No Bailout: Understand the Silicon Valley and Signature Bank Crashes

A bailout would just provoke more moral hazard.

We’ve returned to normal. Normal is where normal economic rules apply. In normal times, we have interest rates around 4% to 5%. For the past number of years, we have been in abnormal times with very low-interest rates. It is important to understand that the very low-interest rates we have had the past few years are a part of very abnormal times.

During COVID, as cash came into Silicon Valley Bank (“SVB”), it couldn’t do loans because nobody needed loans. Because of the very low interest rates, SVB that money in a lot of corporate bonds and mortgage backed securities. But, again, rates were very low. The tech sector started flailing about when interest rates started going back up. The bonds the bank held would pay off if left to maturity. But with interest rates now higher than the bond rates, those bonds are illiquid if cashed out early.

Tech companies started withdrawing money to pay bills. SVB started liquidating its bonds at a loss. SVB tried to sell more stock and raise money in equity markets. Unfortunately, they broadcast their intentions, which provoked a run on the bank. SVB could not liquidate its bonds and generate enough cash to pay out all the accounts, and the run on the bank scuttled its attempts to raise equity. So the Feds stepped in and shut it down.

Some commentators are blaming ESG, but ESG is only incidental. ESG is one of many fads that captured SVB’s investment dollars. The fixation on ESG from the right will distort people’s view of what actually happened if that becomes their focus.

This situation was mostly unique to Silicon Valley Bank but could have wider spillover effects as consumers and businesses test other banks. One regional bank, First Republic, is also big in the tech sector, and people are withdrawing money there crazy fast. That could provoke trouble for it.

Janet Yellin, the former Chair of the Federal Reserve and now Treasury Secretary, says there will be no bailout. That’s a good thing.

Signature Bank is shut down too by regulators in New York. It had massive crypto exposure and it seems the same situation with SVB happened — investment in crypto, bonds, etc. that were illiquid as interest rates rose.

Signature is one of the main banks to the cryptocurrency industry, the biggest one next to Silvergate, which announced its impending liquidation last week. It had a market value of $4.4 billion as of Friday after a 40% sell-off this year, according to FactSet.

As of Dec. 31, Signature had $110.4 billion in total assets and $88.6 billion in total deposits, according to a securities filing.

To stem the damage and stave off a bigger crisis, the Fed and Treasury created an emergency program to backstop deposits at both Signature Bank and Silicon Valley Bank using the Fed’s emergency lending authority.

The FDIC’s deposit insurance fund will be used to cover depositors, many of whom were uninsured due to the $250,000 guarantee on deposits.

While depositors will have access to their money, equity and bondholders at both banks are being wiped out, a senior Treasury official said.

(Source)

Major financial institutions have been engaged in moral hazard for some time. They have made bad decisions or poorly thought-out decisions. They thereafter have expected a federal bailout and generally have gotten one. That then caused a cycle of bad decisions on the expectation of a federal bailout.

To be sure, it would be great if investors stepped in and rescued SVB. There are billions tied up in that bank. The FDIC will cover up to $250,000.00 per account holder. A lot of companies might collapse and employees go without salary. And, full disclosure here, I have one friend whose personal account is at SVB and know two people who work for companies that used SVB for their tech start-ups. All are having issues, though one’s company got wind of the situation and moved most of their money out before it was too late.

Some people are using the phrasing “depositor bailout,” but that would be a bailout, taking more risk out of a system and building more moral hazard. Suppose the affected companies are financially sound excepting their SVB accounts. In that case, the private sector should be able to fashion relief more expeditiously, less costly, and better focused than what the federal government can or would do. If they are not financially sound overall, a federal bailout would further perpetuate a zombie company in need of bankruptcy.

Because the federal government’s books are so bad and it has spent so much, it would be better for the feds to let the private sector handle the situation than for them to step in. The Biden Administration is overflowing with people from the non-profit sector and academia, not the private sector. More likely than not, they would mess up the response, as they did with COVID, provoking inflation. They lack real-world, private-sector experience.

The bottom line is that this should not spill over to big banks, most of which have put their money into cash reserves, not bonds and mortgage-backed securities like Silicon Valley Bank and Signature Bank. Regional banks and banks with a niche focus may have more problems, particularly if they invested in bonds. But many regional banks went with real estate investments and should be fine too.

It will be a long week in the markets, and a few more niche banks will probably have problems.

In the meantime, the government should ignore Bill Ackman, a major Democrat donor and hedge fund operator, who wants another government bailout. We have to stop doing that and let people like Ackman, in the private sector, figure out how to use or not use his own resources. Likewise, the Fed should ignore calls to lower the Fed funds rate.

It is very important to remember that we are back to normal times. Lowering the Fed funds rate would put us back into abnormal times, which we do not need and which would provoke more inflation.

Lastly, it is worth noting that many of those who want a bailout are blaming the Federal Reserve for raising interest rates back to historically normal levels. What the Federal Reserve did was telegraph its intentions well in advance, then raise rates, signal again that more rate hikes would be coming, and repeated the process. The ones who want the bailout continued to disbelieve the Fed, ignore the Fed, and not plan in advance of the rate hikes. The Federal Reserve, in moving back to historically normal interest rates, was abnormally transparent about what it would do. Financiers just chose to ignore that abnormally high level of transparency.

The billionaire and multi-millionaire investors of SVB should be the ones to clean up this mess, not the American taxpayers. They are the ones clamoring for a federal bailout while also funding the leftwing groups that scream about income inequality in the country. They can give up some of their income to save their investment in SVB. The private sector created this mess and can clean it up. To reiterate, for all the problems you and I may have with the Federal Reserve, they signaled they would increase rates well before they did; they continued signaling further increases and have done so; and it is the financiers of Wall Street who convinced themselves the Federal Reserve either would not raise rates or would wrap it up contrary to the statements of the Federal Reserve itself.

Taxpayer money should not be involved in making depositors whole. The billionaire and multimillionaire investors of SVB and Signature can shoulder that burden. As you hear just how indispensable the businesses are that SVB and Signature fund, understand that the people who claim that are the ones who have worked mighty hard for legal and regulatory protection so David cannot slay Goliath because Goliath is too big or indispensable to fail.