☀️☕️ Bailout-not-a-bailout! Silicon Valley Bank and the FDIC (banks & tech)
📊 Also: Kuroda keeps it loose on his swan song (JGBs); 🎓 The FDIC... to the rescue!
Market Roundup 📊 13-Mar-23
US large-cap S&P 500 closed 1.45% DOWN 🔻
Tech-heavy Nasdaq Composite closed 1.76% DOWN 🔻
Pan European STOXX Europe 600 closed 1.35% DOWN 🔻
HK's Hang Seng Index closed 3.04% DOWN 🔻🔻🔻
Japan's Nikkei 225 closed 1.67% DOWN 🔻
— The MoneyFitt Morning (@MoneyFitt)
Mar 13, 2023
Bailout-not-a-bailout! Silicon Valley Bank and the FDIC (banks & tech)
📊 In the Markets
Kuroda keeps it loose on his swan song (JGBs)
📖 MoneyFitt Explains
🎓️ The Federal Deposit Insurance Corporation (FDIC)... to the rescue!
Bumper issue: Bailout-not-a-bailout! Silicon Valley Bank and the FDIC (banks & tech)
Late on Sunday (as another small bank was shut down) the government bailout machine sputtered to action with the announcement that ALL depositors of Silicon Valley Bank would be paid back in full by the FDIC🎓and backed by $25 billion from the Treasury… bank shareholders and debt holders would still get completely wiped out, so sort of not a “bailout”
Silicon Valley Bank, once America’s 16th largest, failed and had to be rescued last week. SVB was a one-off combination of a concentrated customer base (tech startups and VCs) and truly terrible risk management (that bit’s less unique.)
A historic series of inflation-busting rate hikes turned what was a rapid but normal drop in deposits into an implosion of the bank’s balance sheet, causing a full-blown “bank run” as all the other depositors ran for the exits
The fear remains that other smaller or even large regional banks will see the same as depositors shift their money to giant banks (perceived as safer) and cause similar runs elsewhere (around the world).
Meanwhile, the startup tech sector faced "an existential crisis" with billions locked up in a deepening cash and funding crunch... Sunday's bailout-not-a-bailout may have averted this (we shall see)
In a slightly different MFM format given the importance of the SVB collapse, a longer version follows, in easy-to-follow bullet point format starting with the big big picture...
In The Beginning (sort of)...
The GFC in 2008 came about from greedy, irresponsible bankers, raising the genuine risk of a global depression
Central banks slash interest rates to keep economies alive and the world turning
Money is now just about free
Savers earn nothing from deposits
The present value of earnings far in the future shoot up
Stock markets shoot up (along with more speculative “assets” like crypto and meme stocks)
They say "There Is No Alternative" (TINA) to investing in shares
... Especially growth shares like tech (and tech startups)
So everybody piles in
Venture Capital ploughs money into startups
Investments into future growth via venture capital funds (VC) shoot up
VCs are flush with cash and fund more and more startups
VCs: You get some, and you get some, and you get some - Image credit: Our Gang (Little Rascals) / Hal Roach, WBD via Tenor
Startups follow the standard VC mantra to ignore profitability entirely and focus on sales growth right now at all costs — as this gets VC partners (“GPs”) paid even more
Startups burn through the cash as instructed but just raise more free money from more VCs and their investors (“LPs”)
And they stuff the cash they get into their bank accounts before spending it on driving more sales
(Deposits also shot up all across the banking industry, with lockdown conditions combining with Covid “stimmy checks” — US commercial banks pulled in $2.4 trillion more in deposits between 2019 and 2022 than they'd been expecting)
But then inflation
Meanwhile, all the free money eventually causes inflation to pick up, but central banks don’t think it will last
Everybody calm down, it's just "transitory inflation" (2021) - Image credit: Station 19 / ABC via Tenor
Then Russia invades Ukraine, kicking off a further surge in energy and food prices
Central banks freak out and hike interest rates at a record pace as inflation rages across the world
You're gonna need a bigger firehose (2022) - Image credit: Tenor
With higher interest rates, there is now an alternative place to put your money besides investing in shares (i.e. TINA)
Sharply rising interest rates wipe out US$33 trillion from global stock market value (-22% in 2022) and speculative “assets” get creamed
Startups run out of cash
VCs stop receiving money from LPs, which means startups stop getting money, too (the start of the startup "cash squeeze")
Startups keep burning through their cash deposits without getting them topped up
VCs tell them “ermm… do the opposite of what we were telling you to do last week and actually earn some money, please, seriously, guys” (aside: almost always guys)
Money is spent from startups’ bank accounts, reducing the balances, while some deposits are also moved out to get higher returns (now that there are alternatives paying more, like money market accounts... remember TINA)... so deposits start to collapse
Hello, Silicon Valley Bank
The main bank by far for startups is Silicon Valley Bank (ticker $SIVB) — very specialised, yet at its peak the 16th largest in America
Between end-2019 and the first quarter of 2022, the bank’s deposits tripled, adding about $130bn in new deposits. Compared to most banks, SVB couldn’t lend out enough (tech and health startups don’t need a lot of loans, and rarely qualify for them anyway... though tech bro vineyards, fast cars and mansions did get funded)
So SVB stuffed most of it into low interest rate but zero-risk long-dated government bonds (since the interest rate was still above the puny amount paid to depositors)
(Securities portfolios across the banking industry also ballooned, going from $4.0 trillion at the end of 2019 to $6.3 trillion)
At the end of 2022, SVB had roughly $74bn of loans and $120bn of bonds, most listed as "held-to-maturity" — see mini-explainer (1) below) — this is also known as terrible balance sheet risk management, with regulators likely to be hauled over the coals later in the year for not dealing with it earlier.
Luckily, the “loss” on these bonds was technical, just a function of rising interest rates, and SVB could just ride it out... Unless it suddenly needs to come up with the money.
Ticking, ticking, ticking... until last week - Image credit: Call of Duty / Activision Blizzard via Tenor
Deposits flood out, so SVB sold bonds, blowing it up
When all the deposits flooded out, they didn’t have enough cash immediately to hand — this is how "fractional reserve banking" works, see mini-explainer (2) below — so SVB had to also sell some bonds... basically its entire "available-for-sale" stash — see mini-explainer (1) below.
When interest rates go up, bond prices go down, so SVB made a massive $1.8bn loss on those bonds which just about destroyed their balance sheet
This is the same effect as making a lot of terrible loans to borrowers who don’t pay them back, the “usual” reason greedy, badly run banks blow up
(SVB also had "unrealised losses" in the rest of its bond holdings from rising interest rates, the "held-to-maturity" stash, made worse by the interest rate effect being even greater on long-dated bond prices)
Hello, bank run
Which sent even more of the remaining shareholders to the exit, sending the share price through the floor
Which made it even harder when they asked the stock market for more money last Friday
And which sent more depositors to the exit
Especially with leading VCs telling their portfolio companies to get their money out of SVB (ASAP!!)
“I would ask everyone to stay calm and to support us just like we supported you during the challenging times... If everyone is telling each other SVB is in trouble, that would be a challenge.”
Which sent even more of the remaining depositors to the exit... $42bn worth over just 24 hours
This is known as “a bank run”
From the classic 1946 "Christmas movie" about a small town bank run - Image credit: It's a Wonderful Life / RKO via Tenor
More depositors asking for money meant that more bonds would have to be sold,
More bonds being sold in this case means much bigger losses, putting it into even more trouble with banking regulators by wiping out the rest of the bank shareholders’ money
Bank regulators require them to hold capital at a certain minimum percentage of loans (and other assets, including bond holdings) - see mini-explainer (1) below.
Second largest bank failure in history
No surprise, in hindsight, that the fundraising failed, and regulators stepped in on Friday to wind up SVB
The Federal Deposit Insurance Corporation (FDIC) 🎓 was created to protect small depositors and provide a backdrop of security to prevent bank runs
Anyone with accounts under $250,000 will have access to their money on Monday from the new Deposit Insurance National Bank of Santa Clara.
Until Sunday night’s announcement, everyone else was going to have to wait and see how much, if any, of their deposits they’d get back
Initial reports suggest $175 billion of SVB deposits were stuck in the bank, i.e. not enough money to pay them all back. This included startups with continuing cash burn (wages, advertising, IT expenses, rent and other normal business costs)
Will it happen to other banks?
The concern is that depositors around the country (perhaps the world) with anything more than the maximum insured sums ($250k in the US) will consider all smaller banks to be super risky and move some or all of their deposits to the perceived safety of big banks
This might then lead to the same situation that wiped out SVB spreading to other smaller banks, even though SVB was a highly specialised bank with some very unique problems, ultimately of its own making
(SVB is an extreme case with 96% of deposits held, before last week, in accounts exceeding the FDIC’s $250,000 cap)
Announced late Sunday, banks can now access the Fed’s new facility, the Bank Term Funding Program (BTFP), which will offer loans of up to one year to lenders in exchange for a pledge of their investment-grade bonds, backed by the FDIC and $25 billion in cash from the Treasury. (Actually, it's quite similar to the Fed’s existing “discount window” for banks to get cash for short-term liquidity if they really need it.)
The bank’s share and bond holders will get wiped out, so in a way, it’s not a “bailout”
It’s a fast moving space… not long before that was announced, the US Treasury ruled out GFC-style bank bailouts: “We’re not going to do that again... But we are concerned about depositors, and we’re focused on trying to meet their needs.”
Unless... there is a “systemic risk exception”, a rule used repeatedly during the 2008 GFC allowing the government to pay back uninsured depositors IF not doing so would have serious adverse consequences for the economy or financial stability. This is what they're using to tap into the FDIC's funds.
Regulators like The Fed and the FDIC may have been asleep at the wheel with many other banks, too (not to mention the bond rating agencies -- before Friday, Moody's gave SVB an investment grade issuer rating of Baa1.)
Big banks benefit vs little banks?
All banks are facing unrealised marked-to-market losses on their HTM books which the market will start to price in (an estimated $620bn of combined unrealised losses, which is over a quarter of the industry’s overall shareholders' funds of $2.2tn vs realised losses last year of just $31bn.)
Even with the bailout-not-a-bailout, big banks could then see a flood of cheap deposits that they won’t have to pay higher interest rates on (which they will like) even though the ultimate consequence of multiple failed banks (if that happens) could put stresses on their own loan books
It could turn out to be a canary in the coalmine for other as yet unknown risks as different, unexpected bits of the global financial system digests the recent end of a decade and a half of nearly free money
I taut I taw a bank run - Image credit: Looney Tunes / Warner Bros via Tenor
Tech alarm bells
In the tech space, alarm bells were ringing loudly, with the president of Y Combinator (a leading US VC / incubator) calling it an "extinction-level event" for startups and asking for help from Congress
This is an *extinction level event* for startups and will set startups and innovation back by 10 years or more.
BIG TECH will not care about this. They have cash elsewhere.
All little startups, tomorrow's Google's and Facebooks, will be extinguished if we don't find a fix.
— Garry Tan 陈嘉兴 (@garrytan)
Mar 10, 2023
He goes on to say: “There are thousands of US startups that banked at SVB, often as their sole bank. $250K per account is not going to last long.”
But already, there are pushbacks against those calls for help, as they could create serious "moral hazard", in other words, rewarding risky behaviour, just as the banks and the greediest bankers got during the GFC. (Sunday's FDIC move could create moral hazard with depositors, but that's a different matter as most depositors can't really be expected to carry out due diligence on their banks, as implied by the FDIC!)
US Treasury Secretary Janet Yellen said: “The problems with the tech sector aren’t at the heart of the problems at this bank” -- pointing to interest rate hikes and SVB's truly terrible balance sheet risk management.
MINI EXPLAINER (1) - Held-to-Maturity and Available-for-Sale Bonds and SVB
Losses in bonds aren't "realised" at a bank if they're listed as "held-to-maturity" (HTM) since the value doesn't have to be calculated based on current market prices the way "available-for-sale" (AFS) bonds are
For SVB, it lost $1.8bn based on selling $21bn of its AFS bonds... basically all of them (sold very quickly.) That left it with only HTM bonds to sell to repay more fleeing depositors.
At the end of last year, HTM bonds were in the bank's books at their purchase price of $91bn rather than their $76bn market value for unrealised marked-to-market losses of over $15 billion vs its entire equity base of $16.2bn and $11.5bn of common equity.
(Interest rates have continued to go up since then, so basically the equity base was already history -- "insolvent" -- on a marked-to-market basis, based on publicly available information. Hence the desperation to get investors to buy new shares.)
Hello hello, Wall Street's Finest, WHY... ARE... YOU... SLEEPING? - Image credit: Finding Nemo / Pixar via Tenor
MINI EXPLAINER (2) - Fractional Reserve Banking
A system where banks are only required to hold a portion of their deposits as reserves and use the rest of the deposits to lend out to borrowers or invest in other assets, which can generate profits. This lies at the heart of banking systems around the world.
This system creates a multiplier effect, where the initial deposit creates multiple loans and deposits, increasing the money supply in the economy. However, it also creates the risk of bank runs and financial instability if depositors lose confidence in the banking system.
Banks are also required to maintain a certain level of capital as a buffer against losses with the capital requirements depending on factors such as their loan portfolios' riskiness and overall financial health.
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📊 In the Markets
US markets continued to plummet as fears about startup-focused Silicon Valley Bank (ticker: SIVB) mounted, following its emergency fund-raising just a day after tiny crypto-focused peer Silvergate Bank closed shop… sure enough, at the end of the day, the FDIC🎓 had stepped in and wound it up, the second largest bank failure in US history. (By Sunday, the Biden administration had stepped in with measures to try and avert the unfolding banking and tech crises.)
► In particular, news emerged during the day of leading venture capitalists (VCs) Union Square Ventures, Peter Thiel's Founders Fund, Coatue and Founder Collective basically telling their portfolio companies to get their money out of SVB as soon as possible. USV said “SVB is in a severe cash crisis... Do NOT accept any offers from SVB to keep your money there even if they dangle 5% interest rates in front of you.”
► And at Twitter-speed, everyone tried to get their cash balances down to $0 or at least $250,000 (below which balances are insured by the FDIC🎓) ... exacerbating the bank run and leading, after the stock market close, to the biggest bank failure (by far) in the US since the GFC (and the second biggest ever after Washington Mutual.) See the extended Focus story above.
The February increase in non-farm payrolls (basically new US jobs) at 311,000 was way higher than the expectations of Wall Street's Finest. They'd been expecting 200,000 new jobs to be created, a massive slowdown from January's blowout figure of 517,000 when those same experts had been expecting 187,000. Markets would have freaked out again at the ongoing strength of the labour market (implying a higher risk of inflation continuing to be high) if they weren't already freaking out about SVB (above) and also...
► ...They got the happy (for them) news of an increase in the unemployment rate to 3.6% from the 53-year low of 3.4% seen in January, as more workers entered the labour market. Along with a slowdown in average hourly earnings growth to 0.2% from 0.3%, some felt these numbers support the idea of the unicorn-rare "soft landing" for the economy, in which inflation slows right down without sending the economy through the floor and unemployment through the roof.
Meanwhile, in HK/China, Hong Kong's benchmark Hang Seng Index dropped by over 3% while US-traded iShares MSCI China ETF (MCHI) made up of Chinese equities available to international investors closed about flat, after a 4-day 7.5% drop that left the index down for the year.
► Mixed economic data has continued to batter optimism over the reopening economic recovery after a sharp rally on the abrupt December ending of the Zero Covid policy. Specifically this week, expectations for (even) more policy stimulus were dashed after outgoing Premier Li Keqiang announced a pretty modest growth goal of only 5% for this year, coming in below most estimates.
Kuroda keeps it loose on his swan song
On Governor Haruhiko Kuroda's final interest rate setting meeting, the Bank of Japan (BOJ) maintained its ultra-low interest rate policy and held off making any changes to its controversial bond yield curve control policy (YCC). The BOJ maintained its short-term interest rate target at -0.1% and its 10-year bond target at around 0%. Though this was widely expected, the yen and local bond yields fell as traders unwound some high return long-shot bets that the retiring central bank governor would again at least tweak the yield curve control instead of leaving it all to his successor.
► Kuroda's massive monetary stimulus is generally praised for pulling the economy out of deflation, but leaves the bank with a mixed legacy as it came at the cost of bank profits and distorted bond market functioning. Many expect Kuroda’s successor, Kazuo Ueda, to phase out YCC when he becomes the Governor in April.
► Unlike most other central banks, the Bank of Japan is trying to get more inflation, or at least a higher and more sustainable level, to avoid the deflationary trap the country has been stuck in for decades. The BOJ "will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2 percent and stably stays above the target," the BOJ said in a statement. Japan's consumer price index rose 4.2% in January — the highest reading in 41 years.
📖 MoneyFitt Explains
🎓️ The Federal Deposit Insurance Corporation (FDIC)
The FDIC is an independent agency reporting to Congress and no other agency, including the Federal Reserve. It's a regulator in its own right with authority to examine and supervise banks for safety and soundness, and to take enforcement actions against those that do not comply
Its primary function is to protect depositors in case of bank failures by insuring deposits at FDIC-insured banks up to (currently) $250,000 per depositor, per ownership category (e.g. individual, joint, trust, retirement accounts), per insured bank
When a bank fails, the FDIC steps in to resolve the bank's assets and liabilities. This process involves finding a buyer for the bank's deposits and assets, or liquidating the bank if no buyer is found.
Many other countries have similar deposit insurance schemes, such as the Deposit Insurance Corporation of Japan (DICJ), the UK's Financial Services Compensation Scheme (FSCS), Singapore Deposit Insurance Corporation (SDIC) and the European Union's Deposit Insurance Scheme (EDIS) though the specific details and limits will differ.
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