Forcing solvent banks to take over and insolvent banks doesn't have a very good track record does it? The purchasing banks often get screwed with fines and chastised for their acquistions' prior actions.
And even theoretically... either the government is leaning on a private party to do the buying, or the government is creating a windfall for it. Finally, it seems a lot like the idea of MBSes. Let's package together a bunch of crappy banks with some good ones. Just obscures the issues.
When Basel II was under consideration in the early 2000s, the Shadow Regulatory Committee recommended an alternative. All banks would have a mandatory issuance of sub debt. This would used to monitor the valuation of the bank. If the market value of capital to assets fell below 2% (I believe that was the percentage) the bank would be closed via FDIC auction procedure. This would eliminate zombies and protect the insurance fund. Unfortunately, this was a market-based solution. God forbid that economic rationality enter into the regulatory sphere.
I see a lot of blame for SVB is being placed on the FDIC but I believe the real problem is likely with their primary regulator--the California Department of Financial Protection. I suspect a lot of regulatory failure started there. As far as Arnold's proposal, it has more theoretical merit than practical. Bank balance sheets are incredibly complex, with most of their assets and liabilities having opaque market values (or none at all). Worse, there are a lot of embedded options on both side of the balance sheet and the only way to value the bank's book is to make assumptions about the potential impact of those options. During periods of high market volatility, a bank may go from zombie status to completely viable in just a couple of days. Finally, the regulatory system tends to be backwards looking. It's tough to see the cliff in front of you when you're looking out the rearview mirror while driving. There are solution to that.
Regulators and legislators in our era prefer to wait for everything to explode, which gives them the cover to act freely. There's a distaste for the adverserial process in modern American public life. They see crisis as a shortcut around having to expend effort in the process of persuasion and compromise. So, I think that what they will do is try to paper it over until it explodes, at which time there will be a bull market in moralizing and the creation of unworkable regulator regimes that try to overcorrect. It's easier to feed the zombie and then to act surprised when the zombies claw their way out of containment.
Speaking of zombies, when I was in residency I rotated at a downtown psychiatric hospital which was at the time being severely mismanaged. It was so bad that they couldn't retain nursing staff. Instead of fixing the problem, "they" (who exactly I'm not sure) started writing nurses names down on the shift log even when they weren't there in order to make it look like they had a full staff. One staff member called them "ghost" and "zombie" workers.
What Kling says so seems so obvious it only makes me wonder why everyone with the power to stop it doesn't.
I have little doubt Gordon Browning hit on one of the good reasons not to step in. I'm almost as certain The Ice Pick hit on a not so good reason they don't. I'm curious about other reasons, maybe more curious the good reason not to.
Important analysis not covered - SVB had put its depositor's money mostly into "risk free" US Treasuries. It lost billions on these no-brainer assets. Because 10 year Treasuries that pay 1.25% have one cost, but it's less than 10 yr Treasuries that pay 2.5%.
When the Fed increased interest rates, it devalued all outstanding US Treasuries - in all US & Foreign banks.
"Wells Fargo has made loans with nearly 70% of its customer’s money, while SVB had a more conservative “loan-to-deposit ratio” of roughly 42%. ...
SVB failed because they parked the majority of their depositors’ money ($119.9 billion) in US GOVERNMENT BONDS."
As interest rates go up, bond values go down.
"Their 2022 annual report, published on January 19th of this year, showed about $15 billion in ‘unrealized losses’ on their government bonds."
With capital of only $16 billion - the value of their bonds lost about 10% (my guesstimate, not article)
"The FDIC ... estimates unrealized losses among US banks at roughly $650 billion."
Every bank has capital requirements. Most have US treasuries as part of their capital. Fighting inflation with higher rates reduces the value of that capital. This is a huge part of the Mark-to-Market valuation issue, as it interacts with capital requirements, and highlights why the "value at par" part of the bailout is so key.
few experts, including Arnold, have noted this explicitly -- but I expect we'll be hearing more about it. Much more. If the US Treasury is NOT risk-free, and it clearly isn't, lots of the rocket scientist finance models have a huge, wrong assumption inside them.
Russia & China & Iran; maybe ? Saudi Arabia; ? India creating a non-USD based international settlement system.
Thanks to Biden's inflation and supply side constraints.
Without total fraud, the SVB time mismatch was caused by the rapid change in the US dollar as a "store of value". Like the old days of shaving gold off the coins, the feds have been printing money at a very high rate which, with time delays, decreases the value of the dollar. We can the have a measurable impact between currency value and real value we observe as inflation.
If the decrease in the store of value (inflation) is constant you can counter this risk, but when it is large and variable time mismatches between short and long assets and liabilities becomes inevitable.
If you believe that inflation was transitory after all the money supply increase over the last half a decade you become a zombie. Very strong negative real interest rates just destroy the "store of value" component of money.
Meanwhile we evolved a regulatory "vetocracy" that prevents the creation of real physical value like factories and infrastructure.
Glad to see you writing about the banking sector again! Not so glad about the circumstances causing it, but hey, I appreciate the insights even if I deplore the circumstances that prompt them :D
Do you think there is a real solution to banking issues so long as there is a FDIC? I ask because it seems like every fix to the banking sector seems to be a patch to limit the damage that the massive moral hazard of gambling with other people's money that is fully protected causes. I was thinking that one possible work around might be to put bank executive's income (some large percent of it anyway) in escrow for 1-2 years, contingent on the bank existing, and thus forcing a longer term view that is punishing to a "just have a few good years then it can all explode and I am fine" mindset. But then again, I am not optimistic that they can't find a way to work around that.
Forcing solvent banks to take over and insolvent banks doesn't have a very good track record does it? The purchasing banks often get screwed with fines and chastised for their acquistions' prior actions.
And even theoretically... either the government is leaning on a private party to do the buying, or the government is creating a windfall for it. Finally, it seems a lot like the idea of MBSes. Let's package together a bunch of crappy banks with some good ones. Just obscures the issues.
When Basel II was under consideration in the early 2000s, the Shadow Regulatory Committee recommended an alternative. All banks would have a mandatory issuance of sub debt. This would used to monitor the valuation of the bank. If the market value of capital to assets fell below 2% (I believe that was the percentage) the bank would be closed via FDIC auction procedure. This would eliminate zombies and protect the insurance fund. Unfortunately, this was a market-based solution. God forbid that economic rationality enter into the regulatory sphere.
I see a lot of blame for SVB is being placed on the FDIC but I believe the real problem is likely with their primary regulator--the California Department of Financial Protection. I suspect a lot of regulatory failure started there. As far as Arnold's proposal, it has more theoretical merit than practical. Bank balance sheets are incredibly complex, with most of their assets and liabilities having opaque market values (or none at all). Worse, there are a lot of embedded options on both side of the balance sheet and the only way to value the bank's book is to make assumptions about the potential impact of those options. During periods of high market volatility, a bank may go from zombie status to completely viable in just a couple of days. Finally, the regulatory system tends to be backwards looking. It's tough to see the cliff in front of you when you're looking out the rearview mirror while driving. There are solution to that.
Regulators and legislators in our era prefer to wait for everything to explode, which gives them the cover to act freely. There's a distaste for the adverserial process in modern American public life. They see crisis as a shortcut around having to expend effort in the process of persuasion and compromise. So, I think that what they will do is try to paper it over until it explodes, at which time there will be a bull market in moralizing and the creation of unworkable regulator regimes that try to overcorrect. It's easier to feed the zombie and then to act surprised when the zombies claw their way out of containment.
Even if zombie they should be with brand new owners. Fico should mean old owners loose everything. They allowed the need for Fdic
Speaking of zombies, when I was in residency I rotated at a downtown psychiatric hospital which was at the time being severely mismanaged. It was so bad that they couldn't retain nursing staff. Instead of fixing the problem, "they" (who exactly I'm not sure) started writing nurses names down on the shift log even when they weren't there in order to make it look like they had a full staff. One staff member called them "ghost" and "zombie" workers.
Seems like zombies are everywhere these days.
What Kling says so seems so obvious it only makes me wonder why everyone with the power to stop it doesn't.
I have little doubt Gordon Browning hit on one of the good reasons not to step in. I'm almost as certain The Ice Pick hit on a not so good reason they don't. I'm curious about other reasons, maybe more curious the good reason not to.
Arnold, is this the longer answer to the question I asked yesterday? Your short answer was, “HTM is a scam.”
Important analysis not covered - SVB had put its depositor's money mostly into "risk free" US Treasuries. It lost billions on these no-brainer assets. Because 10 year Treasuries that pay 1.25% have one cost, but it's less than 10 yr Treasuries that pay 2.5%.
When the Fed increased interest rates, it devalued all outstanding US Treasuries - in all US & Foreign banks.
See: https://www.sovereignman.com/trends/if-svb-is-insolvent-so-is-everyone-else-146244/
"Wells Fargo has made loans with nearly 70% of its customer’s money, while SVB had a more conservative “loan-to-deposit ratio” of roughly 42%. ...
SVB failed because they parked the majority of their depositors’ money ($119.9 billion) in US GOVERNMENT BONDS."
As interest rates go up, bond values go down.
"Their 2022 annual report, published on January 19th of this year, showed about $15 billion in ‘unrealized losses’ on their government bonds."
With capital of only $16 billion - the value of their bonds lost about 10% (my guesstimate, not article)
"The FDIC ... estimates unrealized losses among US banks at roughly $650 billion."
Every bank has capital requirements. Most have US treasuries as part of their capital. Fighting inflation with higher rates reduces the value of that capital. This is a huge part of the Mark-to-Market valuation issue, as it interacts with capital requirements, and highlights why the "value at par" part of the bailout is so key.
few experts, including Arnold, have noted this explicitly -- but I expect we'll be hearing more about it. Much more. If the US Treasury is NOT risk-free, and it clearly isn't, lots of the rocket scientist finance models have a huge, wrong assumption inside them.
Russia & China & Iran; maybe ? Saudi Arabia; ? India creating a non-USD based international settlement system.
Thanks to Biden's inflation and supply side constraints.
Without total fraud, the SVB time mismatch was caused by the rapid change in the US dollar as a "store of value". Like the old days of shaving gold off the coins, the feds have been printing money at a very high rate which, with time delays, decreases the value of the dollar. We can the have a measurable impact between currency value and real value we observe as inflation.
If the decrease in the store of value (inflation) is constant you can counter this risk, but when it is large and variable time mismatches between short and long assets and liabilities becomes inevitable.
If you believe that inflation was transitory after all the money supply increase over the last half a decade you become a zombie. Very strong negative real interest rates just destroy the "store of value" component of money.
Meanwhile we evolved a regulatory "vetocracy" that prevents the creation of real physical value like factories and infrastructure.
Glad to see you writing about the banking sector again! Not so glad about the circumstances causing it, but hey, I appreciate the insights even if I deplore the circumstances that prompt them :D
Do you think there is a real solution to banking issues so long as there is a FDIC? I ask because it seems like every fix to the banking sector seems to be a patch to limit the damage that the massive moral hazard of gambling with other people's money that is fully protected causes. I was thinking that one possible work around might be to put bank executive's income (some large percent of it anyway) in escrow for 1-2 years, contingent on the bank existing, and thus forcing a longer term view that is punishing to a "just have a few good years then it can all explode and I am fine" mindset. But then again, I am not optimistic that they can't find a way to work around that.
And the new owners have to put up diffident capital not to be zombies. Not doing this was one of the errors of 2008-09