A group of friends meet at a house near the beach in Pajaro Dunes, California, in the early 1980’s to play poker in what is becoming known as Silicon Valley. They choose this name for the company without realizing that this will be their best business introduction letter. This game from more than 40 years ago cost investors around the world tens of billions this week and is testing the ability to respond to prevent financial turmoil from escalating into a full-blown economic crisis.
The experts consulted believe that the authorities can contain the contagion because they have prepared the tools from previous crises. Still, they acknowledge that downside risks and the likelihood of a US recession have increased. The global impact is small for now. Nobody expects a financial crisis like the one in 2008, triggered by the bursting of the US mortgage bubble. Now the catalyst for the crisis is the most aggressive rate hike since the early 1980s, just when Silicon Valley Bank was founded.
This was the downfall of Silicon Valley Bank
The crisis erupted after the start-up bank and venture capital firms laid their cards on the table. In early March, Moody’s quietly warned him that a downgrade was being considered. The reason was that he had invested his customers’ deposits in government bonds, which were very safe at first but had lost value with the large rate hikes approved by the US Federal Reserve last year to fight inflation. The Silicon Valley Bank hired Goldman Sachs and sold them a portfolio of bonds in which they lost 1,800 million and also decided to raise capital by 2,250 million to strengthen their solvency. I thought it was a winning hand.
The execution of the operation was disastrous. The bank’s presentation to analysts on Wednesday afternoon, March 8th, for this placement shows how far managers were from what was coming. The bank sold the strategy it had developed with Goldman Sachs to improve its results. Back then, it wasn’t raising money because it needed liquidity to repay deposits, but to defend its rating and reinvest with higher interest rates.
In the prospectus for the operation, Silicon Valley Bank lowered its projections and acknowledged deposits were lower than expected because customers, mostly tech companies, were consuming more cash. The bank decided to sell the debt portfolio first, write off the losses and wait for the next day to issue the new shares. It was a mistake: “The delay in raising capital opened a window for panic on Thursday that SVB was vulnerable to as more than 95% of deposits were uninsured and a deposit base focused on the risk of funded companies leading to led to major outflows,” explain Citibank analysts, who describe the bank’s downfall as “self-inflicted.”
SVB shares plunged in the stock market early in Thursday’s trading session. The company could not place the new titles. The withdrawal of deposits broke records in both volume and speed. The customers asked to withdraw $42,000 million from the bank within a few hours. The concentration of deposits in a single sector, the fact that the vast majority had no public guarantee (which only goes up to $250,000 per customer), and herd behavior made the prophecy self-fulfilling.
No bank has the liquidity to return the money when all customers request it at the same time. That’s why bank runs are so dangerous. Also, the deposit leaks are no longer in the vein of How Beautiful It Is to Live!, the 1946 film in which James Stewart plays George Bailey, an honest banker who decides to commit suicide after a large sum of money goes missing. In the digital age, you don’t even need long queues or crowds, just transfer orders with your mobile phone or computer. There’s also no way a George Bailey calls for quiet (“the money isn’t here, it’s in Joe’s house, next to yours, in the Kennedys, in hundreds of houses…”). On Friday morning, March 10, the authorities intervened at the bank. After almost 40 years of existence, the Silicon Valley Bank disappeared in about 40 hours.
It was the largest bank failure since the fall of Washington Mutual in 2008 and the second largest in the history of the Federal Deposit Insurance Fund (FDIC). This body, responsible for bank intervention in crises, was created after the Great Depression, after about 9,000 companies disappeared between 1930 and 1933 due to bank panics. By providing a public guarantee on deposits up to a certain amount, citizens do not have to run for their money at the slightest suspicion.
the contagion comes
After the intervention of the SVB, the contagion started immediately. That same Friday, stock prices of other mid-sized banks in the United States fell, and as it later transpired, more deposit runs ensued. The Treasury Department, the FDIC and the Federal Reserve began analyzing how the crisis could be contained. On Sunday evening (in the tradition of the previous financial crisis) they announced the intervention of another entity, the Signature Bank, and the extension of the federal guarantee to 100% of the deposits of both banks, which they could do only exceptionally, declaring a situation of the systemic risks.
The New York Stock Exchange, this Thursday. SPENCER PLATT (Getty Images via AFP)
The characteristics of Silicon Valley Bank (with its focus on VC clients) and Signature Bank (because of its exposure to cryptocurrencies) were unique, but regulators had recently estimated that the banks had about $620 in unrealized losses on increases Billions of dollars in unrealized losses in their portfolios were in interest rates. In addition to guaranteeing the deposits of the two failed companies, the Federal Reserve approved a measure to provide other banks with liquidity for the original value of the bonds as if they were not suffering any losses, thus preventing new deposit leaks.
Authorities fired bank managers, making it clear they would not protect shareholders or bondholders (“This is capitalism,” said President Joe Biden). In practice, they have saved savers, including some investment firms, who refrain from public intervention in the economy. Biden has called for tougher penalties for bankers of insolvent companies and has accused his predecessor, Donald Trump, of relaxing supervision of mid-sized banks. Both Biden and Treasury Secretary Janet Yellen have insisted the financial system is healthy. The Federal Reserve has set out to investigate what went wrong, why its oversight failed to prevent the risks that arose.
Banks around the world, including European ones, have suffered in stock markets since Monday. There are different routes of contagion on a continuum ranging from direct exposure to fallen entities to irrational fear. But Credit Suisse was hit squarely by the shockwave, in part because of its own mistakes. The bank has struggled for years, but released its annual report on Tuesday and identified “relevant weaknesses” in its financial information control systems.
It’s never a good time to say such a thing, but to do it in the middle of a storm… To wrap things up, the governor of the Saudi SNB, Credit Suisse’s largest shareholder, was asked on Wednesday if he would be willing to increase his stake in the Swiss company and instead went to a tangent, he said: “Absolutely not.” The collapse was immediate.
After a multimillion-dollar lifeline was deployed in the early hours of Wednesday through Thursday, Swiss authorities are working this weekend to find a solution that may involve selling the bank, or part of it. “Restoring confidence in Credit Suisse is important for Switzerland,” Canadian company DBRS told Morningstar this week. “Credit Suisse is too big to fail and too big to bail out, so it’s too big for Switzerland anyway,” said an economist at a US firm.
ready to act
In the face of the SVB crisis and its aftermath, the good news is that economic authorities have the tool kit at hand. The 2008 financial crisis, the euro crisis and the pandemic have resulted in central banks and policymakers being trained and knowing what to do and how to do it.
“The mental block that sometimes aggravates crises has been avoided. The authorities don’t like bailouts because of the moral hazard involved, they tend to wait until there is clear suffering, until it turns out there is no other cure and it ends up getting worse. They reacted very quickly this time. In two days, many people went from discovering that there was a bank called Silicon Valley to knowing that it intervened with guaranteed deposits,” says a manager of one of the largest investment firms in the United States from New York, also underlining that Speed with which the Federal Reserve implemented a bespoke mechanism to respond to potential liquidity leaks.
“While there is no doubt that banking problems will attract attention, we believe that it is not a systemic problem, but rather a liquidity problem that the Federal Reserve can contain with its credit mechanisms,” they stress from the Oxford-based firm Economics . “It may seem like another financial crisis, but it isn’t,” they say.
In Europe, the ECB has hiked rates while ensuring it sees no risk of contagion and guaranteeing it is prepared for any liquidity problems. “The expected 50 basis point rise comes with a warning of risks to financial stability. However, the banking system shows no weaknesses or significant burdens from ailing foreign institutions,” summarized Axel Botte, Global Market Strategist at Ostrum AM.
View of a euro symbol in front of the gates of the European Central Bank in Frankfurt (Germany). EFE
Eurozone banks have less exposure to fixed income, a more stable deposit base and tighter regulation of interest rate risk, even for smaller banks. In any case, warned DBRS Morningstar’s María Rivas, “recent bankruptcies show that bank runs and liquidity crises can unfold at an unprecedented rate.” For this reason, she advocates more instruments to deal with liquidity crises.
economic ballast
The financial storm fills the liturgy of these cases. Stock market slumps, government interventions, weekend actions, shocks, relief… But if that’s a tradition, then it’s also a tradition for banking crises to take their toll on the economy. Michael Hartnett, investment strategist at Bank of America, notes this Since 1870 there have been 14 major global recessions, all caused by wars, pandemics, and banking crises. This time, in full recovery from a pandemic, a war has fueled inflation and interest rate hikes have contributed to a (so far small) banking crisis, but it’s not yet clear what impact they will have.
“The US economy will slow down at some point, probably a little sooner than expected after these events, but it could still be a while,” says Vincent Vinatier, portfolio manager at AXA Investment Managers, in a cautious sentence.
“No one has a clue, nor can they have a clue,” says an economist at a US investment giant, more emphatic, explaining that deposits have flowed from one company to another and that it’s not clear how severe the credit squeeze will be. What seems clear is that the downside risks, or recession probabilities, which Goldman Sachs has raised to 35%, have increased.
“These events could lead to a recession,” agrees Tiffany Wilding, US economist at PIMCO. In his view, there is very good reason to believe that credit growth, which has already slowed, will slow further. “Regional banks are likely to exhibit greater risk aversion, at least in the short term,” he argues, because “it is hard to believe that these banks will not tighten their lending rules for fear of a potential sudden deposit outflow.”
The Federal Reserve is also likely to tighten regulation and supervision of large regional banks, thereby indirectly restricting lending. Despite this, the United States has been heralding an imminent recession for almost a year, which has not yet fully arrived. The labor market has shown great strength. The Federal Reserve intends to cool demand to fight inflation, and this period of instability may require a slightly smaller rate hike, but is not unduly altering the economic outlook (at least for now).
Something similar is happening in the rest of the world. Of course, what happened is not good news and risks have increased, but it is too early to assess the real impact on the global economy. Emerging markets, including Latin Americans, are a bit more at risk: “The financial turmoil in the United States, following the failure of two regional banks, has increased volatility and pushed down the value of Latin American assets. The risk aversion episode has not changed our baseline forecast, but it has highlighted the region’s sensitivity to a serious tightening of financial conditions,” explain Oxford Economics.
The experts at the International Monetary Fund (IMF) are currently working on adjusting their global economic forecasts. They will present their conclusions in less than a month. If the damage in the United States stays a few scratches in its financial system, the impact on the rest of the world should not be great. The next few days could be crucial.
It’s not yet clear if the private bailout of First Republic Bank, another San Francisco-based regional bank with $30 billion in deposits from major Wall Street banks, worked. First Republic has continued to fall in the stock market after the injection and nobody is ruling out a surprise this Sunday. The operation was led by JP Morgan Chase President Jamie Dimon. In doing so, he honored John Pierpont Morgan, who orchestrated the response to the financial panic of 1907 and committed his own money to it, knowing full well that it was in the interest of the entire industry to help those most vulnerable. Banks thrive on trust and for a banker it must not have been very pleasant to see Bitcoin soaring this week as money fled banks in search of sanctuary.
The Federal Reserve takes a step
The fall of the Silicon Valley Bank (SVB) will largely mark the Federal Reserve’s monetary policy committee meeting this Tuesday and Wednesday. Following the European Central Bank (ECB) rate hike, now is the time for the US Federal Reserve to act. Before the current financial storm, analysts were divided as to whether Jerome Powell would hike rates by 0.25 point or half a point as inflation is barely easing (it was 6% in February).
Now, after the intervention of SVB and Signature Bank and the other financial turmoil of the last week, there were those who even bet on a pause after last year’s eight straight rises kept the price of money at 4.5 – 4.75%, the highest level since 2007. Rate hikes have added to the woes of mid-sized banks by driving down the value of the bonds in their portfolios, and further hikes may exacerbate financial instability. But Powell doesn’t want to jeopardize his credibility in the fight against inflation, so the dilemma is served.
“You have to choose which mistake you prefer to make,” sneers one economist, who thinks appropriate the principle of separation, in which the central bank uses interest rates to fight inflation and liquidity for financial stability, is appropriate. Of particular interest is not only the decision, but Powell’s statement and press conference on Wednesday.
“We continue to expect a 25 basis point rate hike at the meeting as the Federal Reserve believes it can prevent contagion by providing the necessary liquidity and is ahead of the inflation curve by raising rates. But the financial turmoil is likely to remove the possibility of a 50 basis point rise, which was expected until recently,” summarized Oxford Economics.
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