The 2022-23 Economic Crisis Megathread

[HVC]

Swedens largest pension fund lost 1 billion investment in SVB and signature bank.

[crazy canuck]

The investment folks at my wife's work were discussing the Silicon Valley Bank troubles and they said that it was basically a textbook case of poor and insufficient hedging at SVB.

Now, this is second hand and all but my impression is that those folks know what they're talking about.

... and that would also line up with your observation. Banks who managed their risk competently (or even made bets in the right direction) could very well  prosper in this environment, while those who relied on erroneous assumptions do not.

I have read and heard that from several people in the finance sector - SVB was extremely mismanaged. I guess we'll learn in a year or two if it was incompetence or something shady.

My guess is the former much more than the latter - it was bro bank that structured itself in a way that it could avoid most of the regulations that would normally apply to a bank.  That lack of regulation appealed to the tech bros.  But of course, you need to have a lack of financial sophistication to think putting money into such a bank is a good idea.

[The Minsky Moment]

I would take explanations from "people in finance" about this with some degree of skepticism.  People of finance have a vested interest in a narrative that seeks to explain these bank runs as an anomaly caused by special incompetence or fraud and not as a broader risk or vulnerability in the system.

Is it possible to hedge against interest rate rises?  Sure but it costs money to put those positions on and where does that money come from?  Ultimately from taking on risk somewhere else to generate the return to fund the hedge.  Can you ameliorate duration risk by purchasing shorter duration assets?  Yes but if you if you tried to do that with government securities in the last 10 years or so, you would get virtually zero yield.  So either lose money or take on credit risk or suck it up and eat duration risk.

No financial institution can hedge all risks.  You have to select some risk or risks to be exposed to and then manage it best you can.

I'm not saying SVB were masters of risk management; they may not have been.  But I doubt they are singularly unique in that category as against peers.

It seems to me the focus on SVB's asset book is misplaced.  SVB may have had its problems but it seems pretty glaring that there was a big problem on the liability side, namely high concentration of uninsured deposits among very similar kinds of depositors.  Once the whispers trigger a run, all the risk management and hedges in the world can't save the bank.  To my mind talking about the hedges on the asset book in that context is like debating the merits of different kinds of body armor after the target has been vaporized by a direct artillery hit.

[crazy canuck]

I would take explanations from "people in finance" about this with some degree of skepticism.  People of finance have a vested interest in a narrative that seeks to explain these bank runs as an anomaly caused by special incompetence or fraud and not as a broader risk or vulnerability in the system.

Is it possible to hedge against interest rate rises?  Sure but it costs money to put those positions on and where does that money come from?  Ultimately from taking on risk somewhere else to generate the return to fund the hedge.  Can you ameliorate duration risk by purchasing shorter duration assets?  Yes but if you if you tried to do that with government securities in the last 10 years or so, you would get virtually zero yield.  So either lose money or take on credit risk or suck it up and eat duration risk.

No financial institution can hedge all risks.  You have to select some risk or risks to be exposed to and then manage it best you can.

I'm not saying SVB were masters of risk management; they may not have been.  But I doubt they are singularly unique in that category as against peers.

It seems to me the focus on SVB's asset book is misplaced.  SVB may have had its problems but it seems pretty glaring that there was a big problem on the liability side, namely high concentration of uninsured deposits among very similar kinds of depositors.  Once the whispers trigger a run, all the risk management and hedges in the world can't save the bank.  To my mind talking about the hedges on the asset book in that context is like debating the merits of different kinds of body armor after the target has been vaporized by a direct artillery hit.

And yet in Canada the financial sector seems to be able to figure it out pretty well.  From the Royal Bank first quarter earners report:

Pre-provision, pre-tax earnings of $5.9 billion were up $385 million or 7% from a year ago, mainly reflecting higher net interest income driven by higher interest rates and strong loan growth in Canadian Banking and Wealth Management. Higher Global Markets revenue in Capital Markets, reflecting strong client activity, also contributed to the increase. These factors were partially offset by higher expenses, largely due to higher salaries and variable and stock-based compensation, as well as ongoing technology investments and higher discretionary costs to support strong client-driven growth.

I just don't buy the excuses inherent in your post.

[Jacob]

For sure, there'll be risk somewhere and you have to make some trade offs and so on. But if many other institutions and funds were not exposed in the same way (and it seems like they weren't?) then perhaps the problem is local to SVB rather than being systemic?

[The Minsky Moment]

The problem is not entirely local to SVB because signature went down in NYC as well.  Very different in key respects but similar in at least one - high and concentrated uninsured deposits.  Yes there are special circumstances here but the problem is more on the liability side.

RBC really has nothing to do with it.  I'm sure there are plenty of banks around the world with nice quarterly reports

[Barrister]

Canadian Big 5 Banks are a friggin cartel - they virtually have a license to print money.

[Sheilbh]

It seems to me the focus on SVB's asset book is misplaced.  SVB may have had its problems but it seems pretty glaring that there was a big problem on the liability side, namely high concentration of uninsured deposits among very similar kinds of depositors.  Once the whispers trigger a run, all the risk management and hedges in the world can't save the bank.  To my mind talking about the hedges on the asset book in that context is like debating the merits of different kinds of body armor after the target has been vaporized by a direct artillery hit.

Although is there more of a market problem there?

From my understanding the big thing that distinguished SVB was offering basically full corporate banking on the basis of capital raised for companies that were in other respects (like turnover, staffing etc) often basically SMEs.

Obviously there's huge opportunity in that customer base but they're probably too demanding and too small to be of interest to the major banks - obviously SVB UK is very small fish but its £5.5 billion loan book and about £7 billion of deposits is less than 1% of HSBC, its new parent. I imagine the scale and ratio would be similar for the big US banks.

Maybe I'm wrong but it feels like you'll either end up with a concentration of risk like SVB, or reliance on smaller, regional banks who may not really be able to serve those customers particularly well. Or am I miles off?

Edit: And, inveitably, I'm now wondering if the solution is a state backed corporate bank for companies with high growth potential

[HVC]

Canadian Big 5 Banks are a friggin cartel - they virtually have a license to print money.

But they're safe. And canada likes its cartels. Booze (might only be ontario) phones, tv, internet, I guess milk. It's in our DNA 

[The Minsky Moment]

From my understanding the big thing that distinguished SVB was offering basically full corporate banking on the basis of capital raised for companies that were in other respects (like turnover, staffing etc) often basically SMEs.

It's true that the loan book included a lot of VC subscription backed lines of credit, but while it's easy to see how that could go wrong, that's not what seems to have caused the problem.  Rather it was the "safe" part of the asset base - the agency bonds, that caused the problem.  LOC usually don't lock in rates long term so they don't have the duration risk.

Again what seems to have tripped up the bank is that what one would assume to be the primary risk on the asset side - credit exposure to early stage valley cos - but the steps the bank took to offset that risk by loading up on low credit risk government securities.

[crazy canuck]

Canadian Big 5 Banks are a friggin cartel - they virtually have a license to print money.

But they're safe. And canada likes its cartels. Booze (might only be ontario) phones, tv, internet, I guess milk. It's in our DNA 

I have no idea why BB is calling them a cartel. One of the big differences between Canadian Banks and others, particularly in the US, is that when the US was busy deregulating the banking sector (because government is bad) Prime Minister Martin said no.  He was heavily criticized for his decision at the time.  But it was the correct call.

[Barrister]

Canadian Big 5 Banks are a friggin cartel - they virtually have a license to print money.

But they're safe. And canada likes its cartels. Booze (might only be ontario) phones, tv, internet, I guess milk. It's in our DNA 

I have no idea why BB is calling them a cartel. One of the big differences between Canadian Banks and others, particularly in the US, is that when the US was busy deregulating the banking sector (because government is bad) Prime Minister Martin said no.  He was heavily criticized for his decision at the time.  But it was the correct call.

As HVC pointed out, our heavily regulated banking sector, with very high barriers to entry, does produce very safe banks.

They also produce banks that are extremely expensive for their customers, and extremely profitable for shareholders.

[crazy canuck]

What is the high barrier to entry, other than having proper capitilazation?

[Iormlund]

Been reading stuff like only one board member had a finance background and the chief risk officer was on a nine month uncovered leave. You'd think banks would be a lot more regulated in the states after all the "hiccups", but I guess money and lobbying talks.

I guess svb fell out of normal regulation regardless? How does a bank that big get to act as a "shadow bank" in the first place?

Apparently they successfully lobbied to defang the Dodd-Frank Act, which made them fall outside the scope of many controls.

Citizens United paying off again.

[Sheilbh]

Apparently they successfully lobbied to defang the Dodd-Frank Act, which made them fall outside the scope of many controls.

Citizens United paying off again.

Well Barney Frank also backed that lobbying effort which made Signature Bank out of scope too. He has been on the board of Signature Bank since 2015.

Not sure Citizens United even comes into it, it's just old fashioned jobs for connected politicians post-retirement. I believe Frank has defended taking the role saying "I needed to make some money".