The Jury is Still Out
“mor·al haz·ard … a lack of incentive to guard against risk where one is protected from its consequences.”
– Oxford Languages
“A billion here, a billion there, and pretty soon you’re talking about real money.”
– Everett Dirksen
Haven’t we been here before? The SVB matter in particular has brought back a lot of bad 2008-2009 memories: swirling rumors of bad credits on the balance sheet and inadequate bank capital; bank stocks cratering on Fridays because of weekend uncertainty; shotgun marriages over the weekend; shareholder wipe-outs on Monday. Wasn’t Dodd-Frank supposed to take care of such drama, among other things,
1) Improving accountability and transparency in the financial system
2) Ending the doctrine of “too big to fail”
3) Protecting taxpayers by ending bailouts
So, what went wrong in the now well-publicized case of Silicon Valley Bank? Let’s start at the beginning with what many are calling “the original sin”: Simply put, following the Great Recession (2008-2009), the Fed kept short-term interest rates too low for too long. Granted, the capital of SVB and others were concentrated heavily in Treasuries, the strongest of all credits, but (there’s always a “but”) SVB increasingly was reaching for extra yield by going farther and farther out on the maturity curve. That’s (somewhat) pardonable in a calm interest rate environment. However, along came COVID. Two administrations and Congress let loose the fiscal spigots and the current administration and Congress kept the cash flowing. The result: Fiscal gasoline on an already-burning monetary fire and, voilà, 70s-style inflation. The Fed was way behind the inflation curve, and had to put the pedal to the metal. And, so they did. In 2022, the Fed raised short-term interest rates by four and one-half full percentage points, a considerable shock to the System.
To summarize, “the original sin,” unbridled spending on top of the original sin, inflation, a Fed shock to the System.
Enter Silicon Valley Bank, which largely catered to the tech and tech start-up crowd in, where else?, Silicon Valley. Trouble is, the tech cycle has been on the wane for a while, and many of the bank’s customers needed their money. The need began to pick up steam. At the same time, word began to spread over the Internet that some depositors were experiencing delays in getting their money and that too many of SVB’s deposits were uninsured, i.e., above the FDIC’s $250,000 threshold per account. (In fact, the number was 94%.)
What happened next, of course, was every banker’s nightmare; a Jimmy Stewart/Bailey Building & Loan-type bank run. Only this time, the bank run was high-tech. Depositors
starting draining their accounts via smartphone apps and telling others in their start up networks to do the same. Forty-two billion dollars (that’s a “b”) was withdrawn on Thursday, March 9; at the close of business on that day, the bank had a negative cash balance of $1 billion (that’s a “b”).
The clock was ticking. SVB now had to sell their long-term Treasury bonds in order to fund the withdrawals, and the book losses SVB had been incurring on those long-term Treasuries as interest rates rose suddenly had to be realized. Guess what? Realized losses in the banking world equal capital impairment, and capital impairment in the regulatory world equals a need for additional capital. How about selling additional shares of common stock? That’s one solution, but word travels fast in the blinking-light, computer-screen trading world. SVB common already had been under severe pressure, and “fire-sale” price is an inadequate description of what would be necessary. The stock tanked all over again, and the rumors really began swirling. Compounding everyone’s problems were those uninsured deposits (again, 94% of the total).
OK, where are we now? Despite an heroic, last-minute effort to secure a lifeline, SVB didn’t make it. The regulators swooped in over the weekend of March 11-12 and took over the bank. After Washington Mutual during the 2008-2009 crisis, SVB became the second largest bank failure in U.S. history. But, all was not lost. Regulators took the highly unusual step of guaranteeing all of SVB’s deposits, rather than only those below the $250,000 cap. This reduced the pressure — the stock market pressure anyway — on other regional and community banks thought to be in the same boat or thought to be at a now-competitive disadvantage versus the banking Goliaths. Whether that reduced pressure lasts and SVB and couple of others are considered one-offs or “idiosyncratic,” to use the vernacular, is unclear at the moment. Maybe they are one-offs. On the other hand, if L’Affairs SVB doesn’t blow over and instead becomes in hindsight the canary in the coal mine, as Greg Ip of the Wall Street Journal pointed out, we are faced with two unappealing possibilities: Smaller and regional banks, now exposed as fragile versus their larger brethren, may struggle to survive on their own, and the federal safety net will continue to expand, creating new risks down the road (moral hazard).
Two post-scripts…
First, if an interest rate hike ever can be called heartening, the Fed’s 0.25% hike of March 23 is just that. Chairman Powell et al. sent a powerful message: There is very little evidence of contagion in the banking system, and we will continue to fight inflation. Secretary Yellen also attempted to lower the temperature by saying that Treasury has many tools with which to combat banking stress.
But, second, as reported by the WSJ, in recent days Secretary Yellen “walked back her comments from the day before that walked back her remarks from the day before that about providing a de facto guarantee on all U.S. bank deposits. Who’s on first?” In other words, mixed signals from the same person, and the last thing we need at this point from the administration is mixed signals from anyone.
No question, the jury is still out with respect to possible contagion in the banking system and the ultimate impact of the SVB matter on the overall economy and U.S. equities. In the meantime, as always, the recommendation from here is stay well-diversified and stay the course, and maintain a Rainy Day Fun in case either the known unknowns or the unknown unknowns turn out to be the troublesome kind.
Banks. With all possible candor, we admit that the hand trembles just a little whenever we are buying a bank stock for a portfolio. Not that we’ve never owned bank stocks, and in fact, we own one right now in most portfolios (a Goliath that so far has been above the fray, at least in the operational sense). But, we almost always are underweight banks versus the market as a whole. The problem is, as we see it, with banks one never quite knows what’s under the hood. A large cap chemical or healthcare company, for example…a generous, well-covered dividend implies value and opportunity. Banks…those generous, (seemingly) well-covered dividends sometimes can go away a little too quickly.