SVB’s Execs Were Rats, But They Were Just Navigating the Regulatory Maze to the Government Cheese
A brief follow-up on SVB (which kinds of sounds like a venereal disease, which is kind of apropos I guess).
During the GFC I wrote about how bank capital requirements were like price controls. A regulator can never set the “right” prices–in this case, the shadow costs of assets with different risks. It will underprice some risks, and overprice others. Banks will hold too many of the assets where risk is underpriced, and too little of the assets where the risk is overpriced.
Bank capital requirements focus primarily on credit risk, rather than interest rate risk. SVB incurred very little if any capital charge to hold Treasuries and agency debt, because they are viewed as “safe” from a credit risk perspective. But they did allow SVB (and other banks) to take on interest rate risk.
Very low or zero capital charges on Treasuries fall into the there-are-no-coincidences-comrade category. The government wants to encourage holding of Treasuries and agencies. Big deficits to finance, after all. As Niall Ferguson, Charlie Calomiris, and others have pointed out, governments regulate and structure banking systems first and foremost to facilitate government finance, not private capital markets.
Related to this is the issue of stress tests. The relaxation of regulation passed in 2018 meant that banks of SVB’s size no longer had to undergo stress tests. But the recent government stress tests would not have really stressed SVB: they only tested for a 200 basis point increase in interest rates, not the 400+ increase we have experienced. So SVB would have passed anyways.
In the immediate aftermath of the GFC I expressed skepticism about stress tests. I called the Tinker Bell Economics–“We believe! We believe!” That is, they are intended to assure everyone about the safety of the banking system, rather than to actually test the safety of the banking system.
The unstressful interest rate stress scenarios also plays into the idea that the Fed and Treasury don’t want to do anything to dampen banks’ appetite for government bonds.
One last comment. Many historical banking system crises are the result of yield chasing in low interest rate environments. Low yields (a) allows banks to borrow cheap, and (b) induces banks to chase yield by taking on more risk.
We obviously operated for years in a low rate environment, courtesy of the Fed. Yield chasing was an inevitable. SVB chased yield.
In sum, yes, SVB’s execs were rats. But the government designed the maze (capital requirements, low interest rates) and baited it with cheese. So when the government says that they are going to fix the problem, don’t believe them. But believe this: especially given the United States’ huge debt and deficits, any “fixes” will be rigged to protect the Treasury market, and the devil take the hindmost. Which would be you.
It happens that I can call myself a Certified Credit Analyst also…and still remember the entry question of the prof who was the program leader: ‘Why do we call it credit analyst, not rating analyst? Because ‘rating’ could be the ‘un-word’ of the year already next year’. And there were quite some fundamental points, why it doesn’t work the way regulators and most bank employees think it would…
And then it was clear that credit risk is just one type of risk. And every average bond investor knows this, or?
But as soon as you call it ‘supervision’, ‘regulation’, ‘framework’, ‘market standard’ people stop thinking, if they were able to think for themselves in the first place.
Just this weekend, was thinking, this financial and economic system is just a big ponzi scheme, where they print new money and create new debts, and the public has to play the bank of last resort and bail all the corporates and ‘risk takers’ out, in that game, where they privatize the profits and socialize the losses and risk-taking…and that was before reading Switzerland would guarantee 9 billion within the UBS takeover of CS…
…and as in covid times…let’s shrink the real and normal economy some more, let’s overspend on weapons, military, big pharma, big data, control of citizens, censorship…then we have just what they say brought down the communist block…then bringing down the capitalist block called ‘West’…and then? Is this a privatization scheme? Let the nation states go bankrupt…
Comment by Mikey — March 20, 2023 @ 3:37 am
Interest rate risk is sovereign credit risk in disguise under the federal reserve fiat money system.
Banks get into trouble by lending to people who can’t pay back. Last time it was home buyers, this time it is the government. But when the government is in trouble, they print more, the money supply inflation causes price inflation, and the fed raises rates. Even if the fed does not raise short term rates, eventually long-bond rates go up as people expect a positive real rate of return.
Somebody has to take the loss when a debtor doesn’t pay.
Comment by Jack — March 20, 2023 @ 7:50 am
But as soon as you call it ‘supervision’, ‘regulation’, ‘framework’, ‘market standard’ people stop thinking…
In my naivety I supposed that the management was supposed to supervise, etc. If all that stuff is the purlieu of outside regulators one wonders what the managers actually do.
SVB is now the safest bank in the world, being backed by unlimited federal guarantee. Result!
Comment by philip — March 20, 2023 @ 7:56 am
So what is a better solution?
In a free-banking regime, rival banks try to induce runs if they sense a weak competitor, then play Mr. Potter and grab capital assets on the cheap. This is arguably what Binance did to FTX with their publicly announced liquidation of FXX tokens, and the weakness of such a scheme shows up in FTX’s habit of throwing money at Dem politicians: buying favors to evade reporting requirements and have debt backed by the public treasury pays off big in a game of big fish eats little fish.
A more modern solution may be to de-bundle deposit insurance, so that such insurance shows up as a separate line item and depositors have a choice of underwriters (and terms…pay less to insure only 80%, pay more to insure to a higher limit), but then who insures the insurers…is this just FDIC one level removed? Quis ipsos assecuratores assecurat?
A more radical solution, in the “Bitcoin fixes this” tradition, would be to put everything on public blockchains, and have zero-knowledge proofs of solvency. The technology to do this is still in its infancy (for the liability side, anyhow…proving assets is easy), and of course having proof on a blockchain only works if people actually check with independent full-archiving nodes running the requisite scripts. Nobody was checking FTX, despite most of their double-dip accounting being right there where everyone (with the technical means) could see it, until Coindesk wrote a mildly skeptical expose.
Of course, a deposit insurance underwriter would be checking those blockchains…
Comment by M. Rad. — March 20, 2023 @ 8:12 am
“devil take the hindmost. Which would be you.” So what am I to do? Easily our biggest asset is our house but that’s a pretty undiversified investment and anyway doesn’t generate income.
Our savings and investments are well scattered across different providers, mainly as cash at the moment, but all those providers are in the same country (UK). We own neither physical gold nor bitcoins. We do have some inflation-protected investments. I sold my rifle decades ago so I can’t plan to stick up banks.
Our parents are dead so we have no fear of having to support them. The younger generation are old enough to fend for themselves.
Comment by dearieme — March 20, 2023 @ 9:17 am
@M. Rad. Not sure there is a better solution. The question is also: what is the problem? Looking at banking isolated or only credit risk is maybe part of the problem. There’s ‘systemic risk’…maybe this leads to the problem, ‘systemic…’. But what the banks and bankers purpose?
‘Are you saying that there’s no conflict between your true anarchistic theories and the life you lead, your present life? Do you want me to believe that your life is identical to that of those people ordinarily termed ‘anarchists’?
— No, that’s not it at all. What I mean is that, between my theories and how I lead my life, there is no divergence at all, but absolute conformity. It’s true that my life is not like that of those trade union types or of people who throw bombs. It is their lives that are not truly anarchistic, that fall short of their anarchistic ideals, not mine. The theory and practice of anarchism meet in me, yes, in me—banker, financier, tycoon if you like—and there’s no conflict between them. You compared me to those fools in the trade unions, to those people who throw bombs, in order to demonstrate that I am quite different from them. I am, but the difference is this: they (yes, they and not I) are purely theoretical anarchists; I am an anarchist in both theory and practice. They are foolish anarchists and I am an intelligent anarchist. Therefore, I am the true anarchist. They, the people in the trade unions, the ones who throw bombs (I did the same once until I emerged from that into my true anarchism), they are the detritus of anarchism, the whores of the great libertarian doctrine.’
https://theanarchistlibrary.org/library/fernando-pessoa-anarchist-banker-english
Comment by Mikey — March 20, 2023 @ 9:19 am
dearieme
Your main asset was, until last week, due to take a significant haircut. Rising interest rates would in due course lead to a property market correction.
Now the fear of bank contagion will lead to a more dovish central bank, and increased tolerance of inflation.
Which is good for your asset. For the moment.
It’s an ill wind and all that.
Comment by philip — March 20, 2023 @ 12:18 pm
@philip; thank you – but it’s not clear that the value of the house will matter much to us, as distinct from mattering to our heirs, unless we need to do an “equity release”.
I suppose it boils down to two things: (i) Should we diversify by holding assets outside the UK (needless to say I have no idea how to do that); (ii) Should we diversify out of cash and (presumably) into equities?
My great fear is that my wife won’t have enough to live on if I need expensive “care”. That is, in principle, an insurance problem but I gather that various attempts to make a living by selling Care Insurance have failed. There’s none to be bought.
“Timor mortis conturbat me” isn’t right – it’s years of ill health that’s the worry.
Comment by dearieme — March 20, 2023 @ 1:53 pm
dearieme
The FT100 is dominated by companies that make most of their money overseas, so that alone gives you geographical diversification.
Financial advisors will tell you to avoid equities and go for the safety of bonds. (Perhaps those Credit Suisse tier one bonds that have just got wiped out?) But I wonder if that’s right. So long as you have an income sufficient for your daily needs, not including cruises and expensive spa retreats, you might as well go balls out on risk on your capital.
As for care homes, when I see the end approaching I’m going to buy a fireman’s breathing apparatus and swap the scuba bottle for 100% Helium. Anything to avoid that compulsory daytime TV.
Comment by philip — March 20, 2023 @ 2:45 pm
Ah, bonds. I bought in late ’99 when I sold all our equity on the grounds of “you must be joking”. That all worked out awfully well – market timing proved a doddle – and the bonds did well to maturity. But they seemed an accident waiting to happen once the drive to zero interest was underway.
I think that, with any luck, banking problems won’t affect us at least in the short term. The exception would be if our principal DB pension schemes got into the soup. About which we can do nothing at all.
Comment by dearieme — March 20, 2023 @ 4:28 pm
Back in pre-history I reckoned that government guaranteed pension schemes (especially the DB ones) were a crock, because there wouldn’t be enough money to pay for them if markets chose to include contingent liabilities in government debt.
So far I’ve been wrong. So far…
Comment by philip — March 20, 2023 @ 6:05 pm
Ours are private schemes not government schemes. It’s their own mismanagement that I fear, or some economic calamity so great that they can’t avoid the consequences.
Comment by dearieme — March 21, 2023 @ 12:53 pm