Dominating the financial news is last week’s collapse and liquidation of the SVB (Silicon Valley) bank, the 16th-biggest in the US. SVB’s main business was funding start-up companies, particularly tech start-ups. The bank’s collapse has had such wide reverberations that it even overshadowed the UK Budget that’s scheduled for today. Instead of spending the weekend putting the final touches to his first Budget, the UK’s Chancellor, Jeremy Hunt, had to deal with a begging bowl held out by the British branch of SVB, which was about to become insolvent. Lawyers involved in sorting out the mess tell me that SVB UK sought £1.8 billion to stay in business. Around 180 heads of tech companies lobbied Hunt, asking him to intervene. Panic spread fast; depositors fear a repetition of what happened at IndyMac, the largest savings and loan association in Los Angeles. When it failed in July 2008 depositors got half their deposits back immediately but never got anything else.
In a normal US bank, about 50% of deposits are insured under the terms of the FDIC (Federal Deposit Insurance Corporation), a federal agency which was created in 1933 and was intended to restore the completely destroyed trust in the US banking system. The FDIC’s insurance covers up to $250,000 of losses per depositor, per insured bank, for each account ownership category. In the Great Depression around 9,000 banks failed; depositors lost roughly $7 billion. Apparently 93% of SVB’s deposits – about $165 billion – were uninsured. When Moody’s ratings agency said last week that SVB’s unrealized losses (primarily on long-term US government bonds) meant it was at serious risk of a downgrade, investors took fright. Some pulled their money out while the bank still had funds.
In the UK, depositors with banks are (with some small print exceptions) safeguarded up to £85,000 (about $103,000) by the Financial Services Compensation Scheme (FSCS). This is the largest bank failure since the Great Financial Crash of 2008. “There’s no systemic risk” says the British Prime Minister, Rishi Sunak. But contagion fears rapidly spread around the globe.
Who or what is to blame? According to Jerome Powell, chairman of the US Federal Reserve, it’s the weather’s fault.
When safety runs out
When he gave his annual testimony to Congress last Tuesday Powell had some explaining to do regarding his yo-yo monetary policy talk of recent times. Will interest rates go higher or won’t they?
As we know the Fed has a dual mandate from Congress – it must maintain price stability and achieve maximum sustainable employment. It’s failed on the first – US inflation is now 6%, higher than the long-term average of 3.28% and three times higher than the Fed’s ‘target’ for inflation (2%). The only way the Fed can think of to bring down inflation is the orthodox economic device of raising interest rates, in the hope that this will slow demand and cool prices.
Powell initially said the early signs an inflationary surge – 4.2% in April 2021 – were merely ‘transitory’. Not at all – the average inflation rate in the US in 2022 was an annualized 8%. Powell and his colleagues steadily put interest rates up to their current 4.5%-4.75%. Unsurprisingly this has hardly dented inflation which in February was 6.4%, down just 0.1% from December. It’s a bit too little, too late.
During late 2022, many economics pundits started to speculate that the Fed would soon ‘pivot’ – start to slow down the interest rate rises or even start to cut rates – as the risk was switching from inflation becoming ’embedded’ to the onset of a recession, caused by over-tightening the cost of money. There was gossip that the ‘terminal’ interest rate (the peak) would be about 5%. The January inflation figure put paid to that hope. But maybe the collapse of SVB will encourage Powell to go easy on the interest rate hikes?
On Tuesday when he faced Congress, Powell said the persistently high inflation seen in January might have been due to the “unseasonably warm weather in January in much of the country”. Spending remained high, he speculated, because consumers celebrated the warmer-than-usual spell by shopping. He said “employment, consumer spending, manufacturing production and inflation have partly reversed the softening trends that we had seen in the data just a month ago”. That means inflation remains a problem and, as we get closer to the 2024 US Presidential election, stubbornly rooted inflation may well have an impact at the ballot box.
Far from reversing the trend of raising interest rates, Powell may raise them again in the face of a buoyant economy; the ‘terminal’ rate may well be 6% or more which, given the US has lived for more than a decade with rates at almost zero, is painful for many.
The root cause of the collapse of SVB might be said to be the persistently high rate of US inflation. The Fed pushes up interest rates to fight inflation; this generally causes bond prices to fall; SVB raised tens of billions of Dollars from venture capital clients, some of which it distributed to tech start-ups, some of which it ploughed into long-term government bonds. Bonds plunged in value as interest rates rose. This meant that SVB had mark-to-market losses in excess of $15 billion by the end of 2022 for securities held to maturity, almost equivalent to its entire equity base of $16.2 billion.
As Matt Levine, one of Bloomberg’s commentators put it: “nobody on Earth is more of a herd animal than Silicon Valley venture capitalists”. SVB was vulnerable to a classic, textbook bank run. When one pulled out, everyone pulled out.
No bailouts this time?
The US Treasury Secretary, Janet Yellen, has ruled out the idea of a bailout of SVB, although she said “we are concerned about depositors, and we’re focused on trying to meet their needs”. Someone will have to foot the bill, even if it’s not taxpayers.
Jeremy Hunt has said the UK government will “do everything we can” to cushion companies from being dragged down by the SVB whirlpool. Hurried talks over the weekend resulted in the sale of SVB UK to the banking giant HSBC for a symbolic £1.
SVB before it collapsed was about one tenth the size of JP Morgan; it was a niche business. That doesn’t mean it was insignificant however. It did business with almost half of all US venture capital-backed start-ups, and 44% of US venture-backed technology and health-care companies that went public last year. Yet surprisingly US regulators did not regard SVB as sufficiently important to deem it as “systemically important”. How many of the more than 2,000 banks (with almost $20 trillion in assets) are flying under the radar and have much of their assets in US government bonds?
Over the weekend another US bank, Signature Bank, was closed by regulators, a casualty of the woes in cryptocurrency following the collapse of the cryptocurrency exchange FTX, which was bankrupted in November 2022. The US banking system is full of blind spots. The FDIC said that “all depositors [with Signature] will be made whole…[but] shareholders and certain unsecured debtholders will not be protected”.
The justification for the 2008-09 bank bailouts – which in the US alone are estimated to have required around half a trillion Dollars – was that if taxpayers didn’t stump up the money, much worse would follow. Some commentators assert that things are much better this time, that SVB’s problems are containable and relatively small, and that the banking system as a whole is now much better capitalised and supervised. The failure of SVB is an earthquake; Signature is an aftershock. Markets are nervous there may be more to come; shares in First Republic Bank nosedived by 60% in pre-market trading on Monday.
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