Fed Breaks SVB; Will More Banks be in Crisis Mode?
By Victor Sperandeo with the Curmudgeon
The lagged economic effects of the fastest and greatest percentage increase in the Fed Funds Rate (aka short-term interest rates) in history showed itself this week. Yes, dear reader, the Fed has finally broken something by causing the failure of Silicon Valley Bank (SVB).
The big market moving event of the week was supposed to be the February BLS jobs report on Friday (March 10), but that was totally overshadowed by the completely unexpected, 2nd largest bank failure in U.S. history- that of SVB.
Many articles have been written on this subject. You can read as much as you like on-line, on videos, or in print. To write a detailed review of this event is not important for our readers who are looking for fresh perspectives. We will provide a quick recap, so that there’s a context for the remarks that follow.
The key issues are the essential cause of SVB’s failure, what does it mean for the future of the economy, Fed monetary policy and the markets?
The most important question is whether this was a one-off exception or a systemic event with more bank failures to follow. In other words, are there now serious cracks in the U.S. financial system due to excessive Fed rate hikes and their hawkish drumbeat talk?
SVB, the sixteenth largest bank in the U.S. [1.] is gone. Its demise occurred in just two days (last Thursday and Friday). Ironically, Forbes named SVB one of the best U.S. banks shortly before it went bankrupt and was closed.
Note 1. SVB stock price hit a high of $753.12 on 10/22/21. On 8/16/22 the stock was $476.45; on 2/2/23 it was $333.5; but on March 10th it’s worth $0.31. In December 2022, SVB had estimated assets of $ 212 billion and 3,600 employees with an average salary of $112,000.
SVB owned $120 billion of MBS and Treasuries with an average maturity of 6.5 years. Those fixed income securities were purchased when rates were much lower. As interest rates skyrocketed due to the Jerome Powell led Fed, SVB’s portfolio was worth a lot less.
SVB also banked many startups, which were plentiful when interest rates were low because VC investments increased. When interest rates rose, VCs stopped investing and startups started drawing down more of their money to pay for expenses. So SVB had to come up with cash to pay for their customer redemptions. They recently sold $21 billion of bonds but lost $1.8 billion from the sale. “We are taking these actions because we expect continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients,” SVB CEO Greg Becker said.
When that loss was announced on Thursday, it triggered a run on the bank by depositors. Many start-ups and wineries had more than $250,000 on deposit at SVB. They will be receiving IOUs instead of cash for those excess deposits, which were not FDIC insured. As a result, many small businesses won’t be able to make payrolls! More on this later in the article.
SVB’s headquarters in Santa Clara, CA were closed on Friday.
SVB Downfall Caused by the Fed:
What killed SVB? Simply, the Fed raising rates at the fastest pace and the largest percent in 110 years. The Fed’s “reverse wealth effect” policy has claimed its first big victim! (Please refer to Chris Whalen’s comments below).
In SVB’s case, the bank did not assume nor plan for the Fed’s non-stop, incessant rise in rates, and the unique Powell moral suasion tactic of talking markets down with “threats of higher rates” (hawkish drumbeat) after any minor rally in the markets.
SVB’s bond holdings were held in a “Hold to Maturity” account [2.] which means they were not subject to market risk if bonds are NOT sold. This would be deemed conservative until bonds declined the most since 1789 in 2022.
Note 2. A bank cannot not “sell” a single bond from the “Hold to Maturity” account. If it does (in SVB’s case), the entire “Hold to Maturity” portfolio must be marked to market.
The Fed’s irresponsible and aggressive monetary policy did not allow any time to alter investment positions (called the “adjustment period”) for an investor who had low interest rate holdings of very safe debt.
All this while depositors withdrew their money from SVB to pay expenses and/or to invest in higher yielding Treasury debt (like 6 month and 1-year T-bills and two-year notes). Thereby, the bank was forced to take losses in its MBS’s sold to meet redemptions. They also failed in attempt to raise capital when the huge bond loss was announced.
Thereby, a 39-year-old very successful U.S. bank is now dead and buried along with $100-150 billion in capital.
The bulk of the depositor’s losses came from accounts over $250,000, above which there is no FDIC insurance. Without access to all their deposits at SVB, many startups and small business cannot make payrolls. That will likely cause other business defaults.
àThat will assuredly produce a horrific “reverse wealth effect” which has been the Fed’s goal for the last 12 months.
In addition, this same dynamic process may cause deposits to be withdrawn for higher yields in other banks. Many regional banks, will in many cases, suffer the same fate as SVB.
This is what horrendous Fed policy (both keeping interest rate too low for too long, and then spiking them way up) has done to the banking system. This is what happens when there is a singular goal (2% inflation) that is pursued without regard to the health of the entire system. The danger, today, is that there could be similar such runs on other small/medium sized institutions; all it takes is a rumor. Institutional and large individual depositors, especially those with more than $250K in deposits (the FDIC insurance limit) can easily become jittery, especially when a bank like SVB appears to have failed “out of the blue.”
Chris Whalen’s Comments:
Chris Whalen is a world class bank/risk analyst. I have followed and profited from his thinking for many years and is simply the best bank analyst I know of. Take a listen to what Whalen says in this podcast, “The Fed Is To Blame For The Collapse of Silicon Valley Bank.” He cites the Fed’s “reckless and insensitive” monetary policy.
The Curmudgeon and I concur with him, but other portfolio managers say SVB should have hedged with interest rate swaps? Always nice to look back as a “Monday Morning Quarterback” and state how you could’ve fixed a problem AFTER the damage is done! OUUUCH!
History of the Federal Reserve Rate Hikes:
In studying the history of the Fed (I have followed the Fed in real time from 1966 and before then by reading Allan H. Meltzer’s opus works: “The History of the Federal Reserve 1913-1951 Volume 1” and “The History of the Federal Reserve Volume 2 1970-1986.” Both books total about 1500 pages.
The history of Fed monetary policy (up to March 2022) was to take small slow steps in raising rates as the FOMC members never know the impact rate rises will have considering a very complex U.S. economy, and the dynamics of the consequences of its actions.
The Fed previously spaced out increases, such as in the periods 2004 to 2006 and 2015 to 2018, when lower inflation allowed officials to move more gradually.
Thereby, the history of the Fed is basically to deliberate, act carefully and slowly. When the Fed did not attempt to adjust to the outcomes, the consequences were dire! For example, during the Great Depression (1929-1939) the Fed did not put enough liquidity into the economy as banks folded one after another. Meanwhile, money supply dropped 20+ %.
We are now in another dire period of time!
Lag Time of Fed Rate Hikes Has Increased:
Monetary policy effects on economic growth and inflation operates with a lag time which is difficult, if not impossible, to predict. Developments in one sector of the economy are gradually transmitted to other parts of the economy as agents, which alters the behavior of suppliers and customers. These transmission channels to the wider economy also contribute to the aggregate lags of monetary policy.
Huge government stimulus programs after COVID, supply bottlenecks, pent-up consumer demand for travel and dining out have all increased the lag time of the current round of Fed tightening, which began in March 2022.
Here is a recap of the Fed Funds rate hikes in the last 12 months:
<![if !supportLists]>· <![endif]>3/16/22 +0.25% (from to 0-to +0.25%)
<![if !supportLists]>· <![endif]>5/4/22 + 0.50%
<![if !supportLists]>· <![endif]>6/15/22+.0.75%
<![if !supportLists]>· <![endif]>7/27/22+0.75%
<![if !supportLists]>· <![endif]>9/21/22 +0.75%
<![if !supportLists]>· <![endif]>11/2/22 +0.75%
<![if !supportLists]>· <![endif]>12/15/22 +0.50%
<![if !supportLists]>· <![endif]>2/1/23 +0.25% (to 4.50%-4.75%)
<![endif]>3/22/23 +0.25% OR +0.50%?
Notice that the first two rate increases in March and May of 2022 were small relative to the four increases from June-November of 75 bps each.
Milton Freidman stated that the effects on the economy of rate hikes had a one-year lag time. Thereby, starting in June 2023 through the rest of the year the economy should weaken materially due to the 75bps increases which will hit the economy in the second half of 2023.
Credit Suisse notes the six yield-curve inversions over the past 50 years, with economic recessions following each by an average of 11 months. The current inversion started in October, so we should be due for economic growth to stall out by the end of summer (if not sooner by our calculations).
Also, the Fed beating the drums for “higher for longer” rate rises will cause more havoc. Nothing in the current political/fiscal policy proposals will help GDP growth and thereby avoid a recession.
However, I’m far more pessimistic as I’ve expressed in these Sperandeo/Curmudgeon posts for the last few months. Another potential problem is the battle over the debt limit which is set for June.
Next Tuesday’s CPI Report:
The CPI for February will be released Tuesday, March 14th and will surely be a market mover. The CPI is forecast to rise 0.4% for the month versus 0.5% in January, according to FactSet. Core CPI (which excludes food and energy) is forecast to rise 0.4% for the month after rising 0.4% in January. The CPI, year over year, is forecast to rise 6.0% versus 6.4% in January. If any of those numbers comes in “hotter” than expected, markets will likely sell-off as the Fed’s “higher for longer” rate hikes will be confirmed.
Last week, Gold and U.S. Treasury debt rallied while stocks sold off again (especially the small cap Russell 2000 which lost -8.07%). The SPDR S&P Regional Banking KRE exchange-traded fund (KRE), fell 16% on the week, including 4.4% on Friday. Smaller stocks, many of them financials, also took it on the chin, with the iShares Russell 2000 IWM -2.88% ETF (IWM) off 8% on the week and almost 3% on Friday.
Many individual bank stocks were pummeled for perceived similarities to SVB. PacWest Bancorp (PACW) plunged 37.9% on Friday and 55.3% on the week, while the hits were 20.9% and 34.8% at Western Alliance Bancorp (WAL). Charles Schwab (SCHW) fell 11.7% on Friday and 24.2% on the week.
That’s 100% in sync with my positions and view of where markets should be at this time. I believe these trends will continue. It also should be noted that Commodities using the CRB Commodity index made new lows this year and are at last year’s lows -confirming that price increases are reversing. Bitcoin has declined from $25,000 back down to $19,750 as of last Friday.
I don’t know what the Fed is thinking, but it has nothing to do with history or understanding of human psychology. I posit this question to our readers:
Does anyone seriously think that when the Fed raises rates that it would immediately show up in a completely subjective index like the CPI?
In an economy of 340 million people with immediate needs, does a CPI report have to show declining inflation or else the Fed will punish U.S. residents with more rate increases?
That would be a ridiculous and outrageously senseless assumption, IMHO. Again, I say that the Fed is either dumb or has an undisclosed agenda they intend to play out.
It will be very interesting to see how the Fed responds to the SVB failure and the weaknesses of other banks? That maybe telling for the entire U.S. economy. In the podcast referenced above, Chris Whalen says “the Fed better act by Monday.”
While I’m not sure that will occur, I predict that there will be no increase in the Fed Funds rate at the 3/22 FOMC meeting (As a result of SVB failure, Fed funds futures now predict 79% probability of a 25bps rate hike, 21% of a 50bps hike at the March FOMC meeting).
I take pride in being an outlier/iconoclast and so does the Curmudgeon who’s been a voice in the wilderness for decades!
This quote by Ron Paul is very appropriate now:
“The moral and constitutional obligations of our representatives in Washington are to protect our liberty, not coddle the world, precipitating no-win wars, while bringing bankruptcy and economic turmoil to our people.” Ron Paul
Be well, stay healthy, warm, and dry. Please email the Curmudgeon (email@example.com) if you have any comments, questions, or concerns. Till next time…...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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