I go back to the scene with my parents that always blows my mind. They went to a senior center during COVID and the lady working there offered them several $100 gift cards to major merchants. They said they didn't need them. The lady asked them repeatedly to say they did need them so she could give them away as part of the COVID stimulus they had been asked to give out.
Another angle here, which I don't understand: all of these VCs told their startups to bank at SVB, but neglected to tell these same startups to practice standard cash management. In other words, set up your bank accounts such that you do a daily sweep of all cash in excess of $250,000 into a money market fund. Had VCs told their companies to do this, there very likely would not have been a run at SVB. But it's not clear to me that VCs understand how banking works.
Essentially SVB offered them perks for keeping all their cash there that they found too hard to ignore, and I suspect they just discounted the risk since they figured the bank wouldn't fail and the government would bail them out if it did. The $250k limit isn't taken seriously.
I can’t figure out exactly why, but there are people like David Sachs saying that his portfolio companies did have sweeps in place and still were unable to withdraw funds, possibly due to the California regulator.
Did they sweep to money market *accounts* or money market *funds*? The former are bank accounts that hold treasuries. The latter are not, and are not subject to FDIC insurance, and are not part of the fractional banking system. As he is a VC, I don't think that David Sacks understands how banking works.
Tangentially, it seems like a "regulation smell" (by analogy to "code smell", a pattern or practice well known for generating coding bugs) when you have an arbitrary threshold, like the $250B asset limit that used to be $50B, above which entities are very differently regulated. SVB apparently took pains to stay under the threshold, which is foreseeable system-gaming. Another example would be the rules that only apply to companies with 50 or more employees.
On reflection, the $250K limit on explicit deposit insurance is another arbitrary threshold that failed here. A simpler rule to fix both thresholds would be: if you offer any FDIC insured deposits, you must follow the rules for "systemically important institutions" (the rules that kicked in at $250B assets), and then 100% of deposits are insured, no arbitrary size cap. Otherwise, deposits at your institution are not insured at all. If nothing else, this would treat market actors more evenhandedly, align their incentives better, and be simpler to understand than the existing ruleset.
For months I have been reading how with the increases in the Funds rate that banks are making unseemly amounts of money. Apparently not all banks! Apparently not banks who choose to invest in long duration bonds.
Why would a bank be investing in long durarion bonds? I thought banks borrowed short duration and lended long duration. SVB seems to have flipped the script and was taking cash deposits and investing long duration. Did they not consider interest rates could increase? I'm a nobody and I knew it was foolish to buy long term debt when it was selling at all-time high valuations.
There should be claw backs on salaries and bonuses paid to the executives of failed banks. The greatest moral hazard is executives can pursue riskier strategies, be terribly wrong, and still walk away very well compensates for being wrong.
Agree with the analysis. My only comment is on the halting rhythm of the first line of the limerick. I believe this would improve it: "Regulators lay soft in their sleep"
The only solution to permanently end bank runs is full-reserve banking. The US gov will never allow them to happen because they will destroy the credibility of the existing fractional reserve banks (and also remove the basis for their arbitrary audit/exam powers over banking)
What would be the use of a full-reserve bank? It would have to charge its depositors a fee rather than pay them interest, since it can't lend their deposits out.
In the context of today, a full reserve bank could offer the following:
1) some degree of insulation from the demands of federal regulators (political cancellation) who use the pretext of deposit insurance to operate banks as an arm of government in service to its political aims
2) access to large and fast interbank transfers
3) assurance that your deposits are mechanically not subject to a bank run or arbitrary fee imposed by deposit insurance regulators. (assuming someone checks that the bank is not cheating on its full reserve claims)
Given that most demand deposit accounts have been yielding zero for decades the above benefits seem compelling enough to pay a fee for.
Also, the bank could operate an investment service that would allow for maturity matched investments outside your deposit account. These might look alot like CDs matched to loans of the same length. The important point is that when a client invests he agrees to bear investment risk.
Delong is wrong (it rhymes it must be true)- full deposit insurance doesn't prevent bank runs, it just slows them down. SVB had assets yielding 1.85% on their books, which means they could not pay interest to their customers of more than 1.85% or end up bankrupt even with mark to maturity accounting. Meanwhile, prior to their failure, the 4 week bill was at 4.66% and the 1 year treasury was at 5.2%. I know its elementary school math but any bank in better shape could offer them a 1 year return with a yield up to 3.35% higher than SVBs maximum offer. How long do you really think it would take before some startups realized that they could pick up an extra 20-30 million next year per billion in the bank just by moving their accounts? Oh and the Fed was indicating rates in excess of 6% and then their desire to HOLD them higher for longer.
When you look at the actual environment with VC money drying up and startups still not profitable it is undeniable that these startups would move their money for a higher yield if it was offered for long enough. This bank run, which Delong (and so many others) like to imagine is psychological only was rational and baked in. Interest rate risk is, at its core, opportunity cost risk. The ability to get a higher rate over there makes your lower rate worth less, but most macro economists look at econ 101 as an introduction to be ignored when you get to higher stuff and not as root causes in a complicated system that lead to complex outcomes.
"P.S. I'm not particularly worried about moral hazard. The CEO, management & Board all losing their jobs. Equity going to zero. Bondholders won't be paid in full. These are all the entities that can effectively monitor, is unrealistic to expect depositors to do much monitoring."
Yes, there's always a reason not to worry about moral hazard.
Joe Weisenthal writes,
"In the end, all of Silicon Valley Bank's depositors were protected, while the shareholders and executive team got nothing. This is what a bunch of people were calling for to happen.
It has a whiff of tough-mindedness to it. It sounds like you're not just describing a bailout. You still believe in real capitalism. You don't want a repeat of anything like what happened in the Great Financial Crisis, with TARP and all that.
But the difference between this time and that time is not as wide as it seems. The bailouts in that crisis were largely about protecting depositors as well. For example, it's commonly claimed that Citigroup was bailed out. And yet Citigroup shareholders ended up losing about 98% of their money over the course of that bank run. Yes not 100%. But clearly the massive bailout was not about protecting shareholders, who are still to this day down over 90%."
Getting nothing is insufficient punishment to deter the next bunch.
The way to eliminate moral hazard from banking, IMO, is to ban corporations from the banking industry. All banks and investment banks should have to be partnerships, so that the people who are responsible for protecting your life savings stand to lose their own -- not just the value of their shares in the bank -- if they fail. And all banks should be considered fiduciaries under the law, not merely businesses that owe you ordinary debt.
Then we can talk about outlawing dishonest practices such as making NSF fees a bank's primary profit center, so that banking becomes an honorable job again.
It seems like the answer is doing away with the FDIC and having private deposit insurance. Admittedly I haven't explored the idea in depth to find its flaws, but it seems like such insurers have incentive to risk weight their premiums and customers to decide then which bank with what insurers they trust. Either the bank would cover the premiums in their cost of doing business from however they earn money, or it could be an added fee the customer pays either to the bank or directly to an insurer. I guess the issue would be whether there is moral hazard that the government would be expected to bail out the private insurers.
All expect to go to sleep and wake up knowing they can access all amounts of money they have on deposit at a bank at par, on demand; it really is that simple. There are alternatives to see this happens, but my bet is that going forward all deposits at a bank will be guaranteed as money good, on demand will be the outcome of SVB crisis. There are many alternatives to see this outcome ranging from higher equity requirements on part of banks, maybe adopting an insurance company model, much higher insurance payments by banks to FDIC, and others; all have trade-offs and will be analyzed, but fact remains almost all depositors have no idea with regard to the solvency and liquidity of a bank. Nor do rating agencies once again as in Q4 each of Moodys and S&P had A3 stable and BB stable at end of Q4.
I'm puzzled by the belief that taxpayers are bailing out SVB. It looks to me like SVB is solvent as long as t-bonds don't drop again, and is being liquidated because it couldn't find a better way of handling its t-bond risk.
But, as Noah Smith correctly points out, there was more: SVB did not need its asset sales to raise cash to exert price pressure against it. SVB’s core problem was that its Treasury bonds had lost mark-to-market value. In SVB’s accounting for its hold-to-maturity portfolio, the loss created by the fact that the bonds it held had fallen in price was balanced by an expected capital-gain offset that was going to accrue on the bonds when they were held to maturity. But that only works if the game of musical chairs continues: if the music stops and the bank is liquidated right now, that offsetting expected capital gain vanishes.
Noah Smith:
With VC funding having dried up, many startups had to survive by using their “runway” — burning through cash to pay their employees and other expenses while they waited for the market to recover. But this meant a lot of startups were all withdrawing a bunch of cash from SVB, while new VC rounds were failing to give SVB new deposits.
To meet these simultaneous demands for cash from startups using up their runway, SVB had to sell assets.
I go back to the scene with my parents that always blows my mind. They went to a senior center during COVID and the lady working there offered them several $100 gift cards to major merchants. They said they didn't need them. The lady asked them repeatedly to say they did need them so she could give them away as part of the COVID stimulus they had been asked to give out.
I feel like that's our entire economy.
1) It seems likely to me that anyone who borrowed short and lent long the last few years is insolvent, including depositors.
2) If the fed backstops these people, it has to print the money.
3) If it prints money to bailout anyone who can't handle high rates, high rates will fail to tame inflation.
4) If it doesn't tame inflation rates can't come down.
Another angle here, which I don't understand: all of these VCs told their startups to bank at SVB, but neglected to tell these same startups to practice standard cash management. In other words, set up your bank accounts such that you do a daily sweep of all cash in excess of $250,000 into a money market fund. Had VCs told their companies to do this, there very likely would not have been a run at SVB. But it's not clear to me that VCs understand how banking works.
Here is a good twitter thread explaining why they kept their cash at SVB:
https://twitter.com/jonwu_/status/1634250770555219970
Essentially SVB offered them perks for keeping all their cash there that they found too hard to ignore, and I suspect they just discounted the risk since they figured the bank wouldn't fail and the government would bail them out if it did. The $250k limit isn't taken seriously.
Yeah I saw that Twitter thread. Shows me that VCs don't understand how banking works.
I can’t figure out exactly why, but there are people like David Sachs saying that his portfolio companies did have sweeps in place and still were unable to withdraw funds, possibly due to the California regulator.
Did they sweep to money market *accounts* or money market *funds*? The former are bank accounts that hold treasuries. The latter are not, and are not subject to FDIC insurance, and are not part of the fractional banking system. As he is a VC, I don't think that David Sacks understands how banking works.
Tangentially, it seems like a "regulation smell" (by analogy to "code smell", a pattern or practice well known for generating coding bugs) when you have an arbitrary threshold, like the $250B asset limit that used to be $50B, above which entities are very differently regulated. SVB apparently took pains to stay under the threshold, which is foreseeable system-gaming. Another example would be the rules that only apply to companies with 50 or more employees.
On reflection, the $250K limit on explicit deposit insurance is another arbitrary threshold that failed here. A simpler rule to fix both thresholds would be: if you offer any FDIC insured deposits, you must follow the rules for "systemically important institutions" (the rules that kicked in at $250B assets), and then 100% of deposits are insured, no arbitrary size cap. Otherwise, deposits at your institution are not insured at all. If nothing else, this would treat market actors more evenhandedly, align their incentives better, and be simpler to understand than the existing ruleset.
For months I have been reading how with the increases in the Funds rate that banks are making unseemly amounts of money. Apparently not all banks! Apparently not banks who choose to invest in long duration bonds.
Why would a bank be investing in long durarion bonds? I thought banks borrowed short duration and lended long duration. SVB seems to have flipped the script and was taking cash deposits and investing long duration. Did they not consider interest rates could increase? I'm a nobody and I knew it was foolish to buy long term debt when it was selling at all-time high valuations.
There should be claw backs on salaries and bonuses paid to the executives of failed banks. The greatest moral hazard is executives can pursue riskier strategies, be terribly wrong, and still walk away very well compensates for being wrong.
Agree with the analysis. My only comment is on the halting rhythm of the first line of the limerick. I believe this would improve it: "Regulators lay soft in their sleep"
The only solution to permanently end bank runs is full-reserve banking. The US gov will never allow them to happen because they will destroy the credibility of the existing fractional reserve banks (and also remove the basis for their arbitrary audit/exam powers over banking)
What would be the use of a full-reserve bank? It would have to charge its depositors a fee rather than pay them interest, since it can't lend their deposits out.
In the context of today, a full reserve bank could offer the following:
1) some degree of insulation from the demands of federal regulators (political cancellation) who use the pretext of deposit insurance to operate banks as an arm of government in service to its political aims
2) access to large and fast interbank transfers
3) assurance that your deposits are mechanically not subject to a bank run or arbitrary fee imposed by deposit insurance regulators. (assuming someone checks that the bank is not cheating on its full reserve claims)
Given that most demand deposit accounts have been yielding zero for decades the above benefits seem compelling enough to pay a fee for.
Also, the bank could operate an investment service that would allow for maturity matched investments outside your deposit account. These might look alot like CDs matched to loans of the same length. The important point is that when a client invests he agrees to bear investment risk.
Delong is wrong (it rhymes it must be true)- full deposit insurance doesn't prevent bank runs, it just slows them down. SVB had assets yielding 1.85% on their books, which means they could not pay interest to their customers of more than 1.85% or end up bankrupt even with mark to maturity accounting. Meanwhile, prior to their failure, the 4 week bill was at 4.66% and the 1 year treasury was at 5.2%. I know its elementary school math but any bank in better shape could offer them a 1 year return with a yield up to 3.35% higher than SVBs maximum offer. How long do you really think it would take before some startups realized that they could pick up an extra 20-30 million next year per billion in the bank just by moving their accounts? Oh and the Fed was indicating rates in excess of 6% and then their desire to HOLD them higher for longer.
When you look at the actual environment with VC money drying up and startups still not profitable it is undeniable that these startups would move their money for a higher yield if it was offered for long enough. This bank run, which Delong (and so many others) like to imagine is psychological only was rational and baked in. Interest rate risk is, at its core, opportunity cost risk. The ability to get a higher rate over there makes your lower rate worth less, but most macro economists look at econ 101 as an introduction to be ignored when you get to higher stuff and not as root causes in a complicated system that lead to complex outcomes.
Jason Furman this morning:
"P.S. I'm not particularly worried about moral hazard. The CEO, management & Board all losing their jobs. Equity going to zero. Bondholders won't be paid in full. These are all the entities that can effectively monitor, is unrealistic to expect depositors to do much monitoring."
https://twitter.com/jasonfurman/status/1635112159494701057
Yes, that is the party line. It's Baloney Sandwich, as I hope I explained.
Yes, there's always a reason not to worry about moral hazard.
Joe Weisenthal writes,
"In the end, all of Silicon Valley Bank's depositors were protected, while the shareholders and executive team got nothing. This is what a bunch of people were calling for to happen.
It has a whiff of tough-mindedness to it. It sounds like you're not just describing a bailout. You still believe in real capitalism. You don't want a repeat of anything like what happened in the Great Financial Crisis, with TARP and all that.
But the difference between this time and that time is not as wide as it seems. The bailouts in that crisis were largely about protecting depositors as well. For example, it's commonly claimed that Citigroup was bailed out. And yet Citigroup shareholders ended up losing about 98% of their money over the course of that bank run. Yes not 100%. But clearly the massive bailout was not about protecting shareholders, who are still to this day down over 90%."
https://twitter.com/TheStalwart/status/1635237440536338432
Getting nothing is insufficient punishment to deter the next bunch.
The way to eliminate moral hazard from banking, IMO, is to ban corporations from the banking industry. All banks and investment banks should have to be partnerships, so that the people who are responsible for protecting your life savings stand to lose their own -- not just the value of their shares in the bank -- if they fail. And all banks should be considered fiduciaries under the law, not merely businesses that owe you ordinary debt.
Then we can talk about outlawing dishonest practices such as making NSF fees a bank's primary profit center, so that banking becomes an honorable job again.
It seems like the answer is doing away with the FDIC and having private deposit insurance. Admittedly I haven't explored the idea in depth to find its flaws, but it seems like such insurers have incentive to risk weight their premiums and customers to decide then which bank with what insurers they trust. Either the bank would cover the premiums in their cost of doing business from however they earn money, or it could be an added fee the customer pays either to the bank or directly to an insurer. I guess the issue would be whether there is moral hazard that the government would be expected to bail out the private insurers.
All expect to go to sleep and wake up knowing they can access all amounts of money they have on deposit at a bank at par, on demand; it really is that simple. There are alternatives to see this happens, but my bet is that going forward all deposits at a bank will be guaranteed as money good, on demand will be the outcome of SVB crisis. There are many alternatives to see this outcome ranging from higher equity requirements on part of banks, maybe adopting an insurance company model, much higher insurance payments by banks to FDIC, and others; all have trade-offs and will be analyzed, but fact remains almost all depositors have no idea with regard to the solvency and liquidity of a bank. Nor do rating agencies once again as in Q4 each of Moodys and S&P had A3 stable and BB stable at end of Q4.
I'm puzzled by the belief that taxpayers are bailing out SVB. It looks to me like SVB is solvent as long as t-bonds don't drop again, and is being liquidated because it couldn't find a better way of handling its t-bond risk.
Brad DeLong:
But, as Noah Smith correctly points out, there was more: SVB did not need its asset sales to raise cash to exert price pressure against it. SVB’s core problem was that its Treasury bonds had lost mark-to-market value. In SVB’s accounting for its hold-to-maturity portfolio, the loss created by the fact that the bonds it held had fallen in price was balanced by an expected capital-gain offset that was going to accrue on the bonds when they were held to maturity. But that only works if the game of musical chairs continues: if the music stops and the bank is liquidated right now, that offsetting expected capital gain vanishes.
Noah Smith:
With VC funding having dried up, many startups had to survive by using their “runway” — burning through cash to pay their employees and other expenses while they waited for the market to recover. But this meant a lot of startups were all withdrawing a bunch of cash from SVB, while new VC rounds were failing to give SVB new deposits.
To meet these simultaneous demands for cash from startups using up their runway, SVB had to sell assets.
This why Progressives, Conservatives, and Libertarians ALL hate politicians.