Banking isn't as mysterious as we make it out to be.
Adam Kessler at the WSJ sums up Silicon Valley Bank neatly:
Management screwed up interest rates, underestimated customer withdrawals, hired the wrong people, and failed to sell equity. You’re really only allowed one mistake; more proved fatal.
In case you hit the WSJ paywall and can't hop over it by Googling "Who Killed Silicon Valley Bank?"--here's a longer excerpt:
In January 2020, SVB had $55 billion in customer deposits on its balance sheet. By the end of 2022, that number exploded to $186 billion....
... There was no way SVB was going to initiate $131 billion in new loans. So the bank put some of this new capital into higher-yielding long-term government bonds and $80 billion into 10-year mortgage-backed securities paying 1.5% instead of short-term Treasurys paying 0.25%.
... SVB got caught with its pants down as interest rates went up.
Everyone, except SVB management it seems, knew interest rates were heading up. Federal Reserve Chairman Jerome Powell has been shouting this from the mountain tops. Yet SVB froze and kept business as usual, borrowing short-term from depositors and lending long-term, without any interest-rate hedging.
People deposited tons of money in SVB over the federally insured limit. Uninsured deposits should be treated like any other risky investment, which people with more than a quarter of a million dollars they need to park should be considered competent to manage by diversification and otherwise. Naturally, however, the regulatory geniuses responded to SVB's failure by insulating large depositors from any consequences of choosing a risky bank to invest in. Otherwise, wealthy depositors might panic. They might even start evaluating depository banks according to their inherent safety, which would distract everyone from banks' important functions, such as DIE, ESG, and parting bonuses for deserving employees. Why manage risk the old-fashioned way when the regulators will manage it for you by imposing a tax on other banks instead?
I guess the 'management screwed up' view is the happy-face view, because then only a single bank is in danger. The alternative view is that bad Federal policy has created a systemic risk, and this is just the domino numero uno.
ReplyDeletehttps://www.theepochtimes.com/the-collapse-of-svb-portends-real-dangers_5115178.html
To summarize that argument, the massive stimulus of the COVID era was paid to banks who used it to buy 'securities' like collateralized mortgage debt -- sound familiar? -- and mortgage-backed securities. But now the FED is raising interest rates, and that changes the pricing of investments for investors across the world. As the banks have sunk massive amounts into things that are losing value, the banks are going to start failing.
If that view is the accurate one, SVB's bad management decisions are just the reason it fell first. It doesn't mean the risk stops with them.
What is bitcoin, where did $131 billion come from, and why would interest rates be the sole driver of that same $131billion getting withdrawn?
ReplyDeleteThis has similarities to the S&L crisis of the 80s, in that the federal government wants to move in and make sure wealthier people who made mistakes are protected. I think forgiving student loans is an insane strategy, but when we see things like this, we can see how the kid with debts thinks "Where can I get me some of that sweet cover-my-mistakes (and the irresponsibility of the institutions I trusted) action those other guys are getting?"
ReplyDeleteBTW, in my recent post on Entertainers, I thought of our discussion about Taylor Tomlinson a year ago in specific
When the deposit accounts were first being insured for those 250 stacks, the advice was going out, widely, that those with more cash to hold on deposit should hold it in more than one account, since the "insurance" was, and still is, per account, not per account holder. This is still widespread knowledge, and those with more than $250k have no excuse for keeping it all in one account.
ReplyDeleteBusinesses are in a (very) slightly different position: they have relative tons of cash, and holding the vast multiplicity of $250k accounts to accommodate that is impractical. Their move, then, would be to diversify across banks rather than accounts. Those businesses that chose to commit everything to a single bank also have no excuse. Especially since their managers have (of course they have) done their due diligence on that single bank and knew the risks it was taking with depositors moneys.
The Fed's involvement also is from a long-standing move: its decision to artificially depress interest rates and hold them down for as long as they did. That created the foundation on which today's current rampant inflation, and the longer-lasting resultant higher price levels, has been built. It's true that Congressional spending contributed heavily, but the basic point is that the threat of rising inflation also has been well-known by the investing cognoscenti, and the threat was actualized months ago when the Fed started raising rates to resist inflation. SVB's investors and business depositor managers knew all of this also and have no excuse.
Nobody but the small depositor (those with $250k or less in an account) should be made whole, but all others, including all depositors in all other banks with deposits greater than the formally FDIC-insured amounts now will be also. The Fed now is making that moral hazard, a hazard created by the Federal government, concrete.
Banks are required to hold much of their cash in "risk free" Federal debt instruments. Lots of banks, not only SVB, hold far more of their cash in those instruments, instead of diversifying who they accept deposits from, increasing the rates they pay on deposits, or declining additional deposits when they no longer can lay off those funds as actual market loans rather than those Treasury loans.
The Fed has now promised to swap these [Treasury bonds and Federally-back mortgage bonds] securities for cash at face value [rather than at the market price actually paid by the banks], meaning banks won't have to realize any losses on them for now. Or ever, I claim.
https://www.wsj.com/articles/were-banks-just-bailed-out-by-the-government-6b0a582f
What is bitcoin, where did $131 billion come from....
The two have nothing to do with each other. The $131B is the excess deposit cash that SVB had no hope of lending out in any serious fashion, so they lent it to Uncle Sugar by buying those then-low interest rate long bonds at then-market prices. With the Fed raising interest rates, those already bought long bonds paying their low interest rates lost market price. That's no problem if you're holding them to maturity; you get the face value back at that point as Treasury pays off your loan to it. But SVB needed to sell those bonds now to cover the deposit withdrawals that had begun now and that were running faster than SVB could keep up with using normal deposit redemption tools. That meant SVB had to sell those long bonds at serious market-loss prices. That accelerated the run on SVB since those wondrous cognoscenti, finally, figured out that SVB still wouldn't be able to keep up.
Eric Hines
"... why would interest rates be the sole driver of that same $131 billion getting withdrawn?"
ReplyDeleteThe run on deposits wasn't as much as $131BB. It was enough to exhaust the bank's liquidity, however, and force it to sell assets that could be liquidated quickly only at a steep discount. Treasury notes are "safe" only if you can afford to hold them to maturity. If you have to do a fire-sale, and interest rates are rising, the value of your Treasury notes will be severely depressed in the short term.
All banks have to struggle with the tension between offering interest on customer deposits (the bank's cost of borrowing money) and finding investments that pay a higher rate than deposits (the bank's revenue from lending money). The deposits are by definition short-term, because their whole appeal to customers is the ability to withdraw them at any time without notice. Banks would love being able to loan at high rates on a short-term basis, too, but they're not that fortunate. To get higher rates of return, they have to incur more risk and typically agree to long maturity dates.
A bank that fails to pull this balance off fails, it's as simple as that. As Grim notes, the regulators can make the situation much worse. For one thing, they can pretend that a bank's balance sheet is "safe" when in fact it's only fashionable, as in the case of fake-AAA mortgage-backed securities 15 years ago, or Treasury notes in the context of inflation and rising interest rates.
"With the Fed raising interest rates, those already bought long bonds paying their low interest rates lost market price. That's no problem if you're holding them to maturity; you get the face value back at that point as Treasury pays off your loan to it" That is true, although in an inflationary environment the money you get back may have a lot less real value than the money you put in.
ReplyDeleteKessler's analogy of SVB to a money-market fund din't really make sense to me; those funds, as the term 'money market' suggests, do not tend to hold long-term bonds. They may be exposed to credit risk, but not generally to duration risk.
Their customers were treating the institution as a money market fund. It's just that SVB didn't seem to understand that that's what it means when 80-90% of your deposits are large enough to be uninsured. They were investing like a bank rather than like a money-market fund. They didn't know what they were doing, but the regulators and auditors were giving them passing grades for checking all the boxes.
ReplyDeleteMoney market funds know that their customers may all decide to yank their cash in droves. Banks don't expect it in that volume. Any bank, of course, can be vulnerable to a sudden spasm of bank-run panic, but if its assets are more diversified and less vulnerable to crippling losses in short-sales, it's better able to weather the challenge.
"With the Fed raising interest rates, those already bought long bonds paying their low interest rates lost market price. That's no problem if you're holding them to maturity; you get the face value back at that point as Treasury pays off your loan to it" That is true, although in an inflationary environment the money you get back may have a lot less real value than the money you put in.
ReplyDeleteAnd this is true for a lot of businesses that have used the ever dropping interest rates to keep rolling over debt , and borrowing more for the same interest cost for the last 20 years
-now the shoe is on the other foot, that debt is going to sink them.
The $131B is the excess deposit cash that SVB had no hope of lending out in any serious fashion, so they lent it to Uncle Sugar by buying those then-low interest rate long bonds at then-market prices.
ReplyDeleteA tragic sad heart-breaking component of the story is that a TECH bank can't find opportunities and entrepreneurs worthy of risking even a small best with depositors' money on. No cold fusion? No room temperature electrical conductors? No organic batteries? No space-projects that need a million or to boost on one of Musk's SpaceX launches? No haptic interface device? Nobody else making the Elizabeth Holmes "lab-on-a-chip" dream reality?
Put a hundred bets on a hundred dreams all evaluated as 90-to-1 long shots; but recover your money when one comes in. Make a fortune when TWO come in.
I suspect I could find 100 interesting projects on the GoFundMe or SharkTank style sites by the end of this week.
That SVB couldn't find a single horse to back in the race --in the most entrepreneurial sector of the US economy (the most entrepreneurial economy in all world history) -- is more discouraging than I can express.
The banks are not 'investors,' my friend. They are LENDERS. If Charlie Brown actually makes cold fusion work, the bank may lend him the money to bring it 'to scale.' But only INVESTORS (Griffin, Black Rock, et.al.) will put in money for the long-term growth.
ReplyDeleteIn the case of SVB, there was little demand for loans from tech outfits. You'd have to ask those firms why they were not borrowing--but they weren't.
That's PART of the problem SVB had.
By the way: HULU had $425 MILLION deposited in SVB. Hulu is a Disney property, just one of the close friends of the Biden regime who could have really taken a hit if FDIC had actually played by the rules.
ReplyDeleteI disagree that lenders are not investors. Equity isn't the only valuable form of investment, as critical as it may be in the mix. Businesses need a wide variety of investors, senior, junior, high-risk, passive, active, low-risk, short-term, and long-term.
ReplyDeleteBut it's important to realize what kind of investor one is, and not pretend that an unsecured debt or common stock carries the same risk as a senior secured lender. It's insane to park amounts like $425MM in a bank deposit account, unless you have so much cash to park that $425MM is a tiny fraction of your net worth. That's a garden-variety unsecured loan! It doesn't even come with covenants that could trigger a default. What is with the so-called risk managers these days? A child fresh out of a third-tier business school should know better.
ReplyDeleteBusinesses need a wide variety of investors, senior, junior, high-risk, passive, active, low-risk, short-term, and long-term.
ReplyDeleteWe are in a definition-dispute. IMHO, "lender" is not the same as "investor." Banks usually lend if there are assets they can secure as collateral, and no "idea" is an asset that's bankable. Investors on the other hand, toss money into the ring in exchange for stock (IOW, they capitalize the entity.) Stock may or may not give you really big returns; typical lending gets you 2-3 points over prime. Bond-holders are "investors" not bankers. they may get better than 2-3 PoP, they may not. If they don't, they'll usually get warrants for stock so they can cash in the appreciation thereof.
The classes you list above are all needed. But none of them are banks.
It's true, it's a dispute over definitions. I agree that the traditional role of banks is lending, not equity investment, but the line between "bonds" and "lending" is not one I recognize from my background in financial structuring and restructuring. "Lenders" may include depository banks or other financial houses of all kinds, such as insurance companies or investment bankers. You can generally draw a fairly clear line between equity and lending, if only because equity is based on a percentage of whatever is leftover after debt, and debt is a sum certain plus interest. Within the category of debt, though, is whole panoply of instruments, some taking the form of indenture agreements controlling the complicated terms associated with a promissory note (i.e., "bonds"), some simpler, some merely accounting entries acknowledged as binding repayment obligations under contracts.
ReplyDeleteIn the commercial financial world, huge attention is given to the priority of all these layers, and it can get quite complicated. The gold standard is secured debt, with specific collateral, though even within that category there are a wide variety of senior and junior liens and wide, narrow, or overlapping collateral pools. Next is unsecured debt, sometimes all on a par but often structured into senior and junior unsecured debt (the classic home of "indenture" documentation). Then comes equity, which may include all kinds of preferred stock with prior claims over ordinary stock. Any of these categories may be combined or convertible one into another.
It's all "investment," in my book, and even the boundaries of "lending" as opposed to "equity" are sometimes indistinct. We tend to call it lending when it clearly involves a return of a sum certain of principal (normally plus interest) regardless of whether the borrower's net worth in growing or shrinking. We call it equity when it's "whatever is leftover after the debt is paid." But the labels aren't the important thing: it's the terms of the documents, which explain the priority of claims.
Also, any debt that's "junky" enough that a reasonable person should acknowledge the serious risk that the principal will not be repaid is something that can as accurately be described as "equity investment" as it can "debt." The history of banking demonstrates that a LOT of "debt" falls into this category, no matter what nonsense the rating agencies dish up.
ReplyDeleteThanks Tex, you've made the response to Dad29 I would like to have been able to make.
ReplyDeleteI only add that SVB used excess cash and bought government bonds instead of placing (whether as loans or investments) funds with commercial enterprises. Typically the lay person speaks of bonds as an investment. They could have bought commercial bonds. Those would have been technically loans, too.
My grief arises from the reports that a leading TECH bank couldn't find enough for-profit enterprises they'd trust with their depositors' money.
It all kinda ties in with reports that Bill Gates is not parking his own excess cash in businesses, but is instead buying up farm land.
Yah, well.........my experience in commercial lending goes back to the early '70's--and it stopped then. In those days, a bank could not lend more than 75-80% of its deposit base. I'll grant you that things have changed since then!
ReplyDeleteBy the way, the CFO of Hulu holds a Harvard MBA with undergrad from a university in Switzerland. I am told (have no idea) that Hulu has about $2BN in cash deposited in only 4-5 banks.
Change of topic. Tex, I think you might be interested in the text and subtext of my post and the comments on "The Boy Who Wouldn't Hoe Corn." Please weigh in.
ReplyDelete@Dad29 Please accept my apologies for suggesting we disagree about anything more than definitions. And all respect to your experience in banking, lending, investing, accounting, and explaining it all to the laymen.
ReplyDeleteDo you see my concern? Hulu, Roku, and other such "tech" firms are sitting on LOTS of cash. In SVB books or in crypto-accounts or other instruments we don't know about yet. Banking and the economy generally are not a zero-sum game, but ... it's not been terribly long ago that "tech" investment meant designing and building new gadgets that made ordinary peoples' lives better. Fax machines and cellular phones and cheap disposable contact lenses and digital cameras and color inkjet printers and graphing calculators... ROKU and HULU by contrast are exploiting fiber optic cables, StarLink terminals, and Mesh Wifi to stream Perry Mason, Matlock,& Deep Space Nine wirelessly to an Amazon Fire tablet. Okay, yeah, that's better than ... well.
Seems like one SVB problem might have been that the sort of tech companies approaching them for loans (etc) were competing with their depositors. How did tradtional banks deal with that problem ... when, say, Kodak was the big depositor and Canon or Minolta wanted loans?
J Melcher--like I said, my experience with commercial banking came to a halt in the early '70's. I'm not unhappy with your remark; am always happy to learn more!
ReplyDeleteAnent your very valid concerns with 'what's a tech investment' these days, note well that the list of examples you present have little or zero US manufacturing 'taste' to them. That's because the oligarchy decided to offshore US industry (including manufacture of pharmaceuticals) and both Clinton and Bush2 were happy to oblige with enhanced trade-status for Red China, inter alia. So at this point in time, enhanced machinery is a "meh" while enhanced delivery of porn?? Hot!!!
Even more disgusting--and now, dangerous--is the degradation of the US' ability to manufacture armaments at anything resembling "fast-paced." Obviously, the largest Defense Spend in the history of the universe is upside-down.
A tidbit that I've gleaned from reading various commentary regarding Silicon Valley Bank is that it apparently carved out a niche serving as a custodian for venture capitalist funds being provided to various start-ups, and apparently some not-so start-ups. I surmise the situation is similar to a construction loan where the money is parked in an account and withdrawn either upon presentation of payment of qualified expenses or on request of the account controller. My sense is also that the custodian is chosen by the funders so it might not have been 'stupid CFOs' that parked all their company funds in SVB. There's some scuttlebutt that Pete Theil's VC funds made an abrupt departure from SVB just prior to the run starting. That may also explain the excesses cash position since SVB had to keep more funds than a more normal bank would liquid to satisfy withdrawals without depending on regular loan payments.
ReplyDeleteThere is a certain dichotomy held over from the 1970s-1980s S&L crisis where we've intermixed a bank as a payment processor with a bank as an investment vehicle in response to the yield-chasing that happened during that period of high inflation. It is probably necessary, and very prudent, that the Biden administration backstopped all of the deposits because there really is no way to tell what is operating money versus what is investment money. If the distinction between savings (or payment processing) functions and investment functions were more distinct, you could target the FDIC payments to those people who would be losing operating cash versus those who were making more of an investment decision and could (or should have) performed greater due diligence. It would also allow different regulatory frameworks for each type of function instead of just lumping everything into 'bank'.
Christopher.........gently...........there is a VERY GOOD WAY to tell what are "deposits." The bank maintains an on-line register of them, complete with the name of the entity who made those deposits.
ReplyDeleteOut here, we don't give a flying damn that some VC's will lose a few hundred million of their own money. We DO give more than a flying damn that they (and you) expect US to refund them.
That was as gentle as I could be, pal.