The Fed is fighting back. It's been criticized for not supervising Silicon Valley Bank properly, so now it's leaking the news that it did indeed supervise them:
In 2021, a Fed review of the growing bank found serious weaknesses in how it was handling key risks....But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was in a full supervisory review — getting a more careful look — and was ultimately rated deficient for governance and controls. It was placed under a set of restrictions that prevented it from growing through acquisitions. 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.
This raises as many questions as it answers. Bloomberg, which reported this story first, says the Fed initially called out "operations and technology" problems. It didn't point out problems with interest rate risks until late last year.
So I remain puzzled. If the Fed really was up in SVB's grill, how is it that SVB was able to ignore them? And given SVB's capital and leverage positions, what exactly was the Fed worried about? In the end, even with deposits flowing out at a fairly heavy rate, SVB was able to raise $20 billion—which should have been plenty. It's true they had to take a substantial loss on the sale, but not one of life threatening size.
And beyond that, although the Fed is saying that it warned SVB of problems, there's no hint in either of these stories to suggest what the Fed wanted SVB to do about it. Nothing very dramatic, apparently. Just how concerned was the Fed about these problems, really?
More to come, I imagine.
And so the problem was not with the Masters of the Universe and their greed, the problem was not with the regulations, nor with the law, but with the Little People, and so they must be punished.
Sounds like a case of regulatory capture. Not sure exactly what powers the Fed has here, but I'm pretty sure it's more that sending citations on “matters requiring attention” and “matters requiring immediate attention”.
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This is a problem that most banks, interest risk experts, and regulators have.
"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."
if you raise loan rates higher than you raise deposit rates then your income goes up.
Wall Street loves income to go up. Regulators like income to go up. Management REALLY LOVES income to go up.
Basically, interest rate risk models look at two things. 1) Economic Value of Equity "EVE" and 2) Net Interest Margin "NIM"
If your bank borrows short and lends long, like almost all banks, then the two indicators go in different directions. Your investments (including loans) are worth less and decline faster than your liabilities decline reducing the EVE. Your NIM increases because you are able to reprice your loans and investments MORE than you need to increase your deposits. This is almost always true no matter how big your mismatch is between assets maturing and liabilities maturing.
The problem is that Wall Street, GAAP, and regulators don't pay much attention to the decline in the value of the loans or the value of HTM investments.
THIS IS THE MISTAKE that led to the run on the bank.
Just because you don't have to record the losses on your books doesn't make them any less real.
The regulators need to pay more attention to EVE than to book income. Wall Street needs to pay more attention to EVE than book income.
I know I am beating a dead horse but this is the lesson we should have learned from the S&L crisis but we didn't.
While I never worked for a bank, I did work for a large non bank finance company for many years and had been peripherally involved in it's cashflow lending operation. Cashflow lending market was and is enormous, with most large commercial bank involved in origination, syndication, and purchasing syndicated loans from other institutions. All of those loans were floating rate (LIBOR based) revolving credit and term loans, usually 3-5 year terms. These loans would not lose value if interest rates go up.
Well, we sent them a memo and barred them from eating brussel sprouts. And when it was a bit late to do much about it, gave them a stern talking to.
It coudn't possibly have anything to do with the wealthy depositors, like Thiel, could it?
The SVB CEO being a board member of the San Francisco Fed certainly adds a wrinkle as to why the Feds suggestions went unheeded.
Being grilled by the Fed, and receiving suggestions is substantially different than the Fed taking action against SVB. Did the Fed have the regulatory authority to do anything more than what they did? Was SVB in danger of breaching a liquidity requirement, AS DEFINED BY THE EXISTING REGULATION?
Never thought about it before but why are bank CEOs permitted to serve as Class A Fed directors? Isn't this a fairly obvious conflict of interest? (Easy answer I guess is that the Fed itself is structurally corrupt.)
The bank did not have a risk manager for the past 18 months, so even basic protections were not in place. The interest rate risk was immediate and transparent to anyone who took a brief review, but apparently they believed that their discounted bonds would regain their value in the future when rates go down and didn’t see the run coming, which forced them to accept present day value to cover pressure on outflows. I think there is a pretty basic explanation for this, but even ALL other banks who now were in possession of a portfolio of discounted notes, I hope they have more competent risk management than SVB, which is a safe assumption given SVB had little or any
Regulatory agencies necessarily have a range of responses depending on how serious a problem they perceive. It sounds like the Fed perceived SVB's problem to be at a "warning harumph" stage, not serious enough to call for compulsion. Then the run happened.