ISMS 9: Saving Silicon Valley Bank Brings New Risks

The Silicon Valley Bank crisis started when the US government shut down its economyThe Silicon Valley Bank crisis started when the US government shut down the economy from 2020 to 2021.Let’s take a step back to January 29th, 2020, when President Donald Trump announced a White House Coronavirus Response task force with the director of the National Institute of Allergy and Infectious Diseases, Anthony Fauci, and Deborah Brix as coordinator.The decision to shut down the economy originated from this body but was ultimately implemented by President Trump, members of congress, and eventually President Joe Biden. This decision was truly the worst decision I have ever seen a government make in my lifetime.Businesses and individuals saw their income collapseDuring that time, businesses and individuals saw their revenues collapse and could not pay the costs necessary to sustain their businesses and livelihood.The US government then came up with various programs to distribute money to these struggling businesses and individuals. Unfortunately, the government did not have this money to distribute.As we all learned in political science 101, the source of any government funds, of course, comes from its citizens, but in this case, citizens and businesses were reeling from the government’s shutdown of the economy and hence had no money.The US government had to borrow moneySo the only choice the government had was to borrow money. But the US Treasury department could not borrow from the population as citizens were in dire straits. Usually, the US government would be able to borrow from foreigners; however, as other countries were suffering and for various geopolitical reasons, foreigners didn’t buy much US government debt.In fact, in 2014, foreigners owned US$6.2trn of US Treasury Department bonds; five years later, in 2019, they only held slightly more at US$6.8trn. Throughout the crisis, the US Treasury Department could only get about one trillion dollars of foreign money to buy US Treasuries.The US government needed trillions of dollarsBut the US government needed a lot more money than that. In fact, between the end of 2019 and the end of 2021, the US government borrowed US$6.4trn, causing total US government debt to rise to US$29.6trn by the end of 2021, 122% of GDP.So, the US government needed US$6.4trn and couldn’t get it from taxpayers or businesses at that time, so where did they get it? As I mentioned earlier, they got about US$1trn of it from foreign investors, which left a US$5.4trn hold.In 2020/21, the Fed stepped in and lent money to the US TreasuryThe solution was for the Federal Reserve to step in and lend the money to the US Treasury. Now the Fed is not allowed to buy bonds directly from the US Treasury, so the largest banks bought these bonds and then offloaded most of them to the Fed. The total assets of the Fed grew from US$4.6trn at the end of 2019 to US$8.8trn by the end of 2021, a US$4.2trn increase.To put this into perspective, from 2020 to 2021, the US government spent US$12trn and took in taxes of US$5.1trn.This massive injection of money raised depositsThis massive injection of money resulted in deposits of individuals and companies at US banks increasing by US$4.7trn during 2020 and 2021. The banks put about half of that money, or about US$2.2trn, into cash. About a third of those deposits, or US$1.6trn, went into securities at a time when interest rates were close to zero. In 2020 US 10-year Treasury bonds yielded about 0.9%, and it was about 1.5% in 2021.Banks receive short-term deposits and lend long-termBanks generally receive short-term deposits and lend that to companies on a long-term basis. But in 2020 and 2021, there was enough concern about the economy that banks didn’t lend much. Instead, they put that money into cash and securities.In 2020 the Fed and the Treasury Department intervened and bought bondsIt’s worth noting that during March 2020, the price of bonds, especially high-risk ones, started crashing as investors started to doubt if companies could repay those bonds given the state of the economy.The Fed and the Treasury Department devised a scheme to save the bond market by announcing that they would hire Blackrock to help them buy bonds in the market to support bond prices. This was unprecedented and could have been seen as violating the letter of the law, which generally prevents the Fed from buying bonds in the open market.The prior main Fed intervention was after the 2008 crisis when the Fed bought US Treasuries and Mortgage-backed securities through its Quantitative Easing Program.Silicon Valley Bank faced a boom and bust cycle in TechSilicon Valley Bank (SVB) appeared to be overexposed to the Tech sector and the startup community. This was not a problem when things were riding high for them. In fact, SVB took in lots of deposits from the above-described government stimulus, the IPOs, and the profitable period of 2021.But when these types of companies started to experience a slowdown, they saw their market caps collapse and their profitability weaken. This meant that these companies started to have more of a need for the funds they had deposited at SVB.The Fed started increasing interest rates, and bond values fell by 10-30%Then the Fed started increasing interest rates on February 2022, and by one year later, they had moved rates up by 4.5% sending shock waves through the economy.This rise in interest rates meant that all the bonds the banks held became worth 10-30% less than what they paid for them. The government allows a bank to avoid showing those unrealized losses by classifying those bonds as “held-to-maturity,” which the banks were likely to do with them.Silicon Valley Bank started withdrawing depositsHowever, what happened with SVB was that its customers started withdrawing deposits, which forced the bank to sell those “held-to-maturity” bonds to raise the cash needed to repay the deposits. This forced the banks to make their unrealized losses real.Very quickly, this wiped out SVB’s capital, and the bank had to be taken control of by the Federal Deposit Insurance Corporation (FDIC), which resolves such types of cases.“Strengthening public confidence in our banking system”On March 12th, the Fed announced a Joint Statement with the Treasury and the FDIC to “Protect the US economy by strengthening public confidence in our banking system.” In it, they stated that depositors at SVB in California would have access to all of their money starting Monday, March 13th, and that the taxpayer would bear no losses associated with the resolution of Silicon Valley Bank.Enter Barney Frank (you can’t make this sh*t up)Fed, the Treasury, and FDIC announced the same for Signature Bank in New York, which was also going bust. The irony is that the guy at the center of passing the well-intentioned post-2008 bank legislation, Barney Frank, was a board member of Signature since 2015.Frank was a long-time congressman from Massachusetts and, to quote from the bank’s website, “was instrumental in crafting the short-term US$550 billion rescue plan in response to the nation’s 2008-2009 financial crisis. Later, he co-sponsored the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law in July 2010.”Dodd-Frank created the too-big-to-fail storylineThat act created the Financial Stability Oversight Council and the Office of Financial Research to identify threats to the financial stability of the United States and gave the Federal Reserve new powers to regulate systemically important institutions. This codified the too-big-to-fail storyline, which helped the largest banks gain protection from the US government. The irony, in this case, is rich.President Biden repeats that no taxpayer funds will be used (spoiler alert: it’s nonsense)The Fed, the Treasury, and FDIC statement clarified that shareholders and certain unsecured debtholders would not be protected, senior management was removed, and any losses to the Deposit Insurance Fund to support uninsured depositors would be recovered by a special assessment on banks, as required by law.The announcement from this trio that was repeated by President Biden claimed that no taxpayer funds will be used. Which we all know is nonsense because all government funds ultimately come from the taxpayers. They will claim that these funds come from other banks, but we know that any bank or business must pass on increased government-regulatory costs.The Bank Term Funding Program (BTFP) to guarantee banks don’t lose on bondsFinally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks can meet the needs of all their depositors.They called this the Bank Term Funding Program (BTFP), which will offer loans of up to one year to any US federally insured depository institution pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral as long as that collateral was owned as of March 12th, 2023.The key to this measure is that these assets will be valued at par, allowing these banks to avoid offloading those securities at a loss. They announced that using the Exchange Stabilization Fund, the Department of the Treasury would provide US$25 billion as credit protection to the Federal Reserve Banks in connection with the Program.The government is worried about bank runsThis hints that the government is worried that depositors at smaller banks will attempt to withdraw their deposits and that this Program will prevent that bank from...