zero and the initiation of trillions worth of QE, this was clearly an emergency step calculated to address the deflationary crash in the wake of the coronavirus crisis. Yet it was never revisited once the crisis had passed. Regulators’ efforts to pass the buck provide little encouragement that the core problems will be addressed any time soon.

Barr apparently would prefer to call the banking system “strong and resilient” than actually do anything to make it so.

16 thoughts on “SVB Post Mortem

  1. jk says:

    i’m wondering about the credit contraction triggered by svb. deposits are leaving bank accounts, esp. in community and regional banks, to go to larger banks and/or cd’s and/or tbills. this will reduce loan availability and contract liquidity. further when the debt ceiling is finally raised the treasury will refill the tga account by roughly 1/2 trillion. if the fed is continuing qt that will further diminish liquidity. so my base case is that we get a recession in 2023H2. what do you think of this scenario, bill?

    1. Bill Terrell says:

      Good question, JK … not sure I have a good answer. In the press conference post the last FOMC decision, Powell said he expected some tightening effect but that he thought the only way to know how much was to wait and see. I commented on this at the time:

      “Powell carefully explained that the recent banking turmoil may spur tighter lending standards and pinch hit for some amount of rate hiking, but that it’s not possible to anticipate by just how much: “We’ll just have to see.””

      If the Chairman says “We’ll just have to see.” I’m not sure I want to second guess that;-)

      At one end of the spectrum, you could make an argument for none. Every dollar taken out of the bank has to go somewhere. If it goes into a money fund, it gets lent somewhere. If it goes into treasuries, it’s a loan to, well, the US Treasury. As an exception, it’s conceivable that at the margin some of it winds up under the mattress. If it gets deposited in another bank, it’s still subject to the usual money multiplier effect. Which is, incidentally, given the above cited zero reserve requirement, literally infinite.

      At the other end of the spectrum, it could be a lot. Will banks be less willing to lend? If so, how much?

      This leads us right back to “We’ll just have to see.”. For now I’m sticking with my financial-conditions-as-real-time-indicator-of-monetary-ease test: If stock prices are going up, money is easy. The response of stock prices to the fresh liquidity due to the Fed’s backstop is a prime example. Hundreds of billions of – let’s call it anti-QT – hit the system, at least temporarily offsetting the ongoing programmatic QT. So at the third end of the spectrum, it could actually amount to an expansion of liquidity. One smart sounding analyst on Bloomberg today even said he thinks the Fed is falling behind the curve again.

      Far as markets go, I can’t get past the yield curve inversion. Especially now that it’s starting to unwind, a more immediate omen of a deflationary spell. I also can’t get past that US equities have fallen so far out of sync with the yield increases seen in virtually every other asset class. Just about every market, from US treasuries to foreign stocks is yielding 3%-4.5, while US stocks remain stuck around 1.5% or so. And the only fast way to get those yields in line with the rest of the world would be for them to go on a 50% off sale. Until at least some re-equilibration occurs I’m sticking with mostly foreign stocks, treasuries and commodities including gold.

      1. Bill Terrell says:

        Update: We’re seeing a lot of news about inflows to money market funds (MMFs). At the risk of oversimplification, this is like a bank but without the FDIC insurance. To the extent it’s just a movement of funds from one lending intermediary to another, there’s no net contraction.

        But it’s a problem for the banks. Many are still paying microscopic yields on savings accounts. A 0.1% rate on a bank account looks really bad in a world where market rates are 3.0%-4.5% or so. Banks have grown used to virtually free money and are loathe to give it up, but something’s gotta give.

        Some of this can come from Certificates of Deposit (CDs), which with their more predictable cash flows are a more reliable source of funding for bank lending. And a rush of money into MMFs could ultimately lead to problems there. Don’t be surprised to hear about MMFs “breaking the buck” in coming quarters.

        FWIW, this is an inherent problem with MMFs. Ultrashort term bond funds – very similar but without the stated (but not assured) fixed share price objective – are a much more robust alternative.

        1. cb says:

          How and why would a rush of money into Money Market Funds lead to “breaking the buck” ?

          1. Bill Terrell says:

            Bubbles burst.

            SVB had a huge rush of money before it collapsed. Over 90% of deposits were over the $250,000 insured limit.

            Money funds broke the buck in 2008 too. Far from a certainty … but any time investors throw huge amounts of money at something there’s an elevated risk of disappointment.

  2. jk says:

    Harald Malmgren
    Loose talk of a coming “credit crunch”, making it sound like a brief event. What is coming is a process of credit contaction spreading step by step from one stressed credit sector to another until credit dries up generally and deflationary asset selloff rolls out… everywhere
    Jonathan Urlich

    #Breaking: Kashkari: “Unclear how much Banking stress will lead to a sustained credit crunch”
    Clear to me #Banks will cut lending…Need more transparency…

    1. Bill Terrell says:

      A rolling “credit crunch” would indeed be dollar-positive asset-price-negative (“deflationary”). And would be perfectly consistent with an unwinding of the yield curve inversion. My reference to the latter may have been hasty though … it’s not clear such a thing is under way.

      There are crosscurrents though. China and Brazil just agreed to abandon the dollar in trade with each other, using their own currencies:

      This trend towards global de-dollarization appears to be picking up steam. This is dollar-negative asset-price-positive (“inflationary”). Although this doesn’t say which asset prices … could be stocks, could be gold. But it’s not good for US assets in general … US stocks and US treasuries could be vulnerable … the Fed may be forced to countenance even higher rates to defend the dollar. Your 6% has not been taken off the radar…

    2. cb says:

      For a “buck break” wouldn’t the required rush be a rush OUT of money market funds?

  3. jk says:

    from the wsj
    No companies with investment-grade credit ratings sold new bonds over the six business days from March 10 through March 17, the first week in March without a new high-grade bond sale since 2013, according to PitchBook LCD. The market for new junk-bond sales has largely stalled this month, and no companies have gone public on the New York Stock Exchange in more than two weeks.

    March is typically busy for new corporate debt financings: Companies look to secure financing before the blackout period between the end of the first quarter and the kickoff of earnings season, when they typically refrain from bond sales. Lately, a lack of investor confidence and wild swings in the Treasurys market have kept companies on the sidelines.

    Those with the highest ratings have sold $59.9 billion in new bonds this month, compared with March’s five-year average of $179 billion. The riskier corporations that borrow by issuing higher-yielding junk bonds and leveraged loans are finding it even harder to sell new debt. Companies have raised some $5 billion of junk bonds this month versus the five-year average of $24 billion.

    1. Bill Terrell says:

      The pendulum always swings the other way. If the magnitude of the displacement to one side is any indication, this has a ways to go.

      Remember “covenant lite” when investors were so desperate to buy bonds issuers could sell any junk they wanted? And when sovereign bond investors were so desperate they bought trillions worth of negative yielding bonds? Bubbles lead to busts. Wild parties lead to hangovers.

      Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.

      Charles MacKay, Extraordinary Popular Delusions and the Madness of Crowds

  4. jk says:

    Credit Crunches and the Great Stagflation
    We show that severe credit crunches in the banking system contributed to the
    Great Stagflation of the 1970s. The credit crunches were due to Fed tightening in the
    presence of a large financial friction: Regulation Q, a banking law that capped deposit
    rates. Reg Q became binding whenever the Fed raised rates, leading to large outflows
    of deposits and a contraction in bank lending – a credit crunch. Since firms need
    credit to produce, the credit crunches acted as negative supply shocks, forcing firms
    to raise prices and cut output (stagflation). We find that the Reg Q credit crunches
    align closely with the stagflation cycles in the time series: when Reg Q binds, deposits
    flow out and bank loan supply shrinks, firms’ order backlogs increase, prices rise and
    output falls. To test the hypothesis that the Reg Q credit crunches led to stagflation,
    we compare industries based on their dependence on external financing. We find that
    during the credit crunches finance dependent industries raise prices and shrink output relative to other industries. We find the same result for industries located in areas
    where banks are more exposed to Reg Q, especially if these industries are finance dependent. Our findings imply that when raising rates cuts off credit to firms, monetary
    policy affects aggregate supply and not just demand.

  5. cb says:

    Two questions:
    1. Can an individual bank create new dollars?
    2. Can a money market fund create new dollars?

    1. Bill Terrell says:

      Banks create money through the operation of the fractional reserve model. Now effectively a zero reserve model, as cited in the article.

      To make this concrete, let’s say someone lends you $1000 on the condition they can have it back at any time on a moment’s notice. Then you lend that money to a third party which promises to repay it in one year. As long as the first party doesn’t ask for their money within a year, it works, but you’re in deep doo-doo if they do. This could get you in trouble with the law … unless you have a banking license.

      The party that lent you the money never gave up his claim on it, so effectively still “has” $1000. But the party you lent it to has use of it anyway, and also “has” $1000. Presto $1000 has become $2000.

      You can work out the implications of this for yourself. But it should be obvious that banking crises are the result of a fundamentally flawed model.

    1. Bill Terrell says:

      I don’t think so, but I’m not an expert on MMF plumbing. A money market fund is really just a type of mutual fund which invests in very short term debt instruments and has a stated objective of maintaining – but doesn’t guarantee – a stable $1.00 share price.