The collapse of Silicon Valley Bank (SVB) on Friday, the second-largest bank failure in U.S. history, was extraordinarily fast. It was a classic run on the bank by its customers.
It’s important to note that SVB did not do anything dodgy, like the shenanigans which caused many bank collapses in 2008. SVB held its assets in perfectly safe U.S. Treasury debt. The root cause of SVB’s collapse was the suppression of interest rates by the Federal Reserve during 2020 and 2021, which forced SVB (and many other banks, including the Fed itself) to buy bonds at bubble high prices. (Bond prices rise when interest rates fall.)
When the Fed raised yields in 2022 to combat inflation the value of SVB’s book of bonds fell. Trillions of dollars of U.S. Treasuries held all over the world lost value when the Fed raised the fed funds rate and also began to (gradually) sell their own gigantic book of bonds. The 10-year Treasury shows the enormous swing from a yield of 0.55% in August 2020 to a current yield near 4%.
Banks can carry bond values at par as long as they plan to hold them to maturity. Unfortunately, SVB was forced to sell its bonds when customers demanded to withdraw their cash. The market value of these bonds is much lower than par.
The failure of SVB was due to the Fed’s actions. It is typical for banks to borrow short, and lend long. That is, they get funded by savers with maturities at the short end of the yield spectrum (savings and checking accounts), and lend to companies and households at the long end (mortgages, corporate loans, etc.). It is not typical for the yield curve to be so extremely inverted for such a long time. That’s due to the Fed. SVB (and all other banks and bond owners) were blindsided. The “everything bubble” affected the bond market as much as the stock market.
Many of SVB’s customers are high tech, entrepreneurial and/or small businesses which were already disproportionately stressed by the Fed’s raising of borrowing costs. Many have much more deposited at SVB than the FDIC’s insurance limit of $250,000.
The FDIC moved quickly to assure depositors that they will get their full FDIC insurance reimbursement by Monday (tomorrow). But it will take longer to sort out the remaining assets of SVB. Meanwhile, the companies may not be able to make payroll, pay their suppliers, etc.
The danger from the SVB collapse is more than just an ordinary bank failure. There is a danger of contagion as customers of other banks realize that SVB’s problem is widespread, especially in smaller regional banks. Shareholders have already been devaluing these bank stocks. If customers begin to withdraw their money contagion could spread. At the very least, customers with more than $250,000 could begin to withdraw their money to split their accounts between banks to stay below the FDIC limit.
There is also the danger of the collapse of a large number of high-growth, cutting edge companies (also small companies) in Silicon Valley and northern California. Even England has guaranteed U.K. companies with money at SVB.
Today has a whiff of 2008 as big wigs from President Biden to California governor Gavin Newsom to House Speaker Kevin McCarthy to Treasury Secretary Janet Yellen to Fed Chair Jerome Powell are in discussions and/or making public announcements.
The Treasury secretary’s comments on Sunday morning sought to assure the public that the overall banking sector was safe.
By Alan Rappeport, The New York Times, March 12, 2023
Treasury Secretary Janet L. Yellen said on Sunday that regulators were working throughout the weekend to deal with the fallout from the collapse of Silicon Valley Bank but tried to assure the public that the American banking system is “safe and well capitalized.”…[end quote]
By Nick Timiraos, The Wall Street Journal, March 12, 2023
Eric Rosengren, who was president of the Federal Reserve Bank of Boston from 2007 to 2021, said the fallout could be particularly disruptive because of how heavily concentrated the lender was in venture capital and the technology sector. Any ultimate resolution by regulators could have further reaching implications not only for venture-capital firms, but also for endowments and pension funds that have been increasing their exposure to venture capital, he said…
Jerome Powell, who was a senior official in the Treasury Department during the George H.W. Bush administration, spent a weekend in January 1991 with counterparts from the Fed and FDIC addressing the collapse of the Bank of New England Corp., then the third-largest bank failure in U.S. history.
“We came to understand that either the FDIC would protect all of the bank’s depositors, without regard to deposit insurance limits, or there would likely be a run on all the money center banks the next morning,” he said in a speech 10 years ago. “We chose the first option, without dissent.”…[end quote]
It’s possible, perhaps likely, that the FDIC will protect all of the SVB’s depositors, without regard to deposit insurance limits, as they did with Bank of New England Corp. in 1991. SVB is more sensitive in that the customers represent high-tech, high-growth companies that are more important to the U.S. economy than their total size would indicate.
The links to the Control Panel will be below as usual, but the METAR for next week depends upon the response of government agencies to the SVB collapse.
The Fed will almost certainly restrain the next rise of the fed funds rate to 0.25%. Without the SVB collapse it would likely have raised the fed funds rate 0.5% due to the strong jobs report and inflation.
The stock market’s reaction will be volatile and possibly extreme. If the FDIC announces early Monday morning that it will rescue SVB customers without regard to the $250,000 limit the market will probably respond with glee. If not, there will probably be a hit to the NASDAQ stocks that were affected most by the increase in bond yields since those are most likely to have funding from regional banks. QQQ will probably plunge as many investors will try to get out the door first. SPX will also drop since many financial companies as well as high-tech will be hit.
It’s unlikely but possible that the contagion will spread and the SVB failure presage a financial crisis. The mainstream financial press says that the large national banks will not have a problem since their customer base is widespread and deep and they are well-capitalized. METARs can have a finger on the pulse by watching the VIX and the Financial Stress Index.
If the VIX rises above 40 at the same time that the Financial Stress Index rises above 5 it’s a sure sign of a financial crisis that would cause the Federal Reserve to step in. I think that the Fed will try to keep out of the current situation and stay on its planned course unless this happens. The FDIC (and possibly Treasury to back it up) are supposed to handle banking problems…unless there is a danger of complete market melt-down when the Fed is forced to act.
I don’t know how the bond market will react to the SVB collapse. Treasury yields suddenly plunged on Friday and the entire yield curve dropped. This may continue next week.
The trade is strongly risk-off as SPX and junk bonds literally fell off a cliff (gapped down) relative to the U.S. 10YT price. The Fear & Greed Index suddenly dropped into Extreme Fear.
All bond holders know the market value and par value (if held to maturity) of all their bonds. They are only too aware of their book losses. Investors who hold individual bonds to maturity have nothing to worry about. Investors in bond funds have drops in NAV that cannot be healed by holding to maturity since funds do not mature. They can hold their shares to the duration of the fund as older (low-yielding) bonds will mature and be replaced by newer (higher-yielding) bonds. But selling bonds or shares of the fund will lock in the loss, as it did with SVB.
Next week is probably going to be interesting, to say the least. The METAR is stormy. This may be a good buying opportunity for stocks but not for bonds.