Partha Chakraborty-
In a previous life, I was a Banking Analyst but I never covered SVB Financial Group (SIVB). This morning I had a chuckle looking it up on Yahoo Financials. “Undervalued,” declared the automated ratings genie. The fact that the same day SVB’s deposits and loans were acquired by First Citizens Bancshares of Raleigh, NC, after weeks of turmoil, made Yahoo’s prognostication more poignant; maybe Yahoo has a point there.
At the very minimum, SVB represented the worst of what is known as “Relationship Banking.” In the olden days of baking was a preserve of the rich, the connected, i.e., the ones who had a kinship of sorts with the banker. Routinely this meant the exclusion of the riff-raff – immigrants and Blacks constituted most of those red-lined. When banks said “it is a privilege to serve you,” it meant – often – that you have to be privileged enough. SVB just interpreted the term to fit the time and the place. It can be credibly argued that SVB worked hard to be the bank of, and for, the Stars of Silicon Valley. In its zeal to fit the bill, SVB became a stash fund, in effect, for the bro cabal that gives Silicon Valley its color, good or bad.
Being a Billionaire Bros’ Coffer (almost billionaire OK) had attractions beyond the reflected glory on Page 6. Cost of deposits were super low, deposits were plentiful and the Fed’s easy money meant that the effervescent market was handsomely reflected on its asset side. It was too good, and too easy, to be sustainable. As soon as the Fed started raising rates this cycle, depositors looked elsewhere for better yield on their liquidity accounts. Glued to social media as they are, news spread like fire, resulting in a classic bank run; hence the collapse of SVB. Idiocy of relationship focus held true on the other side of the ledger too. It is reported that one well-known company had USD 500 million in a single account when SVB collapsed, when a cursory glance at its financials would immediately assert an asset-liability imbalance.
To reiterate, banking is a financial relationship and both sides must be transaction focused. Otherwise, the market will force an economic reckoning, as it must. SVB is a living corpse because relationships meant too much for them and their clients, till it did not.
Not everybody can have the wherewithal to evaluate a bank. Deposit insurance is designed to address the liability side – all deposits up to USD 250K were insured so the average Jane or Joe will not be left holding the bag for the idiocies of bankers. As the agency in charge of supervision, the Fed has authority to issue reprimands, including cease-and-desist letters, fortified by various rules of supervision, including, but not limited to, Dodd-Frank rule. None of that helped.
It is not the relaxations to Dodd-Frank in 2018 that caused SVB collapse. The Bank Policy Institute concluded that SVB would fare no differently under the original. It is that the regulations were not designed for this, having devolved into a “check-the-box” to-do list for internal bureaucracies, lawyers, and regulators. It can be legitimately argued that the loan book of SVB was resilient, even in the wake of tech bubble softening. Anybody with a more complete picture – the Fed must be one – should have known that over-reliance on longer-dated treasuries would cause catastrophe in a rising-rate environment. They should have known most depositors came from a small group, leaving SVB vulnerable to multiplier effect in a possible bank run – exactly as it happened. They should have red-flagged that there was no Chief Risk Officer for eight months when these imbalances were bubbling up, one that could have put a stop to such egregious behaviors. In a well-functioning market, such a bad bank would go under. Asset side – the loans – will be bought off by another, small depositors will be protected under FDIC insurance; big depositors, however, will lose their shirts and skirts. They would, in turn, bring pressure on bank management, doing the job of the Fed – pre-collapse. That gets us back to the previous observation that SVB collapsed precisely because both the bank and its clients felt they, as friends, had each other’s back – that SVB was not loading up on money-losing instruments, and that depositors would not care about low yield.
No regulation can help solve this. What can help is to let banks fail, and insure that these failures cost little to the little guy or gal. Dodd-Frank is no panacea as I have argued repeatedly. On the contrary, it is a hedge for bank managers’ lack of vision or effort.
Imagine a world where market discipline enforced by large depositors was absent. I would not blame if warning sirens are going crazy in your head just at the thought of it. We have seen the movie before – in the Savings & Loan (S&L) crisis of the 1980’s. To recap, S&L – also called “thrifts” – numbered over 4000 with assets over USD 600 billion, roughly half of all outstanding US home mortgages at the time. When Paul Volcker tackled “Great Inflation” head on by hiking up rates, mortgages on S&Ls’ book drastically lost value. On top, cost of funding jumped in a new rate regime. Together, this resulted in a “negative spread,” over time S&Ls became insolvent. In the 15-year period ending in 1995, more than a thousand lenders went bust, costing taxpayers over USD 160 billion.
Mismanagement was the most visible cause for the debacle. In a tale mimicking SVB, where all-expense-paid ski trips were handed out routinely, S&Ls lured clients by “lending against racehorses, golf courses, and artwork,” and themselves lived ostentatiously — “the corporate jets, all that stuff was real.” Something else made it all possible, even logical – blanket deposit guarantee issued by the Federal Savings and Loan Insurance Corporation (FSLIC). Thrifts could never die suddenly due to a bank run but became walking-dead zombies with the unwavering support of regulators and no pressing market-driven disciplinary mechanism. When the house of cards came falling down, no FSLIC guaranty could prove adequate. In August of 1985, FSLIC only had USD 4.6 billion in reserves, while losses were estimated at USD 20 billion. Within two years USD 10.8 billion recapitalizations of FSLIC was authorized, in two more years the two governing bodies were dissolved.
Is it too much to attribute their disreputable behavior to the cocoon of guaranty offered by regulators? Not in the least.
That brings us to today. In the wake of meltdown at SVB, Signature Bank and First Republic Bank, the Fed created a new program called The Bank Term Funding Program (BTFP) to provide emergency liquidity. BTFP offers term loans to eligible depository institutions that pledge qualified assets including U.S. Treasuries, agency debt, mortgage-backed securities, and others. The Fed will accept them at face value as collateral, instead of a lower market value. Estimated at USD 2 trillion in size, BTFP wipes away market risk from (broadly defined) fixed-income investments, a very significant part of the asset book of any bank. Earlier this month the Fed insured all deposits at SVB post collapse, no matter the size. In so doing, the Fed Chair Janet Yellen SVB invoked the systemic risk exception, “which permits the FDIC to protect all depositors.” The Fed also discussed using Treasury funds to provide insurance to all deposits without a Congressional approval, though she clarified the next day that she has “not considered or discussed anything having to do with blanket insurance or guarantees of deposits.”
When existing thrift regulations implied S&Ls’ ledgers were protected on both sides, management became rapacious and reckless, they had no fear of opprobrium by the market forces. If the Fed truly does go forward with a “blanket” deposit insurance, as some political busybodies are clamoring for, on top of the new cover of BTFP, regulators will, once again, remove any fear of the market, both on the asset side and the liability side. That is a clear case of moral hazard, of unintended consequences, of vicious cycles of mismanagement and collateral damage. Just as it happened with SVB, or the S&Ls, moral hazard will rule the way bank management works across the entire vertical.
Financial crises happened to various home teams, but one truth emerges from the wreckage – take away the discipline imposed by market’s censure, all you get are suicidal tendencies masked as personal greed. That is nothing new nor unique to financial services. In a well-functioning capitalist economy – and I still think the US strives to remain one – the market is always the best medicine, with some supplements here and there. Specifically, for banking it means that protection – on either side of the ledger – need be available for use on a temporary basis and for outlier cases, and only to save the little guy and gal. Anything more only insures death of the franchise – maybe sudden, maybe slow – with collateral damage on other parts of the economy. Maybe bigger banks will become too powerful and create a new systemic risk (Credit Suisse, anyone?). Maybe smaller banks overall will be chastened by clients, and therefore, they will make their services more inaccessible with lasting damage to all parts of the economy. Maybe the banking system will face new vulnerabilities not foreseen yet. In their zeal to smother the market’s process of natural selection of winners and losers, with ringfenced casualty, US regulators are making the problem systemic but hidden, with lasting and deep consequences.
You are forewarned, here and now. Don’t say it ain’t so, when and not if.
