Should Have Seen It Coming

14 March 2023


Cogito Ergo Non Serviam

SVB Managers Wrecked Bank 

Silicon Valley Bank was the sixteenth largest bank in America last week. This week, it is a failed bank. The Fed has decided to guarantee deposits beyond the FDIC insured $250,000, but the managers are going to lose their jobs. The shareholders will get nothing. The left blames the relaxation of banking regulations under Donald Trump, while the right blames an excess of regulation and/or the Fed for irresponsible interest rate increases. This journal believes, and the evidence supports, the idea that the people running the bank are alone responsible for the collapse of the bank. They did not do their jobs.

To understand this, one must know how this collapse happened. SVB was the favorite bank of Silicon Valley start-ups and success stories. Billions came in during the more recent tech boom. To park that money, the bank bought Treasuries. That is a good move because Treasury assets are the most secure in the world. The managers took the view that the money is in Treasuries so there is no reason to worry. The bank was so lax about the matter that, for eight months, it had no Chief Risk Officer.

This complacency stems from the fact that no banker who was not in the business in the 1980s has never seen subtantial interest rate increased. There have been some upticks, but these are seen as corrections on a downward-trending chart. In other words, very few bankers have the experience of the Fed jacking rates up 5% in a little over a year. As a result, the managers of SVB were asleep at the switch when rates rose.

The rule that did SVB in was the idea of mark-to-market. That is, an asset must be valued in the portfolio at its current market value. For the average investor who buys a Treasury instrument and holds its to maturity, this issue never arises. Banks, brokerages and funds must carry such an instrument on its books at the price it would get for it were the asset sold that day, not the par value it will have at maturity.

When rates go up, the Treasury issues debt at the higher rate. The instruments already sold carry the lower, older rate. That makes the latter less attractive in the market. If one bond pays 4% and another pays 5%, the seller of the 4% will have to offer it at a lower price because the asset is less attractive. In the case of SVB, billions of Treasuries dropped in market value. To shore it up, the managers decided to sell stock worth $1.75 billion. That signalled to depositors that there might be an issue, so many withdrew their funds. The total withdrawn was $42 billion. That is a classic run on a bank/

To blame the regulations is to miss the point entirely. The regulations are there to ensure that the risks a bank takes are not so extreme that they undermine the solvency of the bank and the integrity of the deposits. They are part of the business landscape just like local economic conditions are. Businesses cannot change them in the near term; they must adapt to them.

To blame the regulation roll-back might make some sense. However, it is difficult to see how SVB would have done anything differently if it had been operating under the more stringent standards it would have had to meet in 2017.

Blaming the Fed for increasing interest rates so quickly is a perfectly legitimate argument, and this journal has said the Fed has raised the rates too fast and too far to avoid a recession. However, maintaining interest rates where they were to support banks is not part of the brief the Fed has. Moreover, the rates started rising a year ago. Everyone could see that there were several increases of 50 basis points each time were in the works long before the Fed acted.

The people who crashed the bank were the managers who saw the Fed boost rates and who did nothing. They should have diversified their portfolio. Selling the bonds after the first increase would have required the bank to book a relatively small loss. But they refused to cut their losses. Then, the rates kept going up, and the relatively small loss got bigger and bigger. Like a deer in the headlights, the managers froze.

Shareholders should sue them, and the FBI should see if they did anything criminal along the way.

© Copyright 2023 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Ubuntu Linux.

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