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March
11
2023

Is SVB Just the Beginning?
Brian Maher

Our guard should have gone rocketing up last month — when Mr. Jim Cramer recommended Silicon Valley Bank stock to his listeners.

That is because the fellow is a nearly perfect “contrarian indicator.” If he says x you can very reliably wager on y.

SVB stock was trading hands at $320 that day. Today it trades hands at $0. It has vanished from existence.

Silicon Valley Bank — formerly the 18th-largest bank in the United States — has fallen into receivership, defunct, destitute and dead.

It is presently in the hands of the Federal Deposit Insurance Corporation.

Its demise represents the largest bank flunking since 2008’s Great Financial Crisis.

A Classic Bank Run

What went so catastrophically wrong? Bloomberg:

Silicon Valley Bank became the biggest U.S. lender to fail in more than a decade after a tumultuous week that saw an unsuccessful attempt to raise capital and a cash exodus from the tech startups that had fueled the lender’s rise…

Problems for SVB mounted after Peter Thiel’s Founders Fund and other high-profile venture capital firms advised their portfolio companies to pull money from the bank. The calls followed parent company SVB Financial Groupannouncing that it would try to raise more than $2 billion after a significant loss on its portfolio.

That is, Silicon Valley Bank had a bank run on its hands.

Affirms Mr. John Wu, Ava Labs president:

This is a classic bank run, and when the bank run starts you don’t want to be the last guy there.

No. You do not want to be the last guy there.

In Far Too Deep

The Bloomberg passage cited above referenced a “significant loss on [SVB’s] portfolio.”

That portfolio was packed to the gunwales with longer-dated government bonds.

Prior to its dying, these bonds occupied some 57% of the bank’s investment portfolio. In contrast, not one of the remaining 74 major United States banks held more than 42% of such securities.

And here our tale gathers pace…

You may recall that bond prices and yields are related in the way that polar ends of a seesaw are related.

If bond prices swing higher, their yields swing lower. And vice versa.

Meantime, longer-term bonds are uniquely sensitive to changes in the interest rate. They are more sensitive than shorter-term bonds.

We need not concern ourselves with the whys and wherefores at present.

It is enough to recognize that longer-term bonds are more sensitive to changes in the interest rate than shorter-term bonds. Now, to proceed…

The Fed Killed SVB

The Federal Reserve has been hard at the business of raising interest rates since last March.

This tremendous pushing has worked significant upward pressure on bond yields. But recall, bond prices and bond yields occupy opposite ends of our seesaw.

As bond yields have taken to the upswing… bond prices have taken to the downswing.

Bond prices — especially long-term bond prices and for the reasons listed — have decreased remarkably.

The value of Silicon Valley Bank’s portfolio has therefore endured a fantastic degradation.

Again, recall that it held a great preponderance of longer-term bonds. Now, as our colleague Dave Gonigam of The 5 Min. Forecast explains:

As long as banks don’t have to sell those bonds, it’s all good: It’s just paper losses and if the bank holds those bonds to maturity, it gets back the full value of the bonds.

But if the bank does have to sell to raise cash for some reason, it’s then forced to unload those bonds at potentially fire-sale prices.

This was the hapless fate of Silicon Valley Bank.

Bankruptcy

The bank sold some $21 billion of these bonds in an attempt to reinvest them in shorter-term bonds — which again, are less sensitive to increases in the interest rate.

It attempted to raise some $2 billion to cover its flanks but the operation failed and the bank descended into the oblivion of insolvency.

It died the death.

Here you have the autopsy, to our understanding at least. It admittedly lacks anatomical detail.

Now we come to the question that is worth $64,000:

Will Silicon Valley Bank’s failing lead to a cascade of other bank failings?

After all: In the banking world the foot bone is connected to the leg bone is connected to the knee bone is connected to the thigh bone is connected to the hip bone is connected to the backbone is connected to the neck bone.

Before a fellow knows what has struck him the rumpus in his foot bone has his neck bone in siege.

On the Verge of a Banking Crisis?

It is plausible to assume that the largest banks will prove immune to contagion. They have the wherewithal to absorb a blow.

Yet it is the small to medium-size banks, the regional banks, that may get licked. They lack the wherewithal to absorb a blow.

Explains Zero Hedge’s pseudonymous Tyler Durden:

If depositor confidence in the regional/small bank sector is now shot — and after SVB… it very well may be — we will see a small (to medium if not larger) deposit run among the regionals which could prove devastating for these reserve-constrained banks which will need to scramble to raise capital a la SVB in what eventually transforms into a death spiral for the sector, especially if depositors take one look at what is going on with regional bank prices – which have been in free fall in the past two days – and extrapolate what may come next – there’s a reason why banking is the ultimate confidence game.

And quite a confidence game it is. It occurs on a rickety, ramshackle structure erected atop a foundation of sand.

Jerome Powell’s Trapped

But as Mr. Durden further observes, the entire SVB affair — particularly with its contagion risk — jams Jerome Powell into a very tight corner.

Inflation remains amok and he is hot to get it under his thumb. He must continue to elevate interest rates to get it there.

This he pledged to do in this week’s congressional testimony. He was very clear about it.

Yet if he elevates interest rates further, he will further depress bond prices… which could place stupendous strain upon the regional banks… and eventuate in additional Silicon Valley Banks.

Mr. Durden:

The Fed may have no choice but to cut rates if it wishes to save the (regional) banking system. But then again, the Fed is still stuck fighting runaway inflation, which means that Powell is now trapped… Powell is now trapped: More hikes: regional banks collapse; Less hikes: inflation target must be raised.

Trapped… indeed. How will he wriggle out of it? What will the poor man do?

Following this week’s “hawkish” testimony, the market gave nearly 80% odds of a 50-basis point rate rise this month.

Today, with the SVB hullabaloo, those odds have plunged to 35.1%.

Mr. Powell must pick his poison, as the phrase runs. He can opt for one poison or the alternative poison.

Regardless: Poison it will be…

Regards,

Brian Maher
Managing Editor, The Daily Reckoning

 

 

Brian Maher is the Daily Reckoning’s Managing Editor. Before signing on to Agora Financial, he was an independent researcher and writer who covered economics, politics and international affairs. His work has appeared in the Asia Times and other news outlets around the world. He holds a Master’s degree in Defense & Strategic Studies.

 

 

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