SVB: Silicone Valley Bust? And Where Is Occupy Silicon Valley?
Bank failures tend to come in waves, and we are experiencing at least a mini-wave now.
Banks fail for three basic reasons: 1. Credit transformation: deterioration in borrower creditworthiness, usually due to an adverse economic shock (e.g., a real estate bust). 2. Maturity transformation: borrowing short, lending long, and then getting hammered when interest rates rise. 3. Liquidity transformation combined with an exogenous liquidity shock, a la Diamond-Dybvig, where idiosyncratic depositor needs for cash lead to withdrawals that exceed liquid assets and therefore trigger fire sales of illiquid assets.
The two most notable failures of late–Silicon Valley Bank and Silvergate–are examples of 2 and 3 respectively.
In some respects, SVB is the most astounding. Not because a bank failed in the old fashioned way, but because it was funded primarily by the deposits of supposed financial sophisticates–and because of the disgusting policy response of the Treasury and the Fed.
SVB took in oodles of cash, especially in the past couple of years. The cashcade was so immense that SVB could not find enough traditional banking business (loans) to soak it up, so they bought lots of Treasuries. And long duration Treasuries to boot.
And then Powell and the Fed applied the boot, jacking up rates. Bonds have cratered in the last year, and took SVB’s balance sheet with it.
Again, an old story. And hardly a harbinger of systemic risk–unless such reckless maturity mismatches are systemic.
SVB was the Banker to the Silicon Valley Stars, notably VCs and tech firms. These firms are the ones who deposited immense sums in exchange for a pittance of return. Case in point, Roku, put almost $500 million–yes, you read that right, 9 figures led with a 5–into SVB!!!
I mean: WTFF? Was the Treasurer a moron? For who other than a moron would hold that much in cash in a single institution? (Roku claims its devices “make your home a smarter.” Maybe they should have hired a smarter treasurer and CFO, or replaced them with one of its devices). Hell, why is a company holding that much in cash period?
A few of these alleged masters of the universe (like Palantir) saw the writing on the wall and yanked their deposits: deposits fell by a quarter on Friday alone, sealing the bank’s doom. Those who were slow to run howled to the high heavens over the weekend that if there was not a bailout there would be a holocaust in the tech sector.
Even though the systemic risk posed by SVB’s failure is nil (or if not, then every bank is systemically important), the Treasury Department and the Fed responded to these howls and guaranteed all the deposits–even though the FDIC’s formal deposit insurance limit is $250,000. You know, .05 percent of Roku’s deposit.
When evaluating this, one cannot ignore the reality that the Democratic Party is completely beholden to Silicon Valley. This is beyond scandalous.
Occupy Silicon Valley, anyone?
Treasury Secretary Janet Yellen insulted our intelligence by assuring us this is not a bailout. Well, it’s not a taxpayer bailout, strictly speaking, because the Treasury is not providing the backstop. Instead, it is being funded by a “special assessment” on solvent banks. Which are owned and funded by people who also pay taxes. And such an “assessment” is a tax in everything but name–because it is a contribution by private entities compelled by the government.
The policy implications of this are disastrous. The whole problem with such bailouts is moral hazard. What is to stop banks from engaging in such reckless behavior as SVB did if they can obtain seemingly unlimited funding from those who know that they will be bailed out if things go pear-shaped?
And the regulatory failure here demonstrates that bank regulation–despite the supposed “reforms” of Frankendodd–can’t even catch or constrain the oldest bet-the-bank strategy in the book. Free banking–no deposit insurance, no bailing out of depositors–couldn’t do worse, and would likely do better.
No, the failure of SVB is not the scandal here. The scandal is the political response to it. This reveals yet again how captured the government is. This time not by Wall Street, but by tech companies and oligarchs that are currently the primary source of Democratic political funding.
A couple of weeks ago the Silvergate story looked juicy, but SVB has put it in the shade. Silvergate also grew dramatically, but on the back of crypto rather than SV tech. It became the main banker for many crypto firms and entrepreneurs. The crypto meltdown did not affect Silvergate directly, but it did crush its depositors, the aforesaid crypto firms and entrepreneurs. They withdrew a lot of funding, and an old fashioned liquidity mismatch did it in.
In traditional banks, deposit funding is “sticky.” Banks that rely on wholesale funding (“hot money”) are more vulnerable to runs. Silvergate’s funding was not traditional sticky deposit funding, nor was it hot money per se. It was money that was pretty cool as long as crypto was cool, and became hot once crypto melted down.
A run started, but the run was precipitated by a liquidity shock. Simple story, really.
Silvergate’s failure was not a scandal. SVB’s failure per se was not a scandal (except to the extent that our vaunted banking regulators failed to prevent the most prosaic type of failure).
Again–the scandal is the politically tainted response that will have baleful consequences in the future, as the response virtually guarantees that there will be more SVBs in the future.
as a market participant w some minimal exposure to SVB, it wasn’t SVB itself causing the issue. it was the taint on all uninsured deposits at any non TBTF bank.
we had wires queued up out of our very well run regional bank for tmrw morning to JPM, who we also use. the regional has a large self originated mortgage book, largely to its own clientele. but they hold a material amount of uninsured deposits, both retail and commercial.
there were other ways to skin the cat but the regional bank we use would’ve likely been out of business by end of this week and i would bet there would be 5-10 other medium sized banks taken out as well
Comment by Danny — March 12, 2023 @ 8:02 pm
They never did a swap or hedged their portfolio the doofuses. But, they published their green stats and they were LGBTQ+ friendly!
Comment by Jeff Carter (@pointsnfigures1) — March 12, 2023 @ 8:47 pm
Is counterparty credit risk an alien concept to firms who generate cash in such quantities they can’t track of it. This is basic failure at SVB but also basic failure of the treasury teams at the tech firms. In all their attention on the alphabet of acronyms did they forget about DV01?
Comment by Andrew — March 13, 2023 @ 7:36 am
I am actually surprised they could take that much IR risk. in Europe, IR risk of banks is limited to 20 percent of solvency capital (under a 200bp shift).. Banks have to continously report and disclose that figure. Breaching 10 percent puts you an alert list…The only way you could blow up this way is by faking the number, i.e. fraud.
“…why is a company holding that much in cash period?…”
These start ups have large cash balances because they are heavily loss making. They raise money and burn through the cash, rinse repeat. that’s the business model
It was a covenant of their debt contract to keep the cash at SVB – althogh probably they could have diversified somewhat.
are u really surprised billionaires get bailed out in the US?
Comment by viennacapitalist — March 13, 2023 @ 8:01 am
There’s a Bagehot quotation that I cannot locate to the effect that banking is a vigilant profession not a laborious profession.
No doubt the SVB executives boasted how hard-working they were; pity they couldn’t boast how vigilant they were.
Perhaps this famous quotation applies to banking too:
Kurt von Hammerstein-Equord 1878–1943
German general
I divide my officers into four classes as follows: the clever, the industrious, the lazy, and the stupid. Each officer always possesses two of these qualities. Those who are clever and industrious I appoint to the General Staff. Use can under certain circumstances be made of those who are stupid and lazy. The man who is clever and lazy qualifies for the highest leadership posts. He has the requisite and the mental clarity for difficult decisions. But whoever is stupid and industrious must be got rid of, for he is too dangerous.
attributed, 1933; possibly apocryphal
Comment by dearieme — March 13, 2023 @ 6:37 pm
1. They were doomed since Barney Frank was on the board.
2. Their deposits were a function of low to zero interest rates and tech companies, many in a cash burn mode.
3. It is and was reasonable to assume that if when interest rates moved a lot of their deposit base would shrink dramatically as fewer new start ups or secondary rounds of financing for said customers would slow or stop. Hence the true duration and thus value in the deposit base would drop more rapidly than in a normal bank. This value relationship is similar to owning an mbs pass through versus a Treasury: as rates go up the mbs will lose value faster than the static duration Treasury would ( pace Taylor number sequence fans).
4. The morons put a lot of securities I. The held to maturity bucket, showing that the hadn’t a effing clue about their deposit base volatility and exposure.
5. Having a liability structure whose value behaved like being long passthrough mbs, the clowns doubled down by actually buying mbs in the HTM Portfolio!!!! You couldn’t have come up with a stupider strategy if you sat on both hands for a Fortnight.in other words, they had assets and liabilities that would both move the same way in value with interest rates.a double whammy.
6. This was made worse by both being negatively convex.
In summary the only way this bank could have structured itself to maintain value was to have extraordinarily liquid assets 50% or more >6 months.a duration negative portfolio offsetting the negative convexity of the value of the liabilities.
They hadn’t a fucking clue.
Comment by Sotosy1 — March 14, 2023 @ 3:40 pm
Got it! Bagehot wrote “Banking is a watchful, but not a laborious trade.”
Suddenly Very Bust’s management wasn’t watchful enough.
Comment by dearieme — March 14, 2023 @ 4:37 pm
Hello Prof,
would love to hear if you think Trump rolling back Dodd-Frank regulations back in 2018 – raising the asset size threshold for banks considered too big to fail from $50bn to $250bn – has contributed to SVB’s failure?
Comment by [email protected] — March 15, 2023 @ 8:38 am
@liberte–1. Trump didn’t do anything. Congress (including a large number of Democratic reps and senators) did it when Trump was in office. 2. Substantively, I don’t think this change mattered at all. I fail to see how any heightened level of supervisory scrutiny would have affected this. The huge interest rate risk SBV had assumed should have been flagged by supervisors of the Podunk Bank with $1b in deposits, let alone one with 9 figure billion deposits. 3. This relates to the stupidity of bank regulation generally, and Frankendodd in particular. Treasuries are sanctified on the balance sheet due to low credit risk, damn the interest rate risk. A snapshot of Treasury holdings is used to determine compliance with High Quality Liquid Assets regs, with little consideration to how that balance sheet value might change when interest rates spike.
During the post-GFC era/Frankendodd era I wrote several posts on how capital and liquidity requirements essentially price various risks, and that banks will pile into assets with underpriced risks. It is clear that the regulatory framework generally underprices pure interest rate risk when setting capital and liquidity requirements, so (a) no shit that banks like SBV piled into assets with low credit risk (which is priced) and high interest rate risk (which isn’t), (b) this is what caused SVB’s demise, and (c) if anything the post-GFC regs made this problem worse and the 2018 changes did not affect at all this underlying problem.
Comment by cpirrong — March 15, 2023 @ 2:37 pm
I note that the S&L crisis (in which I was involved in analyzing), Congress’s fingerprints were all over it. The deregulation was blamed on Reagan but it was Congress’s doing.
Comment by cpirrong — March 15, 2023 @ 2:39 pm
Actually it was kind of kicked off in 93-5′ by actions in the Housing Dept. under Clinton when new CRE regs were made broadening requirements for “local” lending (abetted by the usual suspects in the Treasury, FSLIC, OCc, etc. Not that Congress did its best to make matters worse.
Oh and the name of the Undersecretary of Housing was Andrew Cuomo. Yup, the NY Granny killer himself.
Comment by Sotosy1 — March 15, 2023 @ 5:23 pm
As you pointed out SVB ran a mismatched book. But remember the original thrift crisis was brought about by disintermediation in 1984-85. That both let grifters into the business (more than usual that is) and triggered the wave of we’re going to lend our way out of this crowd in relatively so called solvents into the first Great Meltdown (84 in TX, everywhere else in 1987-91.
Order was restored and the Andrew Thuggo was turned loose on the industry a year or so later.
BTW the worst losses were in the MBS portfolio (misidentified as HTM in my original post, God alone knows how.
Comment by Sotosy1 — March 15, 2023 @ 5:34 pm
It’s that hybrid form of capitalism that we call the banking system that causes all the problems.
If people want absolute safety with the awesome power of Uncle Sam to back that guarantee, let them have checking accounts at the Fed.
If people want to earn a bit of interest, let them buy CP or bank deposits etc. No guarantees at all.
Of course, this is politically impossible because it would wipe out all the small banks (Congress, eh?) and leave the banking industry looking like the airline industry, the railroad industry, etc etc with no more than 7 or 8 big players.
Yeah, we’re stuck in the quagmire of late capitalist political economy. Every few years there will be a banking crisis and the wealthy and politically connected will get bailed out. It sucks but that’s the system, man
Comment by Simple Simon — March 19, 2023 @ 11:21 am