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I debated whether to create a podcast regarding the banks because the news changes so rapidly. On the other hand, some of what I want to say isn’t related to the news of the moment. So, here goes:
A rigid stress test of banks was part of the Dodd-Frank Act—a response to the financial failures leading to the Great Recession. Any financial institution supervised by the Fed over $50 billion was subject to stress tests. A Risk Committee was also required. This was the “Too Big to Fail” conversation.
In 2018, these rules were liberalized by a Republican Congress and signed by Trump so only financial institutions with over $250 billion in assets were subject to the Dodd-Frank rules.
That answers the question of, “Why didn’t the Fed know?” Because Silicon Valley Bank didn’t come under the Dodd-Frank umbrella. As an aside, Silicon Valley Bank was a major lobbyist trying to decrease the scrutiny to those under $250 billion. Under the original legislation, they would have been subject to the stress tests of the larger banks.
Silicon Valley Bank, or SVB for short, had a very concentrated client exposure to venture capitalist aka VC funds focused on technology, the startup companies and life science companies. According to T. Rowe Price, with the influx of cash, SVB bought long-dated treasuries and mortgage-backed bonds. While they didn’t take credit risk, they took what is called “duration” and “interest-rate” risk.
Recall that if interest rates rise, the value of your bond declines. For example, if I buy a $1,000 bond – the par price is $1,000. Assume it pays 2% interest. Now, interest rates increase to 4%. I can’t sell my bond at par—$1,000—anymore. If a person can buy a new bond at 4%, why would they buy mine for $1,000? So, I have to reduce the value of my bond below $1,000 in order to adjust it for the higher interest rate before I can sell.
In the case of SVB, their bonds’ durations were long, usually defined as over 10 years, AND they bought at low interest rates. According to T. Rowe Price, if they had to sell this bond portfolio for cash, the lower value would have wiped out all of their capital.
Add to that, SVB’s Chief Risk Officer left in April 2022 and was not replaced until December. How dumb is that? According to Charles Elson, a retired professor of corporate governance at the University of Delaware, “It is like flying a plane without a pilot.”
Let’s talk FDIC. The insurance is per individual up to $250,000 per institution. Credit unions have an equivalent to the FDIC. Every bank has uninsured deposits in their institution. The average, according to David Kelly of JP Morgan, is around 50%. SVB’s was 94% per CNN.
To some degree, the venture capitalists shot themselves in the foot. And they ignored the FDIC limits. With business slowing in the VC arena because of the higher interest rates and the economy slowing, some were beginning to be concerned SVB couldn’t pay their depositors. These VC people started suggesting funds be withdrawn from the bank. Now you have the making of a run on the bank. Everyone trying to withdraw at the same time.
Journalist Carolyn Said wrote in the San Francisco Chronicle about the hypocrisy of the venture capital tech companies. “They want the government to keep its paws out of their business and free from stifling regulations. But when tech needs help – suddenly it’s a different story.” They were seeking a government bailout. Author Hunter Walker tweeted, “It’s incredible how many members of the incredibly wealthy and supposedly self-reliant entrepreneurial set have spent the last 24 hours begging for government bailouts for their friends.”
And the government came through. Regardless of the FDIC limit, you can withdraw your money. The government also set up the Bank Term Funding Program or BTFP, permitting banks to get loans using their government and mortgage-backed bonds using the full value or par value on the bonds – so no discounting as would occur if sold on the open market. They have one year. Banks are to use the time to get their balance sheets in order. The cost will be borne by premiums paid by banks—not the taxpayer.
Let’s move to First Republic Bank. A number of our clients bank with them. They are known for high-touch customer service and the employees we know say they are a great company to work for. They cater to the wealthier segment of society. As a result, like SVB, there are many depositors with money in excess of the FDIC limit.
With SVB, the public woke up to the FDIC limits. First Republic has 68% of their deposits above the FDIC limits, considerably less than SVB’s 94%. Having said that, according S&P Global – State Street Bank has 91%, Bank of NY Mellon 97% and Citibank at 77% of depositors with balances over the FDIC limit. You can see it is not abnormal for people to keep money above the FDIC limits. Sometimes it’s just easier than trying to go from bank to bank and spreading your money.
Under normal circumstances, banks have ratios of what they need for cash on hand to conduct daily business. The problem is when there is a run on the bank, things are no longer normal.
Where do we go from here? I’m hoping we move back to the original Dodd-Frank metrics. While each of these banks individually don’t fall in the category of “Too Big To Fail,” there is a domino effect of one bank having difficulty and it dominoing into other banks as we are seeing.
You are always free to call us with questions. We’ll try to answer them.
I didn’t have a lot of time to research good news because I wanted to get the podcast approved by our Compliance Consultant and published.
One piece of good news – being tongue and cheek here – April 20 is the anniversary of my new left hip. She is so excited. For her birthday, she is going to do lunges down the hallway to show off.
The U.S. Postal Service is buying 9,000 new electric vehicles and installing 14,000 charging stations. I always thought the postal trucks were prime candidates for electric vehicles. Good for the Post Office. By the way, the maximum speed will be 35 mph.