March
12
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Silicon Valley Bank – Did the Fed break it or was it broken already?
By David Nelson, CFA
The failure of Silicon Valley Bank has sent regulators and the Federal Reserve scrambling for answers on how and why this happened. In some ways little has changed since the dark days of the financial crisis.
This was a bank pushing the envelope, growing at break neck speed and seemingly unafraid that rising interest rates could turn their model upside down.
While it’s an obvious failure of management perhaps the bigger question is where were the regulators? California regulators along with the Fed should have been well aware of the situation yet it seems to have come as a complete surprise.
With assets of $209 Billion the failure of SVB is the largest since Washington Mutual in 2008.
There will be a lot of op-eds and of course finger pointing as to how SVB was allowed to grow this fast and take on this level of interest rate risk.
You’re borrowing short term with customer deposits that got invested in long term securities that decline in value as interest rates rise.
It’s not necessarily the model that’s in question but how the regulators let them push it as far as they did. 90% of SVB’s deposits were uninsured. That along with rapid growth and long dated assets exposed to interest rate risk should have given regulators pause.
Blood on the streets
Bloomberg Data
The wholesale selling of the banking sector in a 48 hour period wiped out $Billions in investor capital. The KBW regional bank index was down close to 13% on the week. When the news broke the market reaction was swift and severe. Shoot first ask questions later.
On Thursday just about the entire sector was for sale but by mid-day Friday investors were starting to rotate into GSIB’s Globally Systemic Important Banks like JP Morgan (JPM) and Wells Fargo (WFC). The thinking of course being too big to fail.
Next Steps
On Sunday Secretary of Treasury Janet Yellen said the United States won’t bail out SVB. The Federal Deposit Insurance Corporation said on Friday that all insured depositors would have full access to their insured funds no later than Monday morning.
Unfortunately, many of the depositors in this bank had assets in excess of the $250k insurance cap. SVB had become a favorite of venture capital firms and even the wine industry.
Fed to the Rescue
Bloomberg
Late Sunday index futures exploded higher on news that the Fed was creating a new Bank Term Funding Program that would safeguard deposits at the failed institution. Details are scarce so I’ll have to reserve judgement until I can dig into the release.
Today banks are far better capitalized than during the financial crisis and the situation at SVB may prove not to be systemic. However, the Fed isn’t an innocent bystander.
The Fed’s failure in 2021 set the stage for much of what we are seeing today. The late start at getting rates off of zero still buying bonds all the way until March last year let inflation become entrenched in the system.
Yes, there were many other factors including supply chain issues that had been building since Covid some of which are still with us today. Add an administration that continues to offer legislation that would flood the system with even more capital, pours fuel on the fire.
We’ve had 8 hikes in Fed Funds since March last year with another expected on the 22nd. Coming into last week investors had priced in hikes all the way till September with no chance of a cut until sometime next year.
What a difference a week makes – On the heels of last week’s blow-up investors are now pricing in June as the last hike with the possibility of a cut as early as December.
Bloomberg Data
We still have a lot of data between now and the next rate decision with CPI and PPI prints on Tuesday and Wednesday this week.
All of the above complicates the decisions the Fed faces but I think they should all re-read the paper by Raphael Bostic, Atlanta Fed President from November last year. He pointed out that Fed policy can take 18 months to two years to wash through the system.
I think when the post mortem on Silicon Valley Bank is complete we’re going to find a lot more than just rising rates at the heart of the problem.
No, I don’t think the Fed broke SVB but give them time. If history is any guide they will keep hiking until something breaks.
*At the time of this article some funds managed by David we’re long JPM
DAVID NELSON, CFA 