All banks borrow short and lend long, playing the (typical) shape of the yield curve (& drawing on the stability of most short-term funding most of the time)
But anything taken to the extreme can become a source of risk. Silicon Valley Bank clearly took things to extreme.
1/x
But anything taken to the extreme can become a source of risk. Silicon Valley Bank clearly took things to extreme.
1/x
As @M_C_Klein shows in an excellent post at the Overshoot, SVB "overshot" the limits of a borrow short/ lend long model --
The overwhelming majority of its deposits were large and technically uninsured. Its insured deposit base would only have supported a small bank!
The overwhelming majority of its deposits were large and technically uninsured. Its insured deposit base would only have supported a small bank!
The safe thing to do in the face of a big deposit influx during the pandemic would have been to hold a lot (and I mean a lot) of short-term bills and 2 year Treasury notes ...
SVB tho went for the extra yield at the long-end of the curve.
3/x
SVB tho went for the extra yield at the long-end of the curve.
3/x
As @jeuasommenulle and others have illustrated, SVB built up a huge hold to maturity bond portfolio -- over $90b of bonds that weren't marked to market.
That included per SVBs own disclosure over $80b of Agencies (effectively funded with short-term uninsured deposits).
4/x
That included per SVBs own disclosure over $80b of Agencies (effectively funded with short-term uninsured deposits).
4/x
That is a bit nuts.
US Agency backed mortgages have one globally unique feature. They get pre-paid when interest rates fall, but no one exercises their right refinance a fixed rate mortgage when interest rates rise. So in a world of rising rates, SVB had "wrong way" risk.
5/x
US Agency backed mortgages have one globally unique feature. They get pre-paid when interest rates fall, but no one exercises their right refinance a fixed rate mortgage when interest rates rise. So in a world of rising rates, SVB had "wrong way" risk.
5/x
The interest rate on its short-term liabilities would increase -- while the duration on its assets (and the associated mark to market losses, which were hidden in the HTM book) would increase ...
6/x
6/x
This model only works, technically, if the bank holds "safe" (as in no credit risk) assets -- as Treasuries and Agencies have low/ zero risk weights and thus don't eat up the bank's equity capital base.
Risk wasn't captured in capital charges. It was on the funding side
7/x
Risk wasn't captured in capital charges. It was on the funding side
7/x
The 2008 gallows financial humor springs to mind --
"Q: what is the difference between a big bank and a hedge fund?
"A: A hedge fund is better capitalized"
8/x
"Q: what is the difference between a big bank and a hedge fund?
"A: A hedge fund is better capitalized"
8/x
The losses on the not marked to market Agency portfolio (and a smaller muni portfolio) were equal to SVB's regulatory capital ...
Because of the associated "gamble for redemption" risks alone the regulators should have been all over it ...
9/x
Because of the associated "gamble for redemption" risks alone the regulators should have been all over it ...
9/x
Matt Klein's post also highlighted a second. more subtle fact --
Deposit rates have been rising much more slowly than the Fed's policy rate -- a lot of SVBs deposits were still paying zero interest when it got into trouble.
10/x
theovershoot.co/p/thoughts-on-…
Deposit rates have been rising much more slowly than the Fed's policy rate -- a lot of SVBs deposits were still paying zero interest when it got into trouble.
10/x
theovershoot.co/p/thoughts-on-…
So trouble was building on a second front --
SVB was obviously illiquid (no one would, prior to Fed facility, lend against underwater Agencies at par). But it was about to start bleeding income as deposit rates rose over the interest income on its legacy HTM Agencies.
11/x
SVB was obviously illiquid (no one would, prior to Fed facility, lend against underwater Agencies at par). But it was about to start bleeding income as deposit rates rose over the interest income on its legacy HTM Agencies.
11/x
The Biden Administration was, correctly I think, worried about funding contagion -- looking up SVB's big deposits until the value of its assets was determined (through a sale) was legally and analytically justified ...
12/x
12/x
But it risked a run on all the regional banks that drew heavily on large insured deposits for funding and had been exempted from the stricter liquidity regulations applied to bigger banks.
washingtonpost.com/us-policy/2023…
13/x
washingtonpost.com/us-policy/2023…
13/x
But it is also I think clear that a lot of longer-term "safe" bonds (Treasuries and Agencies) issued between 2015 and 2021 are in portfolios that aren't marked to market. In the US of course -- I was shocked by BoA's HTM book -- but also in places like Japan.
14/x
14/x
So with US short-term rates where they are and with US long-term rates where they were, a bunch of financial intermediaries are going to be bleeding income and unable to self capitalize easily.
15/x
15/x
The BoJ was onto this risk in its latest Financial Systems Report --
it is a known known in Rumsfeld's formulation.
The associated liquidity run risk should have been a known/ unknown.
16/x
it is a known known in Rumsfeld's formulation.
The associated liquidity run risk should have been a known/ unknown.
16/x
But there is no doubt that there needs to be a lot more focus globally on the risk associated with long duration instruments that are underwater and funded with short-term liabilities whose price will adjust to a higher rate world even with a lag ...
17/end
17/end
interesting *to me* detail in the semafor story on SVB/ the systemic questions it poses
semafor.com/article/03/14/…
semafor.com/article/03/14/…
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