Lingering Questions from the SVB Fallout

Four months ago, everyone was learning about SBF, now we’re learning about SVB.

Silicon Valley Bank (SVB) was likely the fastest bank failure – from rumor to demise – in American history. Unlike Sam-Bankman Fried (SBF), and his failed crypto exchange, fraud didn’t cause SVB’s downfall. SVB blew up with while holding, mostly, high quality assets (things like Treasuries) on its balance sheet.

The media super cycle that followed fleshed out many of the key elements of this story, including what can happen to banks when the Fed is raising rates, management is bad (terrible?) at risk management, and the depositor base is concentrated in one industry.

But this story is far from over, and many questions remain, including:

Whose fault was this?

Blaming one single person or entity for a failure generally misses the mark. There’s the old saying, “it takes two to tango” and in the case of SVB, possibly more.

Three parties – and the arguments – people are focused on:

1) The Fed: by hiking rates as quickly as they did, something was bound to break, and it seems SVB was the first thing that broke.

2) SVB management: management incorrectly held long-term bonds with a depositor base that was short-term oriented and didn’t do anything to hedge their interest rate risk.

3) SVB depositors: the deposit base was primarily concentrated in technology companies – which benefitted them as tech thrived – but quickly went in reverse when the market turned.

Deciding who is responsible for what percentage of the collapse is an impossible task, but each compounded on one another to create the conditions that led us here.

What was unique about SVB’s depositors that made them susceptible to a bank run?

On Bloomberg’s Odd Lots Podcast, bank analyst Dan Davies made the interesting point:

“SVB’s risk department didn’t realize the extent to which their customers were not separate entities in terms of financial decision making. The mistake was thinking that even within tech they were diversified. They thought they had thousands of customers with millions in deposits, but they actually had a few customers (mostly venture capitalists that ran in the same social circles) with billions who all coordinated leaving together, causing the run.”

The asset-liability mismatch and risk management were bad, but the false sense of diversification and herd nature of venture capital killed them.

Will more domino’s fall?

Two other banks failed in the early part of last week as well. Heading into the weekend, Credit Suisse became a “going concern” (fancy terminology for heading towards insolvency) and received a bailout from UBS and the Swiss government.

First Republic – another large northern California based bank – has received large capital injections from a collection of big banks.

In short, it’s clear Silicon Valley Bank is creating contagion in the banking industry, the extent of which is unclear.

JP Morgan’s head of asset management, Mary Callahan Erdoes, remarked the following on whether this crisis will run through the entire banking system:

“We don’t think this crisis is systemic. The biggest banks in the U.S. have other buffers [compared with Silicon Valley and other failed banks], particularly a much bigger piece of long-term debt on their balance sheets, and much more diversified types of clients, including institutional and retail clients.

One of the lessons is that when something looks too good to be true, it just might be, and that comes from high deposit rates and low loan rates. Another lesson is that these problems will go away, and regulators will help make that part of the banking system even stronger.

During the 2008 financial crisis, the large institutions were the focus. Today the loan-to-deposit ratio for U.S. banks is at a multidecade low, and capital ratios are at a three-decade high. Both of those statistics are telling you that the large, systemically important institutions are doing all the things that we hoped would happen when we tried to make the banking system stronger.”

It’s too early to know how widespread the damage but there’s hope that big money center banks are not within firing range of this crisis.

Does the Fed reverse course?

The Fed was expected to hike rates 25 basis points at each of their next three meetings as recently as last week. This is no longer the expectation. The futures market is now pricing a 50% chance of a rate hike and a 50% chance of no hike this week.

Via Bespoke, “Fed Funds Futures have priced out 175 basis points (7 25 bps moves) by the January 2024 meeting. At 3.68% (down from 5.43% last week), that's about 100 bps lower than the current Fed Funds Rate.”

Regardless, the Fed now must think much harder about their future direction.

Is my money safe in banks?

People are worried about the safety of their money and it’s not something we usually think to worry about.

There was a brief period last week where SVB depositors thought they lost everything. Then the bailout assurances came from the government depositors would have full access to their funds.

The government intervention certainly makes it feel like all deposits are de facto guaranteed going forward. To be clear, this is not a statement of fact.

Federal deposit insurance usually only covers up to $250,000, but only 12% of SVB’s depositors were insured, meaning a significant majority of their depositors had more than $250,000 in their account.

If the opposite was true, and 90% of SVB’s depositors were insured, would this bailout have come? We can’t say with certainty, but the answer is probably not.

People will likely be re-evaluating the cash levels they keep at banks going forward. If you have more than FDIC approved amounts, you should probably look into money markets, treasuries, or other alternative cash management options.

But for the average commercial bank depositor, money still seems pretty safe in a bank.

What is the Federal Deposit Insurance Corporation (FDIC)?

The FDIC is an independent agency of the U.S. government. Their purpose is to provide insurance to bank depositors in case banks fail.

FDIC is not paid for by taxpayers, it’s paid for by the banks themselves. FDIC-insured banks pay premiums to the agency, with premiums paid based on the size of deposits that banks hold, in addition to the risk they’re judged to be taking.

FDIC was created in 1933 in response to bank failures during the Great Depression, which left millions of depositors without access to their funds. The FDIC plays an important role in maintaining confidence and stability in the banking system.

At the end of 2022, the FDIC insurance fund had roughly $128 billion in assets.

Is technology speeding up major market events?

The speed of the bank run and corresponding response by the government was extraordinary.

Prior Fed tightening cycles often led to financial flameouts – one parallel example being the Savings and Loan (S&L) Crisis during the eighties. The S&L Crisis played out over a decade and more than a thousand banks went under.

During that crisis, people had to physically show up to a branch to pull their deposits. These days, you don’t even need to call anybody – you can ask for your money back with a couple clicks.

Major market events seem to happen faster these days. Covid saw the quickest bear market in history followed by the quickest recovery in history – all in about 90 days.

However this story ends, hopefully we know sooner rather than later.

After an incredibly volatile week, both in headlines and market moves, stocks ended in positive territory, with the S&P 500 rising 1.4%. The index is now up 2.0% year to date.

Going forward, what actually happens could be worse than what markets are reflecting. But there’s also the chance things could be better.

Is that the most non-answer answer of all-time? Probably.

Unfortunately, this is what you sign up for when you invest in stocks. Uncertainty is always high, and volatility is nothing new. There will always be black swans floating around and pundits lamenting about the next risk that pushes the economy over the edge.

But history would indicate – given time – things often turn out better than we expect.

In the words of William Bernstein, “the only black swans are the history that investors have not read.”