Most of the commentary over the past two weeks regarding the failure of Silicon Valley Bank (SVB) has been rather breathless. And mindless.
Mostly, it’s amounted to a tiresome search for villains. We say tiresome because seemingly lost in all the hysteria has been the basic truth that progress is born of the very failure that so many are so puzzlingly trying to abolish. The latter extracts precious resources from the hands of the bad so that the good can get to work. But we’re getting ahead of ourselves.
For now, some claim SVB management simply wasn’t very good. One pundit described SVB’s balance-sheet errors as “rookie mistakes.” Really? While it’s certainly true that the best financiers most often aren’t commercial bankers since bank assets are comprised predominantly of lower-risk securities and loans secured by real property, we find Monday-morning critiques of SVB’s management team remarkable. Just what was management supposed to do? Banks make money by borrowing short and lending long. They always have and always will. How would "smart” bankers have acted any differently?
The source of SVB’s troubles began when management was forced to sell bonds at a loss to meet deposit outflows. But only in hindsight can we criticize management for its balance sheet vulnerability in the face of rising market interest rates. Perhaps management should have kept the duration of the bond portfolio shorter than it was, especially given the nature of the bank’s deposits (predominantly from VC-related firms that would look to redeploy the cash as investment opportunities arose), but these knowing comments bring new meaning to the old adage about hindsight being 20/20. Please read on.
Claiming that maintaining such a long duration portfolio was irresponsible when the Fed had “telegraphed” that it would keep raising rates is most unconvincing, and contradictory. On the matter of contradictory, if the direction of interest rates was so obvious, then by extension it should be obvious that a rate-hedging strategy would have been incredibly expensive. If you doubt this, try to buy earthquake insurance when the earth is shaking.
The SVB critics are wholly unconvincing when it's remembered how economists and strategists have a pitifully poor track record when it comes to forecasting interest rates. Put another way, the surest sign that the Fed’s power over the cost and amount of credit is much more theoretical than real is the pitifully poor track record of those who fancy themselves rate forecasters. To know the future of interest rates is to know future market prices. Much easier said than done.
Some on the right claim SVB highlights the danger of fractional-reserve banking. But banks are not money warehouses. Deposits are lent out to borrowers and earn an interest rate spread for the bank. Only a small percentage of deposits are retained to meet any routine withdrawal requests.
Faulting businesses for leaving deposits at SVB above FDIC deposit insurance limits similarly rings hollow. There are many reasons for a business to keep liquidity on hand as bank deposits; generating the highest possible return (e.g. sweeping funds to a money market fund) is not necessarily the highest priority. Most large businesses leave millions on deposit at banks to facilitate day-to-day business transactions. Do they even really care about the FDIC limits? Highly unlikely.
That is so because depositors would be made whole amid a bank run with or without the FDIC. That is so firstly because the business model of banks is to be very conservative as SVB’s asset mix hopefully vivifies. Second, a bank run that theoretically taps a bank out in the near-term doesn’t mean those who held deposits won’t get their money, it just means they won’t get their money right away. See SVB’s conservative balance sheet yet again. Third, failure doesn’t cause a business to vanish as much as it creates an opportunity for another institution to quickly gain market share at distressed prices. The main thing is that whether the FDIC is selling a bank it’s taken into conservatorship or if a failed bank is simply purchased sans the FDIC, implicit in either scenario is that depositors will be made whole.
Back to SVB, once it started having problems, other banks would have been willing to go shopping only for the FDIC to step in before that was even allowed to occur. Which is a shame, as in the just announced Citizens Bank acquisition might have happened even sooner, and for the much better. Things only tend to cascade downward when government intervenes. Which is a statement of the obvious. Market interventions by government can’t improve markets.
In the end, could this simply have been a culmination of some poor internal decisions that happen all the time in the business world? Is this the start of a contagion? Doubtful. Signature Bank and Credit Suisse are coincidences, not related. Let’s stop making mountains out of molehills. Government hysteria in response to failure drives crisis, not the failure itself without which there is no progress.