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The SVB story: narrative and causes
How it's possible to blame different actors depending on your point of view
Before saying anything else, I would like to recognize Edward J. Kane, who I just learned died two weeks ago. Kane’s understanding of the S&L crisis shaped my perspective. For example, he wrote,
In a kind of Gresham's Law scenario (an analogy suggested by Joseph Stiglitz), "bad" zombie thrifts tend to drive out healthy competition. Zombie institutions do this by sucking deposits away from their competitors by offering high interest rates and by bidding down loan rates on high-risk projects. This squeezes profit margins and the proliferation of weak competitors and risky positions ultimately raises deposit-insurance premiums for everyone.
In other words, You Don’t Want Zombie Banks.
SVB’s path to disaster
Think of Silicon Valley Bank as having gone down a path that ended in disaster. Along the way, there were various actors who might have given SVB less encouragement to go down that path or taken positive steps to keep SVB from going down that path. Depending on how you look at those actors, you can play the blame game in different ways.
The path was this:
A few years ago, thanks to a frothy venture capital market, the tech start-ups in SVB’s customer base were flush with cash. SVB found itself with a supply of deposits that exceeded the demand for loans. It invested the excess in government securities. To try to squeeze some kind of earnings out of its investments, it invested in long-term government bonds, which might have yielded between 1.25 percent and 2.00 percent.
Subsequently, as you know, the financial winds shifted. Inflation heated up, and the Fed could no longer keep interest rates low. More recently, long-term bond rates have risen to 4 percent or more.
As part of this wind shift, venture capital became less plentiful. Ken Wilcox, who was CEO of SVB from 2001-2011, wrote in the WSJ the other day,
But the venture market became less frothy, and the venture capitalists’ portfolio companies needed some of their deposits back.
Hemingway famously said that he went bankrupt gradually, then suddenly. In 2022, SVB was gradually going bankrupt, because to meet deposit outflows it had to sell assets at a loss. Then, in the week of March 6-10, SVB’s big depositors, who had more than the $250,000 maximum covered by deposit insurance at the bank, got nervous and started to run for the exits. Now SVB was going bankrupt suddenly, and over the weekend the government stepped in to take over SVB and pay off all depositors, insured or otherwise.
Looking for someone to Blame
It’s nobody’s fault, but we need somebody to burn—Elvis Costello
We could talk about fiscal and monetary policy. For many years, especially during the pandemic, the Federal government ran large deficits, and the Federal Reserve monetized these deficits using so-called “quantitative easing.” This put too much paper wealth into the economy, some of which found its way into the venture capital universe and hence into SVB.
The loose fiscal and monetary policy also—finally—sparked inflation. That in turn made it impossible to hold interest rates down, and when rates shot up, any bank with a large portfolio of long-term bonds took losses.
In fact, the Federal Reserve itself has the biggest loss of all, because under “quantitative easing” it borrowed from member banks and in the money market to finance huge purchases of long-term Treasury bonds and mortgage-backed securities. The Fed is SVB on steroids.
So you can count Congress, Presidents, and the Fed as culpable actors.
Then you can go after the accounting scam called “Held to Maturity.” Instead of SVB having to report the decline in its asset values as they occurred, it put a lot of its long-term bond holdings into this HTM category, so they were exempt from being marked to market. That meant that SVB and other banks who used this device could “extend and pretend” exactly the way the Savings and Loans did in the 1980s.
The irony is that once you put stuff into HTM, if you sell any of it you have to mark all of the rest to market. So SVB was handcuffed, and when it needed money to pay depositors it could not sell the bonds that were in HTM. Instead, it had to borrow money or raise capital.
Incidentally, as part of its weekend rescue plan for all banks, the Fed set up a loan fund for banks with HTM assets, so they will not have to sell them if they need cash. Instead, they can go on as Zombie banks. Have a nice day.
SVB would have been classified as a Systemically Important Financial Institution under Dodd-Frank, which put you in that category if you had more than $50 billion in assets. But lobbyists and their lackeys in Congress (more Republicans than Democrats, but plenty of the latter) got a law passed raising the threshold for SIFI status to $250 billion. It was passed during the Trump Administration, so by all means let’s blame Trump!
But wait. How exactly are SIFIs regulated differently with regard to taking interest rate risk and using HTM? Not at all, as Alf points out. So even as a SIFI SVB might have gone down the same path.
And let’s blame the venture-funded tech firms two ways. First, they should have done due diligence on SVB before they made deposits over the insurance limit. Instead of trusting the bank with so much in uninsured deposits, they should have kept money out.
Second, when SVB got into trouble, they should have made an agreement not to run on the bank. It was selfish and short-sighted of them to take try to get their money out.
Do you understand? The responsible thing for the tech bros to have done would have been to NOT deposit money in SVB when it seemed to be doing fine and to KEEP money in when it got into trouble. Blame them regardless of whether they put money in or took money out.
During SVB’s hectic last days, it was hoping to raise capital. But as Matt Levine reports, SVB bungled the capital raise by making it obvious they were desperate.
Experienced bureaucrats at the FDIC were hoping to arrange a merger with a big bank. But the political leaders in charge of the FDIC were anti-merger by orientation. In addition, Jamie Dimon and other bank executives were tired of cooperating with the FDIC by buying failed banks and then watching the government screw them over afterwards by fining them for actions taken by the failed banks long before the merger.
I may have overlooked other factors in the demise of SVB. I’m still curious about what I call the dog that didn’t bark (except I just read that it did—see below). Based on what we have been told so far, the path by which the bank was busted is relatively straightforward. But there were many ways in which it could have avoided that path or been steered away from it.
As a result, it is difficult to nail down a causal story that everyone can accept. As you can tell by the tone of my comments, I am more inclined to blame government actors than private actors. But you can make the call the other way and not be definitively wrong.
The Dog Did Bark!
In his column yesterday, Matt Levine quoted from a Bloomberg story.
Just over a year before Silicon Valley Bank’s collapse threatened a generation of technology startups and their backers, the Federal Reserve Bank of San Francisco appointed a more senior team of examiners to assess the firm. They started calling out problem after problem.
As the upgraded crew took over, it fired off a series of formal warnings to the bank’s leaders, pressing them to fix serious weaknesses in operations and technology, according to people with knowledge of the matter.
I was looking for that. In fact, the other day, as I was taking a walk and rehearsing my appearance on Reason TV, I kept ruminating on the fact that SVB had $60 billion in deposits in early 2020 and about three times that amount by the end of 2022.
I kept thinking: their operations had to be a sh!tshow. That is way too much growth for a bank. It stresses your management controls. You can suffer from embezzlement, misappropriation of funds, huge trading losses with the trade tickets hidden in a drawer, new services launched without systems in place to connect to the main accounting system, junior employees handling 50 times the money they were used to handling, newly promoted managers hiring new staff and throwing responsibilities at them the way the Russians are throwing raw recruits into the war against Ukraine.
But as of when I was ruminating, I had not heard any such stories. I was saying to myself that it was like Sherlock Holmes, wondering about the dog that didn’t bark.
Well, the dog did bark. Not that operational problems have been implicated in SVB’s failure. It still seems like interest-rate risk and heavy reliance on uninsured deposits are the story. But I feel somewhat vindicated in my rumination.
In fact, as I said during my appearance, rapid growth for a bank is the reddest of red flags that a regulator can see. But this just goes to show you that you cannot rely on regulation. Houdini always escapes the straitjacket.
If I Were in Charge
If I were in charge of designing financial regulation, rather than try to make the financial system hard to break, I would try to make it easy to fix. I sketched this out thirteen years ago.
But my approach would give less power to bureaucrats to channel credit and to see themselves as heroes who rescue the financial system from crises that those bureaucrats helped to create.