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Did the Fed cause the banking crisis?

Did the Fed cause the banking crisis?

Yes, without a doubt the Federal Reserve deserves 100% responsibility for the banking crisis!

Moreover, the unprecedented rising of rates even in the face of economic chaos amounted to a stupid or incompetent act. Furthermore, from Silicon Valley to Signature to First Republic. As a result, Jay Powell has banking blood on his hands.

Did the Fed cause the banking crisis?

As one of the smartest fintech professors on the planet, Duke University’s Campbell Harvey said:

“The Fed’s recent record is quite disturbing: 

1.The Fed kept rates near zero during a period of robust economic growth, low unemployment, and record-high stock prices inducing individuals and institutions to “reach for yield” (e.g., SVB) and take on additional risk. 

2.The Fed tried to talk down inflation as temporary when it was obvious to key observers it was anything but temporary. The strategy seemed to be aimed at tempering expectations. Assessments based on data rather than attempting to mislead to achieve a goal are far preferable.

3.The Fed is now trying to correct its earlier mistake (not hiking early enough) with another mistake (not pausing early enough). In economics, two negative actions do not equal a positive.

4.The Fed is not being transparent about the current state of the banking system. Fed actions have inverted the yield curve, greatly increasing the risk of a duration event for banks. The Fed also appears not to be performing its supervisory duties — at least that’s how I read the reports on the SVB failure.” Said Duke Professor Campbell Harvey on Linkedin.

Did the Fed cause the banking crisis?

Which banks are in danger of failing 2023?

According to Moody’s:

“Comerica’s unrealized losses represent 40% of its common equity tier 1 capital, which is a bank’s highest-quality capital because it is fully available to cover losses. 

This percentage is even higher at U.S. Bancorp: Unrealized losses represent almost 60% of this tier 1 capital. The unrealized losses represent 40% of First Republic Bank’s tier 1 capital but about 80% of the bank’s customers are uninsured.

For comparison, unrealized losses constituted between 30% and 40% of common equity tier 1 capital for Signature Bank and 120% for SVB.”

Firstly, a bank is an institution that provides financial services to individuals and businesses. It plays a critical role in the economy by collecting deposits from customers and using those funds to make loans and investments. However, sometimes banks can fail, which can have significant consequences for their customers and the wider economy. In this essay, I will explain what it means for a bank to fail and the causes and effects of bank failures. Moreover, then we will go into specific banks.

What is UBS paying for Credit Suisse?

When a bank fails, it means that it is unable to meet its obligations to its depositors and creditors.

In other words, the bank does not have enough money to pay its debts. This can happen for several reasons, including poor management, risky investments, fraud, and economic downturns. When a bank fails, it is usually taken over by a government agency or another financial institution that is responsible for liquidating its assets and paying off its debts.

The failure of a bank can have significant consequences for its customers, particularly those who have deposits with the bank. Deposits are usually insured up to a certain amount, so customers will usually be able to recover some or all of their money. However, if the bank has made risky investments or engaged in fraudulent activity, the amount of money that can be recovered may be limited. In addition, the failure of a bank can lead to a loss of confidence in the financial system, which can cause a run on other banks and create a broader financial crisis.

The failure of a bank can also have broader economic effects. Banks play a critical role in providing credit to businesses and individuals, so the failure of a bank can reduce the amount of credit available in the economy. This can lead to a contraction in economic activity and job losses. In addition, the failure of a bank can lead to a reduction in the value of assets held by other financial institutions, which can have a knock-on effect on the wider economy.

There have been many high-profile bank failures throughout history. One of the most notable was the failure of Lehman Brothers in 2008. Lehman Brothers was a global investment bank that had made risky investments in the subprime mortgage market. When the value of these investments began to decline, the bank was unable to meet its obligations, and it filed for bankruptcy. The failure of Lehman Brothers had significant consequences for the global financial system, contributing to the onset of the global financial crisis.

For further reading: Why did Lehman Brothers risk management fail?

In conclusion, the failure of a bank occurs when it is unable to meet its obligations to its depositors and creditors. Bank failures can have significant consequences for customers, the financial system, and the broader economy. While bank failures are rare, they can have far-reaching effects when they do occur. It is, therefore, essential for banks to manage risk carefully and ensure that they have adequate capital and liquidity to withstand unexpected events.

Furthermore, please see our list of articles on various banks in financial trouble:

Is Pacific Western Bank In Trouble?

In 2008, Pacific Western Bank weathered the financial crisis better than many other banks. While many banks struggled with the effects of the…

Is Fulton Bank In Trouble?

Losses are dropping in the bank’s book! More stable news: “Non-performing assets were $177.7 million, or 0.66% of total assets, at December 31,…

Is First Republic Bank Failing?

Will First Republic Survive?

The company’s focus on high-quality customer service and personalized banking solutions quickly earned it a reputation as one of the best banks…

Are Regional Banks Safe?

Are Regional Banks Safe? CNBC reported “Treasury Secretary Yellen says not all uninsured deposits will be protected in future bank failures. (…

Is Umpqua Bank In Trouble?

Will one of the great American banks face demise for purchasing too much debt at the height of the recent bond bubble. And of course, not…

Is Regions Bank In Financial Trouble?

First Republic Bank Run?

Now that SVB’s balance sheet issues and subsequent bank run caused a spotlight to shine on all of the unhealthy banks in America, First Republic…

Is Wintrust A Good Bank?

Today, Wintrust Bank has over 170 locations in Illinois, Indiana, and Wisconsin! In addition, offers a wide range of banking and financial…

Is Synchrony Bank Safe?

Let’s take a look at this American banking giant! Is everything ok over at the firm? Is Synchrony Bank Safe? Things sound rosy from the recent…

Is Intrust Bank In Trouble?

Intrust Bank is a financial institution based 

Is Ally Bank In Trouble?

Is First Horizon Bank In Trouble?

Banks are dropping like flies it seems, now, Silicon Valley, Signature Bank, who is next? Now First Horizon’s stock drops from $25 to $14 and…

Are Banks Safe Now?

In addition, the Federal Deposit Insurance Corporation (FDIC) provides deposit insurance for up to $250,000 per depositor per bank, which means…

Is Zions Bank In Trouble?

Is Zions Bank in trouble? Will one of the great regional American banks face potential death for purchasing too much debt at the height of the…

Is Capital One A Safe Bank?

In conclusion, today, Capital One is one of the largest banks in the United States, with operations in banking, credit cards, auto loans, and.

Which banks are in danger of failing 2023?

Which banks are in danger of failing 2023?

Is Bank of America Safe From Collapse?

Which banks are in danger of failing 2023?

Which banks are in danger of failing 2023?

Today the big banks are flush. In addition, Silicon Valley had terrible risk management. How can you not hedge your bank’s largest asset?” Will…

Is Comerica Bank In Trouble?

Will one of the great American banks face collapse? Are we in a financial crisis? Will the Federal Deposit Insurance Corporation take over…

Is Fifth Third Bank Failing?

Now that Silicon Valley Bank met its demise. Depositors across the country worry about their investments. Sure we have FDIC: Federal Deposit…

Is Western Capitalized?

Furthermore, is Western Alliance Bank safe?

Is Bank Of Hawaii In Trouble?

Below we have a chart showing unrealized depreciation on Hold to Maturity Securities (HTM) for top 100 banks versus equity. These unrealized…

How stable is Huntington Bank?

Why is there a run on banks?

Many across the global financial system wonder if the shocking failure of Silicon Valley Bank is a 2003 “Lehman moment”?

Is East West Capitalized?

East West Bank is a financial services company that provides a wide range of banking, mortgage, and wealth management services to individuals.

Is Truist Bank FDIC Insured?

So with the recent panic, banks with lots of bad loans might become forced to sell these loans. And as a result possibly take huge losses and…

What is contagion effect in banking?

“The result is that FRB default risk is now being spread to our largest banks. Spreading the risk of financial contagion to achieve a false…

What is the meaning of narrow banking?

Narrow banks: an indispensable part of an indispensable part. A ‘Narrow Bank’ can become defined as the system of banking under which a bank…

Why is UBS buying Credit Suisse?

Credit Suisse’s early years were marked by a focus on investment banking and securities trading. The bank was one of the first in Switzerland to…

Is Wells Fargo still a safe bank?

When it comes to the safety of your money, most banks in the United States are insured by the Federal Deposit Insurance Corporation (FDIC). This…

Is Credit Suisse In Trouble?

It’s because our current financial system let’s banks use client funds as collateral for massive financial bets, i.e. fractional reserve banking. Did the Fed cause the banking crisis?

Is my money Safe in Schwab? moreover, will there be a Charles Schwab Bank Run

Is PNC Bank In Trouble?

Chief Economist of the World Bank Sits Down With Rebellion

Did the Fed cause the banking crisis?

How Did Silicon Valley Bank Fail?

Business

Silicon Valley Bank Blinders

Silicon Valley Bank logo, 2022.svg

The Silicon Valley Bank failure strikes me as a colossal failure of bank regulation, and instructive on how rotten the whole edifice is. I write this post in an inquisitive spirit. I don’t know the details of how SVB was regulated, and I hope some readers do and can chime in. 

As reported so far by media, the collapse was breathtakingly simple. SVB paid a bit higher interest rates than the measly 0.01% (yes) that Chase offers. It attracted large deposits from venture capital backed firms in the valley. Crucially, only the first $250,000 are insured, so most of those deposits are uninsured. The deposits are financially savvy customers who know they have to get in line first should anything go wrong. SVB put much of that money into long-maturity bonds, hoping to reap the difference between slightly higher long-term interest rates and what it pays on deposits.  But as we’ve known for hundreds of years, if interest rates rise, then the market value of those long-term bonds fall. Now if everyone comes asking for their money back, the assets are not worth enough to pay everyone back.  

In sum, you have “duration mismatch” plus run-prone uninsured depositors.

We teach this in the first week of an MBA or undergraduate banking class. This isn’t crypto or derivatives or special purpose vehicles or anything fancy. 

Where were the regulators? The Dodd Frank act added hundreds of thousands of pages of regulations, and an army of hundreds of regulators. The Fed enacts “stress tests” in case regular regulation fails. How can this massive architecture fail to spot basic duration mismatch and a massive run-prone deposit base? It’s not hard to fix, either. Banks can quickly enter swap contracts to cheaply alter their exposure to interest rate risk without selling the whole asset portfolio. 

Michael Cembalist assembled numbers. This wasn’t hard to see. 

Even Q3 2022 — a long time ago — SVB was a huge outlier in having next to no retail deposits (vertical axis, “sticky” because they are insured and regular people), and a huge asset base of loans and securities. 

Michael then asks 

.. how much duration risk did each bank take in its investment portfolio during the deposit surge, and how much was invested at the lows in Treasury and Agency yields? As a proxy for these questions now that rates have risen, we can examine the impact on Common Equity Tier 1 Capital ratios from an assumed immediate realization of unrealized securities losses … That’s what is shown in the first chart: again, SVB was in a duration world of its own as of the end of 2022, which is remarkable given its funding profile shown earlier.

Again, in simpler terms. “Capital” is the value of assets (loans, securities) less debt (mostly deposits). But banks are allowed to put long-term assets into a “hold to maturity” bucket, and not count declines in the market value of those assets. That’s great, unless people knock on the door and ask for their money now, in which case the bank has to sell the securities, and then it realizes the market value. Michael simply asked how much each bank was worth in Q42002 if it actually had to sell its assets. A bit less in each case — except SVB (third from left) where the answer is essentially zero. And Michael just used public data. This is not a hard calculation for the Fed’s team of dozens of regulators assigned to each large bank. 

Perhaps the rules are at fault?

If a regulator allows “hold to maturity” accounting, then, as above, they might think the bank is fine. But are regulators really so blind? Are the hundreds of thousands of pages of rules stopping them from making basic duration calculations that you can do in an afternoon? If so, a bonfire is in order. 

This isn’t the first time. Notice that when SBF was pillaging FTX customer funds for proprietary trading, the SEC did not say “we knew all about this but didn’t have enough rules to stop it.” The Bank of England just missed a collapse of pension funds who were doing exactly the same thing: borrowing against their long bonds to double up, and forgetting that occasionally markets go the wrong way and you have to sell to make margin calls. (That’s week 2 of the MBA class.)  

Ben Eisen and Andrew Ackerman in WSJ ask the right question (10 minutes before I started writing this post!) Where Were the Regulators as SVB Crashed? 

“The aftermath of these two cases is evidence of a significant supervisory problem,” said Karen Petrou, managing partner of Federal Financial Analytics, a regulatory advisory firm for the banking industry. “That’s why we have fleets of bank examiners, and that’s what they’re supposed to be doing.”

The Federal Reserve was the primary federal regulator for both banks.

Notably, the risks at the two firms were lurking in plain sight. A rapid rise in assets and deposits was recorded on their balance sheets, and mounting losses on bond holdings were evident in notes to their financial statements.

moreover, 

“Rapid growth should always be at least a yellow flag for supervisors,” said Daniel Tarullo, a former Federal Reserve governor who was the central bank’s point person on regulation following the financial crisis…

In addition, nearly 90% of SVB’s deposits were uninsured, making them more prone to flight in times of trouble since the Federal Deposit Insurance Corp. doesn’t stand behind them.

90% is a big number. Hard to miss.  The article echoes some confusion about “liquidity”

SVB and Silvergate both had less onerous liquidity rules than the biggest banks. In the wake of the failures, regulators may take a fresh look at liquidity rules,…

This is absolutely not about liquidity.

SBV would have been underwater if it sold all its securities at the bid prices. Also 

Silvergate and SVB may have been particularly susceptible to the change in economic conditions because they concentrated their businesses in boom-bust sectors…

That suggests the need for regulators to take a broader view of the risks in the financial system. “All the financial regulators need to start taking charge and thinking through the structural consequences of what’s happening right now,” she [Saule Omarova] said

Absolutely not! I think the problem may be that regulators are taking “big views,” like climate stress tests. This is basic Finance 101 measure duration risk and hot money deposits. This needs a narrow view! 

There is a larger implication. The Fed faces many headwinds in its interest rate raising effort. For example, each point of higher real interest rates raises interest costs on the debt by about $250 billion (1 percent x 100% debt/GDP ratio). A rate rise that leads to recession will lead to more stimulus and bailout, which is what fed inflation in the first place. 

But now we have another. If the Fed has allowed duration risk to seep in to the too-big to fail banking system, then interest rate rises will induce the hard choice between yet more bailout and a financial storm. Let us hope the problem is more limited – as Michael’s graphs suggest. 

Why did SVB do it?

Did the Fed cause the banking crisis?

How could they be so blind to the idea that interest rates might rise? Why did Silicon Valley startups risk cash, that they now claim will force them to bankruptcy, in uninsured deposits? Well, they’re already clamoring for a bailout. And given 2020, in which the Fed bailed out even money market funds, the idea that surely a bailout will rescue us should anything go wrong might have had something to do with it. 

(On the startup bailout. It is claimed that the startups who put all their cash in SVB will now be forced to close, so get going with the bailout now. It is not startups who lose money, it is their venture capital investors, and it is they who benefit from the bailout. 

Let us presume they don’t suffer sunk cost fallacy. You have a great company, worth investing $10 million. The company loses $5 million of your cash before they had a chance to spend it. That loss obviously has nothing to do with the company’s prospects. What do you do? Obviously, pony up another $5 million and get it going again. And tell them to put their cash in a real bank this time.) 

How could this enormous regulatory architecture miss something so simple? 

This is something we should be asking more generally. 8% inflation. Apparently simple bank failures. What went wrong? Everyone  I know at the Fed are smart, hard working, honest and dedicated public servants. It’s about the least political agency in Washington. Yet how can we be seeing such simple o-ring level failures? 

I can only conclude that this overall architecture — allow large leverage, assume regulators will spot risks — is inherently broken. If such good people are working in a system that cannot spot something so simple, the project is hopeless. After all, a portfolio of long-term treasuries is about the safest thing on the planet — unless it is financed by hot money deposits. Why do we have teams of regulators looking over the safest assets on the planet? And failing? Time to start over, as I argued in Towards a run free financial system

Or… back to my first question, am I missing something? 

****

Updates: 

A nice explainer thread (HT marginal revolution). VC invests in a new company. SVB offers an additional few million in debt, with one catch, the company must use SVB as the bank for deposits. Furthrmore, SVB invests the deposits in long-term mortgage backed securities. SVB basically prints up money to use for its investment! 

“SVB goes to founders right after they raise a very, very expensive venture round from top venture firms offering:

– 10-30% of the round in debt

– 12-24 month term

– interest only with a balloon payment

– at a rate just above prime 

For investors, it also seems like a no-downside scenario for your portfolio: Give up 10-25 bps in dilution for a gigantic credit facility at functionally zero interest rate.

If your PortCo doesn’t need it, the cash just sits. If they do, it might save them in a crunch. The deals typically have deposit covenants attached. Meaning: you borrow from us, you bank with us.

And everyone is broadly okay with that deal. It’s a pretty easy sell! “You need somewhere to put your money. Why not put it with us and get cheap capital too?”

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Written by Stanford Professor John H. Cochrane

John H. Cochrane is a senior fellow at the Hoover Institution. He is also a research associate of the National Bureau of Economic Research and an adjunct scholar of the CATO Institute. 

Before joining Hoover, Cochrane was a Professor of Finance at the University of Chicago’s Booth School of Business, and earlier at its Economics Department. Cochrane earned a bachelor’s degree in physics at MIT and his PhD in economics at the University of California at Berkeley. He was a junior staff economist on the Council of Economic Advisers (1982–83).

Cochrane’s recent publications include the book Asset Pricing and articles on dynamics in stock and bond markets.

In addition, the volatility of exchange rates, the term structure of interest rates, the returns to venture capital, liquidity premiums in stock prices, the relation between stock prices and business cycles, and option pricing when investors can’t perfectly hedge. His monetary economics publications include articles on the relationship between deficits and inflation, the effects of monetary policy, and the fiscal theory of the price level. He has also written articles on macroeconomics, health insurance, time-series econometrics, financial regulation, and other topics. He was a coauthor of The Squam Lake Report. His Asset Pricing PhD class is available online via Coursera. 

Cochrane frequently contributes editorial opinion essays to the Wall Street Journal, Bloomberg.com, and other publications. Lastly, he maintains the Grumpy Economist blog.

The Grumpy Economist: Silicon Valley Bank Blinders (johnhcochrane.blogspot.com)

Did the Fed cause the banking crisis?

Did the Fed cause the banking crisis?