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People charged with averting disasters often talk of ‘blackswans’ – unimagined events that cause havoc.
One such swan dramatically landed overthe weekend with the collapse of a Californian bank few Australians have everheard of.
Silicon Valley Bank (SVB), aninstitution that specialised in the tech industry, might seem a long way awayfrom Australia, but those of us who watched the GFC unroll can never forget howinterconnected financial markets are.
So did the world’s monetary and bankingauthorities.
Hence the US Treasury, Federal Reserveand Federal Deposit Insurance Corporation (FDIC) came to the rescue of all SVBdepositors, not just the officially insured deposits up to $US250,000.
Toobig to be allowed to fail
Like Australia, itseems the US has moved to a de facto realisation that all deposit-takinginstitutions are too big to be allowed to fail.
They can’t risk the reverberationsstarted by one failure rattling other foundations. Bear Stearns collapsed 15years ago this week – it took another six months for Lehman Brothers to gounder and officially start the “Great Recession”.
Like many a black swan, with all thebenefit of hindsight, something like the SVB collapse should have beenexpected.
Wiser heads have been worried that amountain of unprofitable companies thriving/surviving on free money would causeserious trouble as interest rates rose and money was no longer free.
That realisation has been hurting techstocks, in particular. The start-ups SVB was famous for funding were findingventure capital harder to come by when it cost real money.
But it is not just the formerly-cooltechies at risk.
Any business is in trouble if it hasbeen built on effectively free money and lacks the ability to increase priceswhen the cost of money rises.
In the rank behind unprofitablestart-ups feeling the heat is commercial real estate.
“US commercial real estate could be abig worry for investors because there is more than $US60 billion in fixed-rateloans that will soon require refinancing at higher interest rates,” *********’s Glenn Dyer reminded readers on Monday.
“Additionally, there is more than $US140billion in floating rate commercial mortgage-backed securities that will maturein the next two years and which are showing unrealised losses.”
Self-described “old bond dog” AnthonyPeters has long reminded readers of the importance of understanding liquidityrisk and that what really counts is the ability to actually repay a loan, notjust service it.
Writing for Reaction, he explained the FDIC’s move before the institution made it: “Unless the FDIC breaks all its own rules and rides to the rescue of SVB’s depositors, the implication for smaller banks could be catastrophic. When the hordes invade the valley, the peasants flee to [the] fortress on the hill.
“It happened during the Asian crisis atthe end of the 1990s when depositors deserted local banks and moved their moneyto likes of Standard Chartered and HSBC, which they perceived to be much saferand whose cost of funding actually fell.
“The same might happen in the States andthe last thing the regulators would want to see would be an implosion of thehighly diversified regional banking landscape.
“If it does, however, step up to theplate and save all depositors, then more or less all bank deposits become defacto insured and moral hazard is off to the races.”
Moralhazard
But that moral hazardsetting up more failures is further down the track.
SVB threatening the US banking system –and the contagion spreading globally – is now. Hence the cavalry arrivingquickly.
Although said cavalry seems to be doingthe job, the fright and the warning isn’t disappearing quickly.
It adds another uncertainty for acentral bank wondering whether to pause its interest rate hikes. Oh, didsomeone mention the RBA?
Another (unnecessary in my humbleopinion) rate rise here next month just became more unlikely.
Somewhat ironically, it wasn’t SVB’sloans to unprofitable start-ups per se that triggered its demise.
Perhaps recognising their riskiness, SVBloaned a smaller percentage of its deposits to clients than most banks,reportedly just $US74 billion out of deposits of $US173 billion as of December31.
This was instead of “lending” thebalance it “invested” (same difference in the end) in what were supposed to besafer financial assets – government bonds, residential and commercialmortgage-backed securities.
Crucialmistake
The bank’s crucialmistake was that it did not hedge its interest rate exposure.
When its tech firm clients needed toreduce their deposits as their easy venture capital dried up, SVB was forced tosell some of its “investments” at a loss, forcing it to try to raise capitalitself.
The bank’s need to raise capital scaredits more savvy big depositors into withdrawing their funds – and a run on thebank.
All institutions that bought bonds whenrates were excruciatingly low are sitting on large unrealised losses.
As long as they can hold those bonds tomaturity and don’t have to mark them to market – SVB did not have to until itdid by selling some at a loss – they can look OK.
(Our Reserve Bank marks its $350 billionworth of government bonds to market and thus has wiped out its reserves andwould be insolvent if it didn’t have the ability to make money. Nice for some.)
There will be increased nervousnessabout other institutions managing to skate under mark-to-market requirementsthe way SVB did.
The American cavalry has contained theSVB black swan, but authorities around the world will be looking more nervouslyfor any signs of others.
