It's time for some serious geekery. This post will (once again) address the question of whether the 2018 bank deregulation law had any effect on the collapse of Silicon Valley Bank.
Yesterday I looked at SVB's capital ratios and concluded that they were higher than required either with or without the law. If deregulation had never passed and SVB had been more tightly regulated, they still would have passed every test easily.
But David Dayen suggests I look specifically at the Liquidity Coverage Ratio (LCR). What if SVB had been required to meet the LCR requirement for medium-sized banks?
The idea behind LCR is simple: During a period of stress, does a bank have enough liquid assets to cover 30 days of cash outflows? The equation for medium-sized banks is:
My horseback guess puts HQLA at about $40 billion and net cash outflow at $30 billion or so. Luckily, though, we don't have to take my word for it. Bill Nelson of the Bank Policy Institute takes a deeper dive and comes up with this estimate:
- HQLA = $52.8 billion
- Cash outflow = $50.3 billion
Thus, LCR was about 105%, well above the 70% requirement. Hell, it was above the 100% requirement imposed on large banks. So even if the strict old law had been in existence, SVB still would have passed with flying colors.
POSTSCRIPT 1: The primary motivation for regulating LCR is to ensure that banks have a leverage ratio above 3% (minimum Basel III requirement), 5% (Fed requirement for normal banks), or 6% (Fed requirement for big banks). SVB had a leverage ratio of about 8%, well above all of these requirements.
POSTSCRIPT 2: I should note that the Bank Policy Institute has a dog in this fight since it supported the 2018 deregulation. Nonetheless, its estimate of LCR looks reasonable to me. Needless to say, I'm wide open to other estimates if anyone has done them.
There's a short bet somewhere isn't there?
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Okay, once again, I don't get why the Fed, presumably knowing all of this in real time, didn't just give this bank a bunch of money to fund the jittery depositors. Doesn't the Fed do that kind of thing all the time?
I still think Peter Thiel is behind this somehow.
The short-answer is the specific mechanism for Fed was not on hand, they set up something responsive right afterwards.
The general answer is that banks should not assume that they will always be bailed out by the Fed, no matter what they do. The Fed actually has done this anyway, but it is pretended that they don't.
But isn't the idea that some bank runs can be irrational -- not the fault of the bankers -- but nevertheless a danger to the "system" and thus should be countered? In other words, it's not a "bailout" by the Fed, as I understand it, but rather the Fed making sure dollars are available where they are wanted, when they are wanted, so that the system doesn't collapse, which would be bad for us all.
(It's not a "bailout", as I understand it, because the Fed gives money to a bank to give to anxious depositors like Peter Thiel and his disciples, but when things calm down the bank has to pay that money back to the Fed. Am I wrong about all of these assumptions? Hey I'm just a voter who reads the newspaper.)
Speaking of Peter Thiel, he’s very much behind this since the bank run he triggered was an astonishing $42 billion. An amount which SVB could never have paid on demand. The question in my mind is whether he just panicked or he’s for a short going on SVB.
Sure seems like his animus -- whatever caused it -- is the explanation for the sudden attack on a bank that was vulnerable but not immediately in crisis.
If you follow the very excellent reporting in the FT, one can additionally take away that Thiel was among a small group of VCs, minority who either did not or betrayed an effort that week amongst the Fund Managers to package on their part a rescue line to stabilise. There is a lot of anger reported re Thiel & co fucking the effort over.
The take away is indeed sans the message by Thiel & Co, and with the various efforts includiing the VC groups putting together equity, this might well have been avoided.
Long story short: SVB was fine until Peter Thiel decided to fuck it over.
If we learn from this, future regulations will say that banks can't have more than x% of their money connected to tech bros.
No, if there is a lesson, it is an old one: that any institution that is highly concentrated in its lending to a specific sector is at elevated risk, all the more so if it is also reliant on the same sector on the deposit side.
So everything points to the panicked run by panicked depositors, it sounds like.
Which could put the onus on Slack chats emanating from that conference that's been mentioned, or other email/social media instantaneous comms combined with instant banking (withdraw 80 million with your phone app? do people really do this?). It'd be an O.. Henry kind of ironic ending, done in by the tech they helped birth.
But other angles seem to give glimpses of 800-pound gorillas, don't they, and here (like plenty of other people) I mean Peter Thiel and his withdrawal instructions to his fundees, plus the bank CEO or president's stock sale just before the run started.
No one would ever accuse Thiel of acting in good faith for anyone else's benefit, let alone the community's, so it's fitting and natural that he gets a lot of side-eye here. That stock sale also looks really suspect absent any other information, so the relevant people, and that includes the public, need to know a lot more about that too.
Fundamentally, is this a story of innocents done in by circumstances, or something more sordid? Would probably make a decent movie either way.
It has been reported that the management stock sale was a pre-scheduled automatic one.
The story around Thiel is murky, he certainly sabotaged what might have been a potentially successful route to rescue via VC funds backed investment - something it appears the majority - but not all, notable except Thiel & Co - were working on (Financial Times reporting)
Re the management sale, that would be the principle thing to know, because I seem to remember a requirement for prior notification that applies to company officers in some cases; didn't know whether it would here.
FT reporting isn't directly available to me-- one or two paywalls too far for me, so thanks. Gotta say, Peter Thiel really is a piece of work.
The more I hear the more it is clear that Peter Thiel engineered this. The bank’s finances may have been a bit brittle but they were OK. Other banks are in worse standing. For some reason Thiel got on Slack and told everyone to get their money out and the bank couldn’t stand up under this onslaught.
Peter Thiel pulled out his money before starting the run on the bank. Maybe this was part of a deal with his buddy Leonard Leo. Now you see a ton of attacks on wokeism causing the failure of SVB.
So I'm watching Frontline's: "Age of Easy Money" right now.
I think maybe they need to re-define HQLA.
Why couldn't the Fed fine someone to "buy" SVB? I'd guess many places are seeing a net draw down of funds, and probably are saddled with long term T-bills, a very safe investment, that they'll eventually need to sell at a loss. Taking on another bank with high expected draw down of funds, even prior to the bank run, only means more losses for the acquiring bank.
HQA have liquidity issues, in this case caused by the issuer changing interest rates in the wrong direction. Smacks of unintended consequences.
The problem is that SVB's loan portfolio is complex and opaque. Unlike a bank that has a lot of mortgages on its books, which can be modeled due to the enormous number of mortgages in a database, loans to start-ups are idiosyncratic. Anyone that might buy SVB is going to insist on taking the time to do extensive due diligence on its assets.
It's less that no one was willing to buy SVB and more that no one was willing to buy SVB this weekend.
And notably SVB has lending instruments that are not classic bank investment loans but are really quasi-equity instruments (nothing wrong with that, I use them in financing, BUT they are not the sort of thing that a standard commercial bank analyst sits down and says, okay we know X on this... so even more idiosyncratic than not just mortgages)
SVB is/was a specialist lender, and has a financing portfolio (lending out) that is radically different than your typical commercial bank including financing instruments designed for early stage companies that are really things a normal commercial bank would never ever be able to engage on.
The very business of SVB for a standard high-street commercial bank doing home mortgages is something that under their normal business model they do not do, period.
As such SVB even in the best of times would need a specialist buyer with the time and risk appetite to get itself comfortable with the very specific, idiosyncratic lending focus, early stage comparatively asset-light companies without really substantial capital assets for collateral.
This is not a business anywhere in the world that your typical commercial bank will touch. It is risky in lending, although as SVB showed over decades on its lending side, as Specialist can do a good job at it.
So just saying "Why not find a buyer on Thursday" is naive - it's ignoring SVB really is not a profile for a commercial bank to buy.
They really, really rather needed and need a specialist (like what was apparently being discussed among VCs ex-Thiel & Co prior to collapse) consortium backed by PE or VC equity to buy - VCs are not bankers so not buy and run the bank (not good idea), but to have an equity backing and ownership set with a comfort and understanding (and risk profile to be comfortable with). Given the size of "dry powder" amongst PE funds out there (not all of which by investment policy could look at this, but certainly some) and with a decent backing from Silicon Valley funds, this is a very plausible proposition - as of the 5-8 March timeframe.
Maybe still can be rebooted with Federal backing.
It does highlight that Thiel & Co essentially confirming the emerging run and triggering the rush to exits last Thursday was at best an egregious moral betrayal of his VC peers where there was plausible rescue routes.
Thanks Kevin. Don’t care. Just like how a teenager who successfully petitions his parents for a car, then goes out and runs up a bunch of credit card charges without permission, and then the parents ground him and take away his driving privileges. There may be no nexus between giving him a car and him running up the credit card - you can run up a credit card without leaving home by going on the internet - but I think it’s totally ok to punish the kid anyway by grounding him. And the same with these midsize banks - some of them obviously can’t handle all the freedom they’ve been given so it would be good to ratchet some of that back… even if doing so doesn’t fully prevent them from misbehaving again.
The bank itself isn't getting bailed out. The shareholders got zeroed out. Any bondholders will only receive money that is left over after the deposits have been fulfilled. If refusing to bail out the bank provides any benefit to restraining other regional banks, this event will provide it.
So the assumed cash outflow in their liquidity coverage ratio was $50.3 billion over 30 days, and uninsured depositors tried to withdraw $42 billion on Thursday alone? SVB funded 80 percent of their total assets with uninsured deposits ($152 billion in their domestic offices), and a liquidity stress test assumed that the maximum outflow over a 30-day period would be less than one-third of the amount exposed to loss in the event of a failure?
No bank could withstand that sort of bank run. If the stress test is supposed to approve only banks that can withstand 60% of its deposits over 48 hours (which is the proportion that was requested Thursday and Friday, though not all of them could be honored), then we won't have a banking industry.
Well, we’ll have some sort of banking industry. Led by the likes of Serta and Tempurpedic.
+1
Thiel is smart and he does not panic. And he certainly knows the real difference of between long term government bonds and the liquidity of those high quality assets when there is an interest squeeze to be arbitraged. Soros did something similar with the British Pound IIRC. It's certain that a Thiel proxy took the short on advice from the master. Proving it is another matter. But Thiel does not panic.
Pretty sure everyone here acknowledges that Thiel is intelligent, and not inclined to panic. But most of us have observed that Thiel is utterly self-centered. In all situations he does exactly what is best for himself and does not give a moment's thought to how his actions affect anyone else.
Why did he tell his colleagues to pull out of SVB? My guess is, he had a grudge against one of the executives there. (After all, this is the guy who destroyed Gawker just because they outed him.) The fact that his vengeance had a real chance of nuking the global banking system does not give him pause, because Thiel is what you get when you combine a high IQ with Trumpian levels of vindictiveness.
It's not about liquidity, it's about stress testing. SVB didn't diversify their assets and they chose to put a big lot of it into a poor place (low-yield bonds that don't mature for a long time, vs. their more-volatile-than-most customer base). It reads like gigantic fuckup mismanagement.
No bank run "has to happen."
Another factor in this being a story is it seems that SVB was used in a rather stupid way by lots of depositors who put all or most of their eggs in the SVB basket.
I’m curious as to how much money the bank lost with the government bonds- what was the present value of those holdings. I’m wondering if the HQLA are factoring an old number for those or a newer lower number (I bet we know the answer to that). Thiel may have reasonably reacted when he saw how big of a hit the bank was taking (one may looking at a loss of tens of billions of dollars since rates have gone up four-fold- meaning one needs 20 billion today to get the same as 80 billion about a year ago- which results on a dead weight of sixty billion and which needs to be supported -the net cash flow loss alone in this example is 3 billion a year plus it freezes the use of all that money).
They did not lose money on the Bonds except those that they had to sell (to try to stem the deposit panic).
Actually held to maturity, the losses are theoretical - that is if you do not sell them you not have the loss at all.
Unrealised losses are an indication of the risk in the face of having to do emergency sale of the assets in order to generate cash. If one does not have to do emergency sale, the bonds or treasuries simply are paying you their coupon and generating some modest cash.
Martin Wolf last night on FT has an accessible chart here (the chart title says it all "The impact of unrealised losses on Silicon Valley Bank was exceptionally large" (the chart visually is more than clear, its not a small degree)
https://www.ft.com/content/09bfbb8d-22f5-4c70-9d85-2df7ed5c516e
People are simply not understanding the difference between realised and unrealised and jumping to the wrong conclusions.
Thank you for your explanations, they've been helpful to me - I understood some of what was going on before, but with you explaining just a piece here and there, I now understand more.
It certainly defies belief that an organization who spent a great deal of time and effort to avoid specific regulatory requirements would have passed those reporting requirements with flying colors.
Thats not how these things work.
We can be absolutely certain to see a full court press by the anti-regulation groups who will go to great lengths to assure us that the regulations designed to identify these risks wouldnt have helped.
As I have pointed out before the two main reasons SVB failed were:
Reason 1: A run on deposits
Reason 2: See Reason 1
There is no way around the fact that ANY, or should I say EVERY, bank will fail if it loses as many deposits as SVB did. $42 billion on Thursday and probably another $40-$60 billion on Friday.
So the MAIN issue has to be: How do we prevent bank runs?
I ain't got an answer for that one.
The horrible waves of bank runs after 1929 were ended by the establishment of deposit insurance in 1933. The run on SVB occurred because at least 90% of deposits were not covered by insurance - effectively insurance did not apply to them.
One solution would be to extend insurance, but make the premiums that banks pay strongly dependent on how much of deposits are over some limit, which would be based on liquidity and not just arbitrary. The liquidity criteria would include the possibility of a Fed rate hike, which apparently Dodd-Frank does not do. Banks probably should pay less interest on deposits over the limit, rather than more.
Banks must make long-term loans or buy long-term bonds - it's what they do. In the QE programs since 2008 the Fed bought over $7 trillion in other than short-term bonds from banks, so yes, banks have long-term bonds. The fact that these would be devalued by Fed raises apparently did not occur to the Maestros or the legislators who passed Dodd-Frank.
Or another thing that could be done is to base the stringency of regulations, and whether a detailed living will must be provided, at least partly on the amount of uninsured deposits. Anyway just saying that Dodd-Frank, with or without the 2018 revision, is all that is needed is not acceptable.
If bank runs start to become problematic, make them superfluous by having the government run a plain vanilla bank for individuals and businesses who need basic deposit and payment services.
No absolute way to prevent bank runs but not having so many of your depositors in one sector would greatly diminish the risk.
Steve
I'm not sure why you're highlighting liquidity as a standalone metric. What matters is whether 2018 bank deregulation would have mandated a stress test which would have flagged a problem with SVBs risk profile, particularly in the case of interest rate increases due to their asset allocation. Whether they would have been OK on one particular metric (liquidity) doesn't matter if they would have failed overall. And from what I've read that sort of interest rate change modelling is a basic part of any stress test.
Can you give a reference to this interest-rate modelling in Dodd-Frank or anywhere else? If it exists, why didn't it cause the Fed or FDIC to raise alarms in the case of SVB?
I can't recall where i read it, but according to the article the reason it did not cause alarm bells is that the 2018 deregulation bill exempted SVB and other "mid-size" banks from that type of stress test. I'll try to find the article when i have some more time and post a link here later if i locate it.
If anyone else can confirm or deny, and provide a reference i'd appreciate it. The details on this have been pretty sparse thus far.
I didn't find the article i was referring to but this Fed doc seems to confirm their stress tests include anlysis interest rate change impacts.
https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20220210a1.pdf
The severely adverse scenario describes a hypothetical set of conditions designed to assess the
strength and resilience of banking organizations in an adverse economic environment. The baseline scenario follows a profile similar to average projections from a survey of economic forecasters. These scenarios are not Federal Reserve forecasts.4 Scenario timing and variables: The scenarios start in the first quarter of 2022 and extend through
the first quarter of 2025. Each scenario includes 28 variables; this set of variables is the same
as the set provided in last year’s supervisory scenarios. The variables describing economic developments within the United States include: • Six measures of economic activity and prices: quarterly percent changes (at an annual rate) in
real and nominal gross domestic product (GDP), real and nominal disposable personal income,
the Consumer Price Index for all urban consumers (CPI), and the level of the unemployment rate
of the civilian non-institutional population aged 16 years and over. • Four aggregate measures of asset prices or financial conditions: indexes of house prices,
commercial real estate prices, equity prices, and stock market volatility. • Six measures of interest rates: the rate on 3-month Treasury securities; the yield on 5-year
Treasury securities; the yield on 10-year Treasury securities; the yield on 10-year BBB-rated corporate securities; the interest rate associated with conforming, conventional, 30-year fixed-rate
mortgages; and the prime rate.
In further reading the stress test doc (and maybe i'm reading it incorrectly) it doesn't seem to explicitly include a scenario of long term treasury rates rising, but that really doesn't make sense to me so i hope i'm misunderstanding it.
oddly, looks like the fed stress test scenario for 10 year treasury rate increase models it going to 2.5%, while in reality the Fed took direct action to drive that rate far beyond that level.
TPM puts together some interesting points:
https://talkingpointsmemo.com/news/four-big-questions-framing-the-svb-blowup
1. Wall Street Journal reports SVB losing money because of interest rate hikes in Nov, 2022. In other words it was being shorted then and people knew there could be trouble.
2. Lack of stress tests and requirement of a "living will", i.e. how to dissolve your bank. So not just liquidity requirements.
3. SVB has a huge run up in deposits--and wasn't really able to handle that. That was rather unique, as well as the rapid draw down of deposits by customers prior to the bank run.
I've read elsewhere the that management was not bad nor malign--just rather conservative and perhaps naive. Meeting official liquidity requirements was not an issue. Dealing with stress tests and/or short sellers--not really addressed?
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