You're all probably tired of hearing me natter on about Silicon Valley Bank, but the conventional narrative continues to bug me.
The most persistent part of the narrative is that SVB had a bond portfolio exposed to lots of interest rate risk and they were morons for not hedging this risk. But normally, you hedge interest rate risk only if it's an extraneous factor to your main business and you don't feel like worrying about it. You don't hedge it if it's a deliberate investment strategy. What's the point?
So of course SVB didn't hedge their interest rate risk. If they wanted less exposure to interest rates, they would have put together a different portfolio in the first place.
What's more, they did hedge their short-term interest rate risk in the strongest possible way: by making sure that short-term losses wouldn't land on their books at all. Their $90 billion bond portfolio was deliberately marked as Hold to Maturity, which means that gains and losses only show up when the bonds are redeemed. That's several years away at a minimum.
Basically, SVB was (a) betting that interest rates would be low in five or ten years and (b) not betting at all on interest rates over the next two or three years. That may or may not be the smartest investment strategy, but it's perfectly reasonable.
Within the investor community, SVB's unrealized losses caused a bit of nervousness but not a lot. SVB collapsed not because of that, but because clients pulled out their money en masse. The proximate causes of this were (a) a Moody's downgrade, (b) a massive miscalculation by Goldman Sachs, and (c) a decision by Founders Fund to pull all their companies' money out of SVB. None of this was substantially related to SVB's unrealized losses.
Would it be too paranoid to attribute the shenanigans by Founders Fund as a Thiel move to embarrass the Biden administration? He is evil.
Google paid 99 dollars an hour on the internet. Everything I did was basic Οnline w0rk from comfort at hΟme for 5-7 hours per day that I g0t from this office I f0und over the web and they paid me 100 dollars each hour. For more details
visit this article... https://createmaxwealth.blogspot.com
But isnt the root cause of the 3 listed 'proximate causes' the fact that SVB had large unrealized losses on its balance sheet, putting it in a position of insolvency?
If not, why was the company downgraded? Why did they need to sell assets and reinvest them along with rasing new capital?
This article makes one think that these proximate causes were arbitrary decisions. But we know thats not true, dont we?
We keep looking for an answer other than the blaringly obvious one.
Exactly right. The three "proximate causes" he cites absolutely were substantially related to SVB's unrealized losses, despite his unsupported assertion.
He's right, however, about the bank's strategy of reaching for returns by buying longer-dated bonds. Given that policy, yes it would be pointless to hedge against it. The problem wasn't that they failed to hedge it; it's that it was a stupid strategy.
"... The problem wasn't that they failed to hedge it; it's that it was a stupid strategy."
Yes, the strategy was the type of thing Wall Street calls picking up dimes in front of a bulldozer. That is risking catastrophic losses for modest gains. Not really the sort of thing you want banks doing if they have safer alternatives which SVB did.
Banks need to get higher returns than what they are paying on deposits. The essence of banking is borrowing (i.e. deposits) short term and lending long term. They make their money on that spread. In a situation of deposits pouring in, and few opportunities to make loans in their core business, there aren't a lot of options for a bank to invest that money in a way that allows them to generate profits, and all of them involve taking on significant risk.
SVB's problem wasn't on the investment side. It was on the deposit side. The sheer amount of deposits they were taking in when there weren't good opportunities for them to make loans within their expertise was the fundamental weakness. It was exacerbated by having those deposits highly concentrated in an industry that will pull out of a bank at a moment's notice. No bank, no matter what their investment strategy is, could have survived the run that developed.
"... there aren't a lot of options .."
How about charging negative interest on their deposits that could be withdrawn at any time?
The instant they announced that policy, it would trigger exactly the run that you are claiming you want to avoid.
Seems like people are "that close to getting it." If, as you say and I would agree, banks don't have a lot of options that would allow them to be profitable without occasionally crashing our economy, maybe the whole model of banking needs to be reworked.
That's exactly right. The collapse was caused by a rush to withdraw, but that rush was precipitated by a real problem. SVB was illiquid. It bet the wrong way on interest rates. It had too many of its assets locked into long term bonds that were now worth less than they cost. It tried to raise capital and failed.
If it had timed its bond maturities to meet its predictable cash flow needs, it would not have collapsed. Sure, someone could have tried to spread a rumor or two, but there's nothing like a series of safe bonds with timely due dates to calm investors.
Unlike, let's say First Republic, SVB had a lot of large depositors, so it faced a different statistical risk. If a bank mainly has small 100% insured depositors, it can afford to take a few risks. If a bank has a handful of large uninsured depositors, it really can't.
We should really stop treating banking like its in the private sector. It's a government service like having an army or a road system. They should either make bank executives accept a civil service salary or let civil servants run the banks. The current situation is just welfare with expensive welfare babies.
Actually, based on an earlier article Kevin wrote, one of the bank tests that looks at the ratio of highly liquid assets (HLAs) to monthly cash outflows (withdrawals) would not have flagged that as a danger - SVB was funded well over the 70% ratio.
That kind of suggests to me that the stress tests may need some serious adjustment toward the pessimistic side - particularly for institutions like SVB. Note that "monthly cash outflow" term. Based on the numbers Kevin showed in his article, the run on Thursday was around 80% of expected MONTHLY outflow. I don't think any bank could survive that easily.
What it suggests is that SVB was a very unusual bank that the stress tests are poorly designed to model.
I believe that the withdrawal rate for the stress tests is a range and its up to the regulators to choose the 'correct' withdrawal rate.
Its impossible to say that SVB would have passed the stress test because we dont know what the selected withdrawal rate would have been.
Its certainly possible to have avoided that massive single day withdrawal if they had improved their balance sheet in 2022.
I dunno much about finance, I'll admit that straight up. But isn't it true that at least some people saying that when all is said and done SVB might not have been insolvent after all? Since all the right people (including Krugman, my guiding star) say that they kept with the same investiment strategy despite strong signals for a long time to do otherwise, I take that as an excellent assumption, of course. But 'chain of circumstances' arguments tend to leave me a little queasy.
This is true.
Their investments would not lose any value if they could avoid having to sell them before the maturity/end date.
Its safe to say that they were insolvent right now and would likely be insolvent for awhile into the future...but if they could avoid having to pay back customer deposits for a year or two or until interest rates fell, they would be okay.
Isn't a role of a bank to allow depositors to withdraw thier deposits when they chose? The depositors accept a low to zero return on thier money because it is supposed to be available whenever they need it, not when it is convenient for the bank's investment strategy.
Yes, banks must allow depositors to withdraw their money from savings and checking accounts (as opposed to CDs) at any time. However, the entire banking system is built upon the assumption that your customers won't all want all of their money at the same time.
By the standard you are implicitly setting up, the banking industry couldn't exist.
"By the standard you are implicitly setting up, the banking industry couldn't exist."
Why not? The government can provide emergency loans against good collateral to cover runs against a fundamentally sound bank. But SVB wasn't fundamentally sound and ran out of good collateral.
So from this I take it thatif SVB had been able to cover projected present losses by trading against the future value of its assets they would still be in business today? You see where I'm going with this.
How would that have worked?
How would they get $20 Billion today by pledging to hand over $20 Billion in 5 years?
"...by making sure that short-term losses wouldn't land on their books at all. .."
This is silly. Keeping losses off your books doesn't mean they don't exist. Arranging to keep losses off your books is in no way a hedge. And the losses were not off the books entirely, they were disclosed in a footnote. Some people actually read the footnote and noticed the bank was insolvent. Which meant it was not a safe place to keep uninsured deposits. So people sensibly started withdrawing their uninsured deposits. So the bank failed.
Back in the 1960s, there was a guide to reading financial statements. They said to ALWAYS read the footnotes. The rest was just numbers and boilerplate.
Kevin keeps fooling around with proximate causes, but if a bank has over 90% uninsured deposits, it will be liable to a bank run if there is any uncertainty about its ability to repay all deposits on demand, regardless of what it has on its books. The uninsured deposits were the most ultimate cause. The next ultimate cause was the raise in rates by the Fed, which devalued assets and created uncertainty about the ability to repay deposits. Most banks make money with long-term loans or bonds, but presumably they do not have that high a ratio of uninsured deposits (does anybody have any data on this?).
If the Maestros are going to suddenly raise interest rates, shouldn't they plan for how this will affect banks, regardless of what Congress has done in terms of regulations? Dean Baker (Beat the Press Blog) today affirms that stress tests did not consider this possibility. If the Fed doesn't know what the consequences of its actions will be, maybe it should just leave things alone. Kevin and some economists (Krugman) have made a good case that inflation is already over (that is what the data are showing now) before Fed raises could have had a constructive effect (if it has ever done so - it did not prevent inflation in the 70's), but if they keep raising there will certainly be more harmful effects.
It has been proven over and over that the safety of the financial system cannot be left up to individual operators - they will risk their own collapse in order to make maximum profits. So trying to pin the blame on SVB executives is not very constructive. It is very rare that there are prosecutions for putting the system in jeopardy - none after 2008 - and the possibility of this is not likely to be a deterrent.
This from NYT today: "Before Collapse of Silicon Valley Bank, the Fed Spotted Big Problems.
The bank was using an incorrect model as it assessed its own risks amid rising interest rates, and spent much of 2022 under a supervisory review."
https://www.nytimes.com/2023/03/19/business/economy/fed-silicon-valley-bank.html
It is critical for everyone (this includes regulators, wall street quants, and the people who make the accounting rules) to remember, that GAAP is NOT reality.
If you buy a bond at 100 and the price drops to 70 then you have a bond that is worth 70. Now, it is an unrealized loss so you won't get a tax deduction until you sell it but the bond IS WORTH 70. It doesn't matter if you classify it as part of your trading account, available for sale, or held to maturity.
Stupid accounting rules allow you to PRETEND that it is still worth 100 but you know, I know, the regulators know, Wall Street knows, that it is worth 70. I find it amazing that people will make financial decisions on information THEY KNOW IS WRONG.
One of the main reasons for this charade is that it is hard to determine the fair value of everything. Maybe the investment bond went down in value but their debt went down even more.
When it comes to a bank deposit, you have a bunch of questions that are hard to answer. How long with the money stay in a 0% checking account? How long will you be able to continue to pay 0% or will you increase the rate to 3% or 4%?
With mortgages, it is actually pretty easy because the experts have a pretty good idea how fast you will pay off your 3% mortgage and how much faster your neighbor will pay off his 4% mortgage.
So FASB basically throws up its hands and says since it is impossible to mark everything to market then they won't bother to mark ANYTHING to fair value.
But just because accountants all agree to current accounting standards where you can pretent most investments don't have to lose value and most loans never have to be marked to market doesn't make it reality.
Yes, it does make it reality in a certain sense because Wall Street will love you if you increase book earnings (even if the reality is you lost money) and the regulators will like it when you show a healthy capital ratio even if we all know you don't have a 12% ratio but you have a 2% ratio.
My solution would be for Wall Street Analysts, especially bond rating agencies, to be required to look at as much fair value accounting as possible. Yes, as I write that, I know it is not practical either.
The value of a long-term bond depends on when you sell it. If the deposits had all been insured there would have no (potential) run and no need for SVB to cash out its holdings at a loss. As Kevin said in an early post, eventually rates might go down again (although not likely to the record-low 2020 levels) and there would be little loss on sale.
If all deposits had been fully insured, there would have been no practical need for mark-to-market accounting. The Maestros apparently took no account of the danger of the their rate-raising
And at maturity, the gov't would pay out the full amount.
Banks can't effectively operate if they lose the public's trust in their financial health and stability. The deposit side risk of SVB was far higher than most banks given the industry concentration, huge deposit sizes, and +95% not FDIC covered.
Notwithstanding book accounting bull shit, or that long T bonds are safe from default (until the MAGA GOP fucks that up), $90B of their assets were underwater, effectively wiping out their equity. The risk to huge uninsured depositors was substantial, and a bank run was almost unavoidable.
If SVB wasn't so greedy or so stupid, and invested the enormous inflow of Tech startup funds in short T bills, high grade CP, or other floating rate instruments, they would likely still be solvent today.
It's not as if the Fed's actions were sudden or unexpected. Anyone would have had plenty of time to react. In fact, pretty nearly everybody, except SVB, did react. ("React" here does not imply 100% success by any objective or subjective metric.)
Which banks reacted and how did they react? If they didn't have 90% uninsured deposits what did they have to do? Maybe some banks still have high ratios and are still in danger.
The people running SVB were not villains T-bills are considered safe bets and are very liquid. But their strategy failed in this situation. People were drawing down funds faster than anticipated and new business dried up as VC dried up. And interest rates put their long term assets under water. Barring the bank run, they'd be losing a few billion every quarter until interest rates turned around--very bad for investors and stock value. Probably survivable--unless larger percentage of deposits are not insured. Ok, some of their moves just before the bank run were questionable--and need to be looked into.
As for hedging--everything was in a bit of a bubble. Yes, they were notified by the Fed that their balance sheet left them exposed--but that was late last year when attempts to fix it, i.e. sell their t-bills and incur large losses, would be bad.
The gamble was probably more along the lines that the Fed would not have kept raising rates for as long ans as much has they have done. The Fed can stay crazy longer than you can stay solvent. Also, just because I don't believe the bank executives were evil doesn't mean I think they were competent in this situation.
"The people running SVB were not villains T-bills are considered safe bets and are very liquid. .."
T bills are safe, SVB got in trouble with T notes and T bonds are longer term and which lose more value when interest rates go up.
I am by no means knowledgeable about the intricacies of SVB's collapse but in our constant attempt to determine why it happened to a bank that passed ALL the stress tests - could the suddeness of the collapse give us the answe?
During the great depression banks run happened over a period from 1931 to 1933. this run happened over the span of 48 hours. So, Theil gets on the 'net, goes into his little group of mega-wealthy compatriots and suggests,or, outright tells them to withdraw their funds from SVB. Voila instant bank collapse. If Theil says nothing the bank gets a minor down grade from Moodys and everyone yawns.
A poster here commented that we are looking at a meme induced bank run. (I apologize for not remembering who exactly posted that comment). this shows BOTH the power of the internet/social media - but it also shows what could happen when you combine THAT power with some dis-information or a personal vendetta.
Did Theil just weaponize the social media platform he used?
At this time, there’s simply no way to know what was going on with Thiel and why he triggered this bank run and financial crisis. The most charitable explanation is that he and his “founders” learned about the various problems at SVB, knew that they had truly immense amounts of uninsured deposits and that they worked themselves up into a lather, panicked, and the rest is history.
Alternately, it’s also possible that Thiel himself had already gotten his money out and was now short the bank stock and maybe also short First Republic. Or maybe he was feeling particularly malevolent and thought he’d see if he could crash the banking system.
Or maybe he was feeling particularly malevolent and thought he’d see if he could crash the banking system.
Mitch
But why? This only hurt very wealthy people and only "few" institutions. Anyone with under $250K is insured under FDIC over $250k you're out of luck. And most banking institutions don't do what SVB did.
I am beginning to wonder if these big businesses will begin to favor some form of muzzling social media against this sort of thing? Kudlow has always been against shorting stocks ( in addition to being against day trading). I wonder if a republican congress would listen to him?
"...they worked themselves up into a lather, panicked, and the rest is history."
What are you supposed to do when you realize you are in extreme danger? Taking quick action to move yourself to safety seems like a good idea.
Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose. It became clear to the Fed that the firm was using bad models to determine how its business would fare as the central bank raised rates: Its leaders were assuming that higher interest revenue would substantially help their financial situation as rates went up, but that was out of step with reality.
https://www.nytimes.com/2023/03/19/business/economy/fed-silicon-valley-bank.html
“What's more, they did hedge their short-term interest rate risk in the strongest possible way: by making sure that short-term losses wouldn't land on their books at all. Their $90 billion bond portfolio was deliberately marked as Hold to Maturity, which means that gains and losses only show up when the bonds are redeemed. That's several years away at a minimum.”
This isn’t *hedging* their risk; it’s *hiding* their risk. All hold-to-maturity (HTM) means is that you don’t intend to sell the security, so you don’t have to account for its market price; you can continue to account for it based on the yield at which you purchased it at. But HTM isn’t a hedge, it’s an accounting methodology. If you end up selling the security at a loss before maturity, the loss is real! You can just ignore it until you sell.
So, yeah, they were “hedged” as long as they never had to sell their long-dated bond portfolio. This is not actually a hedge.
And by the way, what do you mean when you say “redeemed”? Do you mean get their principal back at maturity? Because if so, there wouldn’t be any gains or losses at all - the boom value would equal the final coupon plus the principal, which is exactly what they’d receive.
“Within the investor community, SVB's unrealized losses caused a bit of nervousness but not a lot. SVB collapsed not because of that, but because clients pulled out their money en masse. The proximate causes of this were (a) a Moody's downgrade…”
But wasn’t the Moody’s downgrade due to their poor mark-to-market (MTM) capitalization?!??! That was the underlying cause! Yes, Thiel’s bank run was the actual precipitating event, but it wouldn’t have been as much of a problem if they weren’t MTM underwater, and Thiel may not have caused the run if the bank weren’t already in trouble.
There may be something else going on too, but the big interest rate bets (combined with significant sector exposure to an interest-rate sensitive customer base) were absolutely a huge part of what happened.