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3 Catalysts That Killed SVB

Chris Campbell

Posted March 17, 2023

Chris Campbell

“The banking system is safe.”
-Joe Biden

Yesterday, we learned that there are four types of money, according to the Federal Reserve:

1.] Fiat currency
2.] Bank deposits
3.] Central bank reserves
4.] Treasuries

In theory, issuance of Treasuries is different from the issuance of bank deposits or central bank reserves.

Central bank reserves are backed by the assets the central bank purchased, essentially exchanging one type of money for another.

Bank deposits are backed by loans, which eventually must be paid back, unwinding the amount of money created. (Like central banks, commercial banks also create money out of thin air every single time they create a loan.)


Treasuries are backed by nothing but confidence and trust in the US government.

Although the US Treasury issues trillions of dollars’ worth of Treasury securities, there’s no plan to repay it. Instead, the amount of Treasury securities outstanding continues to grow and grow… and grow.

And not without consequence.

According to former Fed insider Joseph Wang, “This has an inflationary impact because goods and services are purchased by printing money.”

It’s one factor among others that determines total inflation, but it’s a big one.

(As also mentioned yesterday, Wang’s book, Central Banking 101, is a great introduction to modern banking.)

Also, this inflation isn’t distributed evenly. There tends to be an unequal burden placed on the poor.

A paragraph from a recent New York Times article sums up how this is shaking out right now:

“At LVMH, which owns luxury brands like Louis Vuitton and Tiffany, American revenues have been growing strongly, while at Walmart, customers are pulling back as they struggle to afford basic necessities, particularly food, which has run up sharply in price.”

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Meanwhile, risk in the total financial system keeps mounting.

Today, through the lens of the recent Silicon Valley Bank (SVB) crash, let’s break down four major catalysts that have injected tons of risk into the financial system:

1.] Zero hedge: No, not the alt-finance blog. Is it true that banks can’t hedge against certain assets, contributing to SVB’s downfall?

2.] Fractional Foresight: Among other things, post-2008 regulators didn’t anticipate viral tweets, heightened anxiety, and super fast thumbs.

3.] Low-yield banking: Low-yield banking puts more pressure on banks in a high interest rate environment.

Catalyst #1: Zero Hedge

Yesterday, we mentioned that a financial crisis happens when convertibility between all types of money breaks down.

That’s what happened with SVB.

When you buy held-to-maturity (HTM) securities -- which SVB did by the boatload -- you lock in a fixed yield.

In that scenario, rising interest rates represent a risk. To hedge that risk, you can enter into an interest rate swap where you pay a fixed yield and receive variable payments in exchange.

So why in the world didn’t SVB hedge?

One argument is that hedges cost money and the returns on Treasuries were dismal.

But, that’s not the only explanation:

Many argue that banks aren’t allowed to hedge assets classified as HTM. They can only hedge their available-for-sale (AFS) portfolio.

They point to FASB rule ASC 815-20-25-43(c)(2), which says that interest rate risk may not be hedged in a fair value hedge of held-to-maturity debt.

Meaning, they technically can hedge but they would do so at greater risk than would be the case otherwise.

(Some argue that SVB should’ve just kept those investments out of HTM. Others argue that the big banks, with their big brainiacs, found a way around these hedging restrictions.)

I guess the crux here is that SVB never expected to have to sell its HTM portfolio. So, to them, those unrealized losses on paper didn’t matter.

To wit, SVB's chief financial officer, Dan Beck, wrote in an email that "there are no [negative] implications for SVB because we do not intend to sell our HTM [held to maturity] securities.”

During a bank run, banks sell off their AFS portfolio after the liquidity dries up. SVB had a $28 billion cushion in its AFS. When that was gone, they were forced to turn to their unhedged HTMs, which were already deep in the red.

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SVB isn’t alone in this.

In total, banks have trillions to sell to meet any potential runs. BUT they’re also sitting on over $650 billion in unrealized losses, compared to $3 billion just a year ago.

Why? Skyrocketing rates.

Catalyst #2: Fractional Foresight

In 2008, regulators forced federally-registered banks to conform to risk-weighted asset (RWA) ratios.

The idea is this:

The riskier your asset base, the more high quality capital (currency) you need to hold to stay compliant. This was created to avoid the toxic debt securitization mess that led to 2008.

Recall, this framework -- and all other post-2008 banking regulations -- were developed in a different world. Lots has changed since.

Twitter, Reddit, and many familiar tech companies didn’t exist. Digital banking was a thing, but there was a whole lot more friction to the banking process. Smartphones were around, but not nearly as ubiquitous.

During that time, it wasn’t unreasonable to think that a bank run would still have quite a bit of friction, giving banks more time to respond.

The rise of frictionless banking and social media changed the game. Today, worry spreads like gossip at a knitting convention. (Fast.) And pulling money out can be done from anywhere in the world with a couple clicks.

Fact is…

Even with the post-2008 rules, no current fractional-reserve bank can handle a full-blown frictionless bank run.

And all it takes is a viral tweet to light the fuse.

Catalyst #3: Low-Yield Banking

Although this might not be a direct cause of SVB’s failure…

Another risk is a run on the low-yield banking system.

Easy access to risk-free higher rates pushes banking liquidity away from the low-yield banks.

Although raising deposit rates hurts profits, the other option is to sell their portfolios and realize big losses.

Of course, all of the risk in the system can be traced back to the head honcho -- the Fed.

But, after all this confusion, complexity, grift, graft, explosive chaos and other things that induce anxiety-ridden hair-pulling…

Perhaps the simplest solution is for regulators to throw up their hands and disintermediate the financial system from banks completely.

But, of course, not in the way Bitcoiners suggest. (CBDCs anyone?)

On quiet nights of reflection, a wild ogre of a thought sometimes whispers -- after making sure nobody else is listening -- that maybe (perhaps!)...

That’s the whole point.

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