Thoughts on SVB

The situation around the collapse of Silicon Valley Bank continues to move quickly, and at the time of writing it is far from certain that contagion to other banks can be avoided. This live feed from CNN is a useful way of monitoring events as they occur. For now, here are just a few thoughts on some aspects of the situation.

Moral hazard:  Treasury Secretary Yellen was adamant over the weekend that there would be no 2008-style bailouts of SVB or any other bank that got into similar trouble. Then it was announced that the FDIC would be guaranteeing full access to their money to all depositors at SVB, not just those covered by the existing $250,000 deposit insurance limit. Arguably, since shareholders in SVB are going to lose all their money, this is not strictly speaking a bailout. Still, it does raise questions about moral hazard: if all deposits are now in effect FDIC-insured, what incentive do large depositors have to ensure that they are placing their funds in safe institutions? Why should they not just move their money to whosever is paying the most on any give day, secure in the knowledge that Uncle Sam will make them whole if the worst happens/

There is a counter-argument, however. If you are a sizeable company responsible for a million-dollar payroll every week, you can hardly be expected to parcel out your cash in $250k tranches among numerous banks in order to keep everything fully insured. You can opt to deal only with one of the "too big to fail" banks, but if everyone starts to do that, competition within the US banking sector, which has already seen the number of banks fall precipitously in recent decades, will be eroded even further.  

The nature of risk: Secretary Yellen said that suggestions that SVB's problems were largely the result of its concentration on the high tech sector were incorrect. That does indeed appear to be the case: it looks as if an orderly wind-down of the bank's loan book -- something that is obviously not possible any longer -- would have produced enough cash to meet all of its liabilities. 

What actually did the bank in seems to have been....the Fed's aggressive tightening policies. SVB's extensive holdings of Treasuries fell sharply in value as the Fed raised rates. Prudent risk management would have seen SVB selling some of those holdings in order to raise cash. Instead it seems to have held onto them, only trying to unload them when the run on deposits actually began, at which point they were no longer adequate to pay out all those who wanted to be paid out in short order. 

There are many different kinds of risk. Treasuries are considered low risk because they are backed by the credit of the Government, but there are still major valuation risks resulting from interest rate movements, as SVB just discovered. Early in my career I as involved in the asset/liability management committee of a major Canadian bank. This was in the days before the swap market came into being, and the committee's job was to ensure a manageable balance between assets and liabilities within each maturity time "bucket". The swap market has drastically altered how these things are done, but it looks as if SVB was not paying attention to this at all. 

Bad behaviour: as is inevitable when something like this happens, stories are starting to emerge about possibly dodgy events within the bank just prior to its collapse. It has been reported that the CEO sold a chunk of stock not long before the collapse, which is prompting suggestions that he should be made to pay back the proceeds of the sale. There are also reports that employees of SVB received bonus payments just before the collapse; you would hope that the risk management team were not among the recipients. 

It's not just within the bank that there may have been some dubious behaviour. It looks as if the run was triggered by some well-known Silicon Valley names advising friends and competitors to get their money out pronto -- no doubt after first liquidating their own deposits.  In a world of near-instantaneous communication, it's not hard to trigger an all-but-unstoppable bank run that way, which points to the need for regulators to think hard about what needs to be done to contain this kind of issue in the future.

Fed policy: the collapse of SVB may well have been triggered by the Fed,  making Chair Powell's regular assertions that "we know what we are doing" look rather foolish. Does this mean that next week's FOMC meeting will keep rates on hold?  That seems to be the way markets are thinking right now. February CPI data, due out on Wednesday, will be crucial; a low print might give the Fed a convenient excuse to pause the tightening cycle, but it still seems likely that the FOMC would prefer to go ahead with a 25 basis point hike, purely for credibility's sake. 

Interesting times indeed! In a fast-moving situation, much of the foregoing may be proven dead wrong at any second, and no doubt there will be a lot more to be said in due course.