The collapse of SVB is wholly and entirely the responsibility of the regulator and a consequence of the general policy of the government. This bank, contrary to the comments of some experts about irresponsible risk management, pursued a perfectly rational strategy, followed the rules clearly and conducted business in accordance with the external conditions created by the authorities. The problem is these conditions, and there are strong reasons to suspect that this problem is just beginning to develop.
I will not recount here in too much detail the procedural details of what happened – this has been done in recent days by many respected experts and will probably be comprehended and analyzed more than once. I will try to assess what happened in the context of cause-and-effect relations of the current macroeconomic picture and the course of economic policy, which is still followed by the government and the regulator.
What was SVB? It was a top 20 bank in the US with $200bn in assets, $175bn in liabilities and $16bn in equity. In terms of the value of its deposits, it was quite comparable to Morgan Stanley (NYSE:MS), where deposits totaled $209 billion.
What were these deposits and who was putting money into SVB? These were technology companies at the startup stage and already fully functioning businesses, obviously, from high-tech industries – they accounted for about 37 thousand deposits, and about 100 thousand more accounted for individuals.
A significant portion of customer deposits – about $80 billion – had “on demand” status. This was money of technology companies and stratagems received in the form of investment rounds or loans and needed for operational financing.
As for the bank’s assets, the situation was stable for zero rates under the permanent monetary stimulus, when the cost of financing is conditionally zero and yields on market instruments are correspondingly low. The policy in asset allocation was conservative: most was placed in short and long duration government debt, as well as long mortgage bonds.
Placements into loans for targeted IT start-ups and other theological businesses lagged far behind bond investments. This is understandable: with cheap money, the number of failed projects increases, because after any failure you can easily start a new project again, there will be no shortage of funding offers.
Thus, the main exposition in the assets of the bank accounted for government debt as the most conservative investment instrument. About $80 billion was placed in cash and cash equivalents, i.e. short-term debt. About $120 billion more was invested in long-term government debt and mortgage bonds as assets that generate more cash flow due to the higher proposed time risk premium.
This asset-liability structure allowed the bank to generate stable returns with minimal risk in an environment of low rates and stable monetary expansion. Deposits were attracted at 0.5 percent and long-term bonds yielded more than 2.5 percent. Accordingly, the bank earned about 2 percent on virtually risk-free spreads and on instruments whose bankruptcy risk was extremely low. That amounts to about $2.4 billion to $2.5 billion a year from the portion that was invested in long government debt.
At the same time, the bank’s assets, in accordance with the regulations, were structured as follows: part of the assets – in the category “held to maturity”, and part of the assets – “ready for sale”. These regulations are one of the most important sources of potential problems in banking. They have the old “unkind” purpose of financing growing government spending and monetary expansion, where the government issues long debt, then sells it to banks, who account for it as an asset, then pledge it to the FED and get liquidity against it.
Assets with “ready-for-sale” status are obviously revalued by the market every day, which is reflected in the value of the assets.
Assets in the “held-to-maturity” category are valued at the price of the last transaction with them. That is, once bought, 10-year bonds are valued at the purchase price for all of 10 years, unless they are sold or there is a new purchase – then the entire portfolio is overvalued at the price of that new purchase.
What does this ultimately lead to?
It leads to the fact that banks benefit from sticking most of their volatile assets in the “to maturity” category because that status eliminates their regular revaluation, which means that if their market value falls, it is not reflected in the asset value and does not affect the bank balance sheet in any way.
Thus, the SBV reported to shareholders and the regulator without accounting for the drawdown in the value of the long-term bonds.
With the FED forced to tighten financial conditions and reduce consumer and business activity by raising rates to curb accelerating inflation, companies and businesses in high-tech industries with high valuations of future cash flows living on rounds of investment and credit injections are beginning to have significant difficulty financing and valuing their value.
The reasons are obvious: the cost of raising and servicing capital is increasing, and the rising federal funds rate increases the rate of discounting future flows, thereby lowering the estimated value of the company, on the basis of which investors and lenders make decisions about the amount and cost of lending for such companies. This is how tech startups have to choose all of their remaining liquidity.
Meanwhile, the inevitable crises and bankruptcies of high-tech companies, such as the bankruptcy of the FTX exchange, as well as rising lending rates force banks to tighten conditions for borrowers, who are often simultaneously depositors. Thus, the difference between the interest rate when making a deposit and the lending rate widens, forcing companies to cut deposits.
Overlaying all this is the assessment by the depositor companies of the bank’s financial situation and its ability to repay its obligations to them. As soon as the trigger of doubt arises (and it can be either a negative event that has already happened, or the anticipation of a negative event or an analytical assessment of the data), the bank’s clients, already struggling with liquidity and operational funding, intensify demands for deposit repayment. I believe that a sudden drawdown in the bank’s asset value could well be such a trigger.
Bank Run Begins. The bank’s narrow customer focus has only intensified the takeout, as has the dense communication network in California’s stratagem industry. The bank is forced to sell its most liquid assets, short-dated bonds, to meet the growing demands of its liability obligations.
In addition to government bonds with short duration – $80 billion – the bank’s assets consist of long-term bonds, and their declining value in line with market prices, but not reflected in the bank’s asset valuations, immediately becomes reflected in the value of total assets with the first sale to meet the excessive deposit repayment requirements. In addition, loans to technology startups dramatically lose their ability to be refinanced and carry increasing risks of default, which also worsens the quality of the bank’s remaining assets.
Thus, the bank’s core assets have dramatically and “unexpectedly” lost a significant portion of their value.
As a result, the bank’s assets are insufficient to cover its liabilities.
The FDIC’s promise to pay all depositors an insured sum of $250,000 is only 15% of the current value of the deposit base. That said, 80% of deposits are uninsured, and with a significant number of deposits exceeding $250k simply because of the structure of the bank’s customer base, a substantial portion of the refund claims are at risk of default.
There are, however, two pieces of relatively good news.
First, about 25 percent of the deposit base customers managed to take away. About $135 billion remained.
Secondly, the government decided to bail out the bank and satisfy all the demands of the clients – depositors of the bank. However, in fact, this bail out will be financed at the expense of the bank’s shareholders and debt holders – they will receive nothing.
The question of why the investment department and the bank’s risk-management did not restructure the portfolio when the rates started rising and continued to hold long-term bonds on the balance sheet, which are the most affected by the rising rates, is not very interesting to me in this context. Perhaps bank management was not expecting a bank run, perhaps there was a scam or deliberate deception. Either way, this kind of collapse would not have happened if not for the rampant government stimulus, as well as the relevant regulations.
It is questionable that sensible regulatory rules, such as comparing and matching the maturity of liabilities and assets, are still not the norm for banks, which certainly leads to such imbalances, causing systemic failures, among other reasons.
But all in all, what has happened is a perfectly natural, predictable and standard consequence of long-term and hypertrophied monetary expansion, which has different morphologies from case to case, but has the same essence, right down to the procedural nuances. Exactly the same thing is happening now.
It is quite obvious that the dilemma of the government and the FED – inflation or recession – is becoming a thriller: inflation, recession, or crisis.
I have mentioned many times in my essays over the past two years the inevitable negative effects of the same inevitable cycle of monetary anti-inflationary tightening on asset values and participants in the entire financial system, above all banks, pension funds, and insurance companies. We saw some rehearsal in the fall with the assets and liabilities of pension funds in the United Kingdom. Today, the asset depreciation effects of rising rates are beginning to take their toll in the U.S. as well.
The consensus among experts is that the government has learned the lessons of 2008 and will do the impossible to prevent a domino effect, i.e., to keep the financial system from going to the brink of collapse. However, this impossible thing is in fact a banal emission. Now we will have to choose not from two, but from three worst options, simply because there are no others.
The recession that follows the cycle of intense rate hikes is not a big problem for the political elite and the government: they will simply launch a new cycle of monetary expansion and hyperstimulation, as they have been used to do for the past decades. Another question is what the consequences of continuing such expansionary policies will be in the context of global structural economic and political change. After all, it is quite clear that all hyperstimulation means increased government spending, which is financed by increased borrowing and taxation. As they say, hello again.
Inflation is by far the greater enemy for the government, because its negative impact on the economy is deeper and more lasting than a recessive decline in economic activity. Sustained high inflation depreciates value added and income, and reduces the purchasing and productive capacity of economic agents, which is perhaps one of the main political risks for the authorities.
Accordingly, the risks of recession as a consequence of fighting high inflation are not comparable in terms of their negative consequences and opportunities to overcome them quickly with the risks of persistent high inflation, the consequence of which could be a depression and a total deflation.
An asset depreciation crisis is the most unpleasant potential consequence of monetary tightening, especially after such a long cycle of rising costs that we have seen in the last 10-plus years. This risk seems to be becoming a basic point of reference for the government.
On the one hand, continuing to raise rates and bring asset prices and economic activity down to more or less equilibrium fair levels for a de-credit economy is necessary to combat high inflation.
On the other hand, allowing such an inevitable depreciation of assets is unacceptable, because it threatens to collapse the financial system as a mechanism for the balanced distribution of funding in the economy.
The depreciation of assets will cause an inevitable collateral crisis and further down the chain, according to any student of macroeconomics and historical precedents. But in order to avoid such “extreme credit-inflationary” deoxidation, the government will have to put the brakes on monetary tightening, and with continued high inflation, labor market shortages, sustained consumer activity, and disruptions in global economic chains (for various reasons), any loosening in inflationary dumping will mean further price increases and hinder production.
These are all consequences of toxic expansionist and dirigist economic policies and forced lending of needs beyond capacity. With global economic and geopolitical contradictions, there are fewer and fewer possibilities, and needs and their spectrum are still prohibitively high.
Now the government will play the classics, jumping on three squares – inflation, depression and financial crisis. Unfortunately, up to this point we have not seen anything effective from the authorities, except the fight against inflation through raising rates and QT (honestly, the only and no alternative solution), but there were plenty of oddities.
The increased regulatory overhang, the hypertrophied government spending and social programs that have led to inflationary distortions, the inflation law that complicates and aggravates tax requirements, the tax tightening in the draft budget for year 24, the lack of any clear concept of industrial policy on industrial repayment from manufacturing countries back to the United States – these are the actual results of the Democrat administration.
Well, gentlemen, you have trapped yourselves. The only trouble is, so has the whole economy.
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