The collapse of Silicon Valley Bank (SVB) in just under 48 hours is loaded with ironies. Till just a few days back neither the big rating agencies nor the ‘smart’ Wall Street analysts whose ratings and views are considered before millions of dollars are invested, had any clue about it. It was not just that! SVB had as its customers, some of the brightest managers of capital — private equity investors and venture capitalists who too were completely in the dark. Add to it many purporting to propel the fintech revolution that can transform the world using their highly sophisticated algorithms and analytics, too are its customers. Their balances are now stuck with the insolvent bank.
Maybe their analytics must first be tested inhouse with regard to their money management. When relatively safe and liquid money market funds were yielding over 4 per cent per annum, why they left excess money lying idle in substantially lower yielding SVB deposit accounts will remain a mystery.
But as if these ironies weren’t enough, here is the biggest of them all — in 2008 when big banks knocked on the doors of bankruptcy threatening to bring down the global financial system along with their failure, the rout then was triggered due to their reckless investments in worthless mortgage bonds. This time though, rout of the SVB and its collapse was triggered by its investments in what is unanimously considered the safest investment in global financial markets — US treasury bonds!
Whose fault is it?
The run on the bank was triggered on March 9, post the bank’s strategic update to investors on March 8 that it had sold substantially all of its Available for Sale securities portfolio of $21 billion, most of which were US treasury bonds. SVB had locked into these treasuries at a yield of 1.79 per cent, but since interest rates had gone up substantially in very short time, their low yielding bonds were worth less and the bank had to book a loss of $1.8 billion on this transaction.
When banks or for that matter anyone sells their safest assets at a loss, it means nothing but a liquidity crisis. Thus the banks assurances as part of the strategic update meant nothing to the deposit holders, whose money was at stake. Run on the bank was a given following that.
This raises an important question. Who is to be blamed here? Some experts blame the bank management. In their opinion, SVB did not manage risks properly. SVB had too much of sector concentration (VC and tech world) in its liabilities and assets base. It was also over invested in short term treasury and mortgage bonds in a rising interest rate environment. But is it entirely the bank’s fault? In a fast rising interest rate environment which can slowdown economies and see spikes in NPAs, treasury bonds are safe havens.
Further, the world hasn’t witnessed interest rates increase at the scale we have seen for over multiple decades. One will have to revisit the Volcker era to get some idea. But even at that time, the hiking cycle was not from a base of zero or negative interest rate regime as witnessed now. One data point sheds some light on the impact of this significant change in interest rates in an incredibly short time — as per a report, 2022 was the worst year for US bonds in over 250 years of recorded history.
Even as of December 2021, the widely followed Fed dot plot was projecting a Fed Funds rate of just 0.9 by end of 2022. Compare this with the fact that the US ended 2022 with Fed Funds rate at 4.5 per cent.
As Uday Kotak noted, when interest rate rise at this pace, financial accidents were waiting to happen. So maybe the Fed too is at fault here for not factoring for inflation risks by mid-2021, when economic recovery had already picked up steam. In an interview to bl.portfolio in May 2021, Mohamed El-Erian, former CEO of Pimco, had called for the urgent need for the US Fed to have an open mind on inflation. So, while there were voices sounding caution, the risk management in the Fed too was absent.
Thus Silicon Valley has put the US Fed in a gorge with limited options. The last time when banks were becoming insolvent in 2008, deflation was gaining steam, recession had already started and the Fed and the US government could pump in money and infuse liquidity. This time it’s the exact opposite, inflation remains unacceptably high (in Jerome Powell’s own words), the economy is still chugging along well and injecting liquidity to save failing banks can only fuel inflation further. Thus it appears there is no painless solution and the global economy must brace for turbulent times. Whether the SVB fiasco is just the start (like Bear Sterns) or the peak (like Lehman/AIG), only time will tell. India should brace itself for the ripple effects either way.