Now that we are a few weeks removed from SVB, Signature Bank, Silvergate, and Credit Suisse crises, the overhead storm finally seems to be abating.
Whether the crisis is truly over or not, only time will tell…
What will stay with us will be its lessons and consequences, much like how the lessons of 2008 continue to shadow us.
But if we’re not careful, we may draw the wrong conclusions from this whole ordeal.
2008 showed us that bad assets lead to bad problems. NINJA (“No income, no job, no assets”) loans or anything that looks like one cannot end in any way other than in tears.
The shadow of 2008 has likely encouraged most people to focus on the asset side of SVB’s balance sheet. Most of the discourse and coverage of SVB over the last few weeks seem to prominently highlight the paper losses SVB (and the banking system as a whole) racked up on treasury and agency holdings. The magnitude of these losses are large and are enough to wipe out, in some cases, a majority of book equity in many banks if the losses were to be realized.
Although the asset side certainly has issues worth discussing, singularly focusing on the assets would likely lead to the wrong lessons.
Even though SVB’s treasuries and agency paper lost value, this had very little to do with poor underwriting. These are not NINJA loans and would have delivered positive profits if held to maturity regardless of where interest rates go.
At the end of the day, treasuries and agency paper are amongst the safest assets SVB could have put their money into. These assets carry effectively no credit / underwriting risk. Almost anything else would have left them even worse off. Not only would they be contending with liquidity challenges, they would certainly be losing sleep over rising credit risk in a rapidly slowing economy.
The decline in value of treasuries and agency paper is not a unique property of those assets but rather a function of rising interest rates. Almost all assets go down in value when interest rates rise. This is almost a fundamental law of finance.
Had SVB put money into things other than treasuries and agency paper, not only would SVB likely still face similar losses, SVB would have very likely had an even more illiquid asset portfolio. Treasuries and agency paper are very liquid…most other things are not. SVB did / does have an allocation to rare wines. Perhaps things like rare wines do not lose much value in a rising interest rate environment (questionable), but, certainly, wines would be even harder to use to satisfy deposit redemptions than treasuries.
The only thing that could have been safer from an asset allocation perspective is straight cash or short-term cash-like instruments.
In some alternate universe perhaps this could have been the path they chose, but arguably the business model of a bank demands that this road not be taken. Banks exist to lend. Not to sit in cash. Customers want mortgages. Businesses want loans. Banks want to and exist to meet those needs. And it is good for society that banks do try to meet those needs.
Would sitting in cash have saved SVB? Maybe…but maybe they wouldn’t have ever existed if their risk preference is to sit in cash.
The point is – Focusing on SVB’s assets would very likely hide the true lessons that need to be observed.
To see what we need to see, we have to look to the other side of the balance sheet.
In Capital Flywheel’s opinion, this crisis echoes a fundamental problem related to the structure of liabilities. And this applies not only to banks but to nearly every aspect of our modern economy.
The common thread behind all of this is the fact that the economy increasingly stands on a foundation of confidence.
This was not always the case, but as our economy becomes increasingly interconnected and financialized and driven by credit, confidence becomes the very air we breathe.
No amount of regulation or deposit insurance or government intervention can save us all if we collectively decide to “run on the bank”.
Decades ago during the Great Depression, deposit insurance and the FDIC was created to help prevent bank runs.
But – The FDIC does not exist to actually insure our money. The FDIC exists primarily to ensure our confidence.
Currently, the U.S. commercial banking system holds $17.5 trillion of deposits.
The FDIC is not and will never be capable of ensuring all $17.5 trillion of deposits if a material part of the deposits start to run. $17.5 trillion is almost the same size as our entire economy and is many times larger than the US government’s entire fiscal budget (currently ~$6 trillion).
To state again for emphasis – The FDIC does not exist to insure our money. It exists to ensure our confidence.
It’s a bluff – and a bet – that if they can instill just enough confidence, we never have to actually call in our insurance claims.
The crazy part is that this works exactly as advertised as long as we all believe!
And if we don’t, even the best run banks would likely collapse.
Back in February 2021 half a year before markets peaked, Capital Flywheels started becoming concerned about very similar dynamics occurring in other parts of the financial system. Although Capital Flywheels was primarily concerned with a “run” on equity markets (and wrongly concluded that deposit insurance has made bank runs unlikely…oops), the lessons are all the same:
In a highly financialized world and an ever more financializing world, this growing gap between what we believe we are worth on paper and what can actually be turned into cash is a key driver of market crashes during times of stress precisely when a lot of people suddenly want cash.
Although I am not a bitcoin-truther and do not know whether bitcoin is our future or not, one thing that is true of both bitcoin and all financial assets today is that its existing value can only hold if you increasingly convince holders to HODL.
Because if any meaningful portion of hodlers want to go back to cash, it will be a rude awakening for all of us.
Source: Money Creation and our “HODL” Economy
Our increasingly financialized world rests upon a foundation of confidence, a foundation of sand. And as our world becomes increasingly financialized, shoring up confidence is paramount. Without confidence, even great assets and systems will suffocate.
And in a world where confidence is the air we breathe, whether we like it or not, our primary job is to convince everyone to HODL.