This is a fascinating tale of what we have discussed for over a year. When you know where to look for warning signs, they become clear. Where those end up manifesting is tough, but knowing something is wrong is helpful.
How long have we talked about the yield curve and the warnings it was presenting? Many will discount it as nothing yet we get situations like this.
To quickly recap, the yield curve, both LIBOR and Treasury, has been telling us for a year that inflation and growth expectations are tempered. This means that, over time, they were going to collapse. Of course, in this world of short attention spans, this does not mean by the next report.
The bond market was telling us something else. Things are very sick, something many want to ignore. When you have the 3 mo paying 100 basis points higher than a 10 year, we end up with no demand for long date bonds. This is a problem.
SVB got caught in a position where liquidity dried up. Do not think for a second this is the last bank to see this fate. We are going to have many smaller banks (non national mega banks) encounter the similar problem.
Understand how banks operate reveals the entire situation.
So let's take a look and see what we are dealing with.
Trading Account Versus Book Value
Bond have a par value along with a coupon rate. A 10-Y Treasury will have a par value of, say, $10,000 with a coupon rate of 1.5%. This means the bond pays $150 per year for 10 years. This was the case a couple years ago.
Now, due to increase in rates, we have the 10-Y at 3.75%. That means, for $10K, the bond will pay $375 per year.
If a new bond is yielding that, why is someone going to pay $10K for $150 per year? The answer is they will not. That means the value of the first bond drops, by like 60%. That means we are dealing with a bond that has a value of $4,000.
This is what the market is telling us. It is also what led some to claim that the bank was hiding losses. It was not.
When a bond is on the balance sheet as book value, it is not mark-to-market. Why is that? Because the bond is going to garner $10K at maturity. The par value is paid up along with the last interest payment at that time. Hence, any instituion holding bonds to maturity know exactly what they will get.
So far, so good. It is not a difficult concept once you know how things work.
Liquidity Crisis
What happened with SVB is people started to want to get their money. This is where the term bank run comes from. Since banks are not sitting on the deposits in cash (which is impossible since people want to be paid interest), there is not enough cash. Here is where liquidity funding enters.
Interest rates going up the past year means that many of the long dated bonds were now worth a great deal less than they were before. Hence, when SVB went to sell them, they were getting 30%, 40% or 50% of the par value. It is likely the bank made no plans for rising rates and had a lot of long end securities (they had mortgage backed securities too).
Things really escalated when you exit the trading hours of traditional markets. Here is where the weekend liquidity crisis can crop up. Without the ability to secure short term funding (to get them to whem markets open), they are screwed. Here is where SVB ran into a wall.
Having hundreds of billions in assets is of no use if you cannot put you hands on a couple billion in liquid form. This is where SVB was a couple days ago.
Short Term Lending
We talked a great deal about the Eurodollar system. This provides an estimated 90% of the funding for global trade. Few understand this market since it is not something they deal with on a regular basis. That said, they do enjoy the benefits of it.
Liquidity is crucial for financial institutions. It crops up all over the place. For example, how do you have $7,000 in your account the day after selling the stock? Stock transactions take a number of days to settle. By rights, you should not have access to that money for 3 days. Yet, here you can trade again the next morning.
The reason is the brokerage firm entered the short term funding market and borrowed the cash if needed. This is how it can keep all its customers going even though transactions are not settled.
So now Janet Yellen is promosing no bailouts. Instead, they are going down the path of bail ins, just like Europe did a 15 years ago. This will make everyone happy since we all know how the masses hate bailouts.
Of course, now that many tech companies, including small businesses, do not have access to their accounts, how are they going to make payroll. The contagian from this is going to be widespread.
The decisions made 15 years ago took place during an election year. We know how these things work. This year is not.
That means they will favor the rhetoric, while promising to protect the depositors.
I am sure many of the companies in Silicon Valley had payrolls more than $250K per pay period.
So much for that money.
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Spot on mate, seen a lot of your posts early on and agree. This year was always going to be a year of liquidity. It's a hard one because there is talk of interest rates going down in the future but can it be trusted?
A lot of people have lost a lot of money and it will get a lot worse. It almost feels worse than the 2008 financial crisis.
IMHO the present is simply the consequence of the past. What we are seeing today is the result of what was done in 2008. What will happen next will be the result of actions taken today. Closing banks closes liquidity spigots, enabling liquidity to continue to pour out of those spigots remaining. Overall liquidity will decline, but those spigots most essential to the heart of the financial oligarchy will be the last to experience any reduction in flow. The megabanks like JP Morgan, Citi, and their ilk will be where money continues to circulate until there is no money to circulate.
Edit: I just learned Jim Cramer has stated that JP Morgan is a fortress. Based on Jim Cramer's near 100% failure rate, I have to revise my comment regarding JP Morgan, and now expect it's imminent collapse. The basic premise that liquidity will continue to remain primarily available to the tip of the pyramidal hierarchy of finance is sound, but such wealth is entirely mobile, and can simply be moved without any of us knowing it occurred.
Anything Jim Cramer recommends is doomed. I apologize for any confusion created by my not knowing Jim Cramer advocated JP Morgan.
Cramer does seem like the ultimate contrarian investment. Whatever he said, go against it.
The GFC was a bank run but by banks running to be made good on their collateral.
You are right, this started in 2008. We have been in deflationary money since then. The financial system has been starved as balance sheet constraint arose.
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The yield curve is screaming that interest rates will be heading down in the future.
When the 3 month is 100 basis points above the 10-Y, that doesnt bode well for the idea that things will be getting beter.
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This is the crux of the fallout from SVB's piss poor management. Many other banks hold long positions on these bonds which is fine if they hold them until maturity.
Other banks did not and that's where the problem is. These are mostly US regional banks.
SVB failed to adapt it's strategy when interest rates rose and got caught short.
They should have been buying the new higher yielding short duration bonds like many other banks did. This would have generated positive cash flow.
It has also been noticed that the directors started selling millions of their stocks 3 weeks ago. Insider trading?
They knew what was happening and bailed on everyone.
They have a subsidiary bank in the UK with 350 staff. Needless to say. No one will go to jail?
Capitalism at it's finest 😂👍🏼
Fractional reserve banking made that impossible for SVB. IIRC, cash reserve requirements have been lowered to ~5%. SVB couldn't uninvest from long term bonds to react to short term interest rate fluctuations without eradicating it's capital reserves. As @taskmaster4450 points out, they could only liquidate those investments at a substantial loss. When massive accounts like Thiel's moved their deposits on Thursday, SVB simply had no cash pay other depositors on Friday.
In 2020, the Fed removed the reserve requirement and hasnt implemented it. I dont know what other regulators such as the OCC require.
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LOL LMAO even. Fractional reserve banking without reserve requirements strikes me as absurd as the most drug fueled hallucination.
Thanks for setting me straight.
Is this not another bail out of the 1% who should by rights be taking losses on this bank failure?
There are few things better defended than the assets of the wealthiest. Water flows downhill, and bailouts draw from the shallowest wells first. It is rare that the accounts of plebs are secured by being offshore, in trusts, and etc., making them more available to raid.
Shit flows downhill and if the financial impact (negative) hits at the upper end, it flows to most.
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Do you consider a paycheck only the 1$?
If a tech firm has $5 million in SVB and cannot access it, how do they pay their bills, including salaries.
This is the problem of the 1%-hate the rich mantra constantly espoused.
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Signature Bank was closed by regulators on Sunday, the second massive bank failure in three days!
poor risk management by SVB, but i don't know what's worse. That or the Fed setting the precedence for bailing out smaller, riskier non SIB banks..
I know that they had to realize a lot of unrealized losses through the bond selling but I also think their lending practices also had a part in things right? I don't really think the companies were doing so great in a recession and it could have also contributed towards their cash reserves.
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In this situation, the lending practices werent a problem, at least now. This is a liquidity crisis.
You could be right, in the long run, bad lending could have been a problem for SVB. But at this time, it was liquidity which happens when long dated bonds are halved in value, restricting access in financial markets.
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I am definitely learning the ins and outs of global debt markets, and it seems like no banks wanted to acknowledge that rates could go up, even tho the charts were pointing to an upward move for over a year.
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