Macro Updates

A Very Bad Week in the Banking Industry

 This week has seen the second and third largest bank failures in the United States. In addition, over the last few days the stock of Credit Suisse have taken a huge beating. People are asking: what is going on?

The quick answer is: bad bank management and a lack of understanding of economic history. Let me explain.

Over the past weekend Silicon Valley Bank, the 16th largest bank (based on assets at end of 2022) in the US, and Signature Bank, the 29th largest bank, were closed by the FDIC after both suffered bank runs. Let's take a look at each of these in turn.

Failure of SVB

Silicon Valley Bank, or SVB for short, grew to such a large size primarily by being the bank for high tech and bio-tech venture funded start-ups and the Private Equity entities that funded them. During the post-COVID venture boom tech start ups were getting huge amounts of venture funding. These funds made their way into deposit accounts at SVB.Awash in cash SVB poured these deposited funds into very safe Treasury securities. In a search for return SVB decided to buy long-term Treasury bonds since they paid a slightly higher yield than short term Treasury bills. Sounds nice and safe, right?This is where the lack of understanding of economic history comes in.

What the people at SVB did not appear to understand that those yields on the Treasury bonds were the lowest they had been in several decades. These low interest rates were not sustainable. When interest rates rose, the market value of those bonds would decline. That meant that if SVB needed to sell those bonds to pay off depositors the bank would suffer significant losses. They did not seem to understand this price risk. This may have been because the people in charge of SVB had never managed a bank during times of "normal" interest rates. Nor, it appears, did they understand any of the history that they did not live through.

They also did not seem to understand the history of the venture capital markets. It is very boom and bust. They must have thought that the booms always continue. Even in early 2022 when VC funding dried up and the new deposits flows slowed significantly, they did not seem to understand the world was changing. Their venture backed start up depositors continued to spend money like the good times would never end, pulling money out of their accounts at SVB, but there was a lack of new deposits rolling in to cover the withdrawals. That meant SVB would need to sell those long-dated Treasuries. But, by then Fed had gone on an interest rate increasing binge.

So the stage was set for SVB collapse. A lack of risk management coupled with a seeming lack of understanding of economic history caught up with bank last week. They also put their foot in their mouth when they claimed they had new funding lined up to save the bank, when that wasn't exactly 100% accurate. Then the run started late in last week and by the weekend the SVB was no more.

Signature Bank failure

Signature Bank with headquarters on the other side of the country from SVB in New York seemed to forget one of the key lessons in the history of banking: banks are a confidence game, and that confidence is often based on the "company you keep."Let me explain.

Signature Banks prided itself on being a scrapy little bank that would lend to those the Wall Street bank shunned. The bank initially saw growth by taking deposits and making loans to small businesses in New York that were not all that "glam."They lent money taxi drivers, small apartment owners, and the like.According to a story in Bloomberg they would often mock the Ivy League educated, bogie art buying, bankers that dominated the southern tip of Manhattan.

But then things changed at Signature Bank. They became enamored with the cryptocurrency market.In 2015 shortly after becoming of the first virtual currency exchanges to be licensed in the state of New York, Gemini Trust announced it had found a bank to take their cash deposits: Signature Bank. This was the start of tens of billions of dollars of deposits that would flow into Signature from the crypto industry. Signature created a crypto currency trading platform, although the bank never held cryptocurrency as an asset and it made no crypto currency loans. But by 2022 with over 1/5 of its deposits coming for digital customers and with 90% of its deposits over the $250k FDIC insurance limit, it earned the title of being a "large crypto bank."

So, when SVB troubles appeared along with the recent collapse of FTX crypto exchange, depositors at Signature got spooked, and starting pulling deposit out in masse.While Signature looked fine on paper (unlike SVB) once large numbers of depositors started pulling and a "white knight" with cash to infuse into the bank could not be found, the FDIC decided to close it. In the end, it is generally agreed, it was Signature's ties to the crypto market that brought it down.

Credit Suisse problems

No matter the country, with whom you choose to deal with is very important in the banking industry. History has shown over and over again that fractional reserve banking, in the end, all revolves around confidence. If depositors and investors have confidence in "the bank" then things work fine.When the confidence is lost, the institution can crumble quickly. That is what happened to Signature, and what was staring to happen to the Switzerland's second largest bank Credit Suisse.

Until the central bank of Switzerland threw Credit Suisse a 50-billion-franc lifeline it looked as though Zurich based global bank was going the way of SVB and Signature. As with Signature, the problem with Credit Suisse was the "company it kept."

Credit Suisse has been involved in scandal after scandal over the years and decades. I remember back in the mid-1980s when it was revealed the bank was involved in helping Filipino dictator Ferdinand Marcos hide millions of dollars he and his wife had stolen from the country he ran. Then there were the cases of helping Iran and Sudan get around global sanctions, a seemingly endless list of tax evasion cases and then last year the bank was charged with being involved in money laundering as part of a Bulgarian cocaine smuggling operation. Also in 2022 where was a massive data leak out of Credit Suisse that put on display a long list of tawdry characters the bank had been doing business with around the world: various drug smugglers, human traffickers, and even those guilty of torture.

This data leak may have been "one scandal too many" as depositors started to flee the Swiss Bank. The sell of the bank's shares started in 2021 when losses started to mount after the collapse of Archegos and Greensill Capital investment funds. Things only got worse with a revolving door of top management. In the fourth quarter of 2022 depositors pulled out 110 billion francs from the bank, while it announced an annual loss of over 7 billion francs, the largest loss since the global financial crisis in 2008. When the Saudi National Bank, a key investor in the bank, announced it would not be it's white knight, many began to wonder if the 167 year old Swiss bank was on its death bed. Only time will tell if the money from the Swiss central bank will be enough to restore confidence in Credit Suisse.

This then is what has the entire world on edge. Which will be the next financial institution depositors and investors will lose confidence in and start to make withdrawals in masse? Or will calmer heads prevail, and this crisis will pass? In either case it should be clear that reforms of the global financial system are needed as is a deeper appreciation of the economic history of financial markets.

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Another interesting week...
Problems with the Fed's "looking out the window"

Comments 1

Guest - Stas on Thursday, 16 March 2023 16:51

thank you, very well laid out.

thank you, very well laid out.
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