William Galston devotes his Wall Street Journal column to explaining how Silicon Valley Bank avoided oversight. Here’s the meat of it:
On one level, this is a saga of bad management. As deposits soared, SVB’s executives had invested in long-term assets without hedging adequately against interest-rate risks. And the firm lacked a diversified portfolio of depositors, most of whom came from the venture-capital sector. As the sector came under increasing pressure, its members tried to withdraw their funds simultaneously, and the bank couldn’t meet its obligations.
But there is a story behind this saga. After the financial collapse in 2008 and the ensuing Great Recession, Congress passed the Dodd-Frank Act of 2010 to regulate the banking practices that had nearly plunged the world into a second global depression. Among other measures, Dodd-Frank imposed new reporting requirements on banks, toughened standards for capital adequacy, and restrained banks’ ability to use deposits for speculative investment. Banks with assets above $50 billion were deemed “systemically important†and subjected to especially strict scrutiny.
These standards brought greater stability to the sector, but also higher expenses and lower profits. Bank leaders weren’t pleased and soon began lobbying to mitigate the legislation’s impact on their operations. SVB’s CEO Greg Becker was an early objector who argued that subjecting his midsize bank to the full range of Dodd-Frank requirements “would stifle our ability to provide credit to our clients.â€
and I want to endorse his conclusion:
Not all regulations are “burdensome.†Some are essential to prevent bad things from happening, as in this case. Congress and the Fed should rethink their decision to exempt key parts of the financial system from the discipline of oversight.
As I’ve said above, I think the primary culprit here is Congress. They listened to whose money was talking the loudest but that’s not what they’re elected to do and they don’t have to do it. There’s a clear conflict between their personal interests and the public interest. Their primary concern should be the public interest. The primary concern of bankers should be their banks. As long as they believe that Congress will cover their bad bets, they’ll keep making them. Not to do so would be remiss.
Guess we will end up disagreeing. I still find it bizarre that if you dont require banks to do gap analysis and account for interest rate changes they wont do it, so its the fault of Congress. Isn’t that like Banking 101, maybe 102? Also, do banks need regulators to tell them it is riskier to have all its deposits come from one sector? And what goes on with the banks anyway? Is it… “whoopee, the regulations dont say anything about not having all of our depositors come from one industry so lets go do that!”
Steve
Steve
“SVB’s executives had invested in long-term assets without hedging adequately against interest-rate risks.”
Early reporting had it that the long-term investments were T-bills, and that banks are required to hold them, at least as a certain percentage of their investments. Also, the trap SVB fell into was that it was the Fed that raised interests dramatically.
I have to think the US government is at least partially, if not entirely, responsible for the SVB collapse and today’s stock sell-off. Some European banks might go away in the next few days, e.g., Credit Suisse and Deutsche Bank.
And we can trace the problem back to the huge money dumps into the economies of the US and Europe during the covid panic. Those trillions of dollars and euros created the inflation the Fed is trying to quell.
One ham-fisted economic “tuning” after another, and we get big erratic swings. Who woulda thunk it? Like getting in Russia’s and China’s faces is a good idea, too.
I think it should be noted that inflation was a worldwide event. Maybe they only read international news or thought the US was getting better fast, but given that this was worldwide they had to have noticed it was going on.
I also find it odd that some people want to relieve the bankers for any responsibility since the inflation was caused by, as they see it, the government. If I call my banker to ask if they are managing our money with interest changes in mind he gets to say “No! I didnt cause inflation so even though we are 18 months or so into and inflationary period I have not and will not do anything to hedge risks!”
Steve
I certainly think that any actual wrongdoing should be prosecuted to the full extent of the law. I suspect there will be no charges filed against anybody.
If no laws were broken, what is it that you think bankers should have done and why?
Its hard to model because it is unprecedented.
The rise in 10 year treasuries from 0.6% in Aug 2020 to 4.2% in Nov 2022 has the same effect on bond prices as going from 10% to 16% — which is slightly more then what Volcker did in Jun 1980 to Sept 1981.
Combine that in 1980, debt to GDP was 40% while in 2020, debt to GDP is 100%. i.e. the losses from the rise in interest rates is much larger because there is so much more of these “assets” sitting on banks and everyone else balance sheets.
By the way, the other thing is nobody would have modelled interest rates going down all the way to 0.6% in 2020 — that too defied economics 101.
“If no laws were broken, what is it that you think bankers should have done and why?”
They should have been doing their own internal gap analysis/stress testing. The interest rate environment changed. Everyone else noticed, why didnt they. Someone should have been doing their own internal stress testing. They should have modeled what would happen if all your depositors are from one industry and that industry gets hit hard or there are interest changes that affect that industry.
I really dont get this. You seem to be saying the bankers had zero responsibility. They just take the money in and hope for the best. Just ignore any change in conditions. Maybe I should try that. Just put someone on a medication and then if they get sicker ignore the changes. I am sure that will work great.
“thing is nobody would have modelled interest rates going down all the way to 0.6% in 2020”
Dave is telling us that bankers dont look at interest changes anyway since it will be the government’s fault. Should have become a banker. Good pay, good hours, zero accountability.
Steve
No, I’m saying that the federal government should have held them to the standards they expected them to observe. They will do what they can get away with with impunity. Right now they’re escaping with bonuses and the sale of millions in stocks immediately before they were closed.
As I’ve been saying it stinks to high heaven but what in the world do people expect when banks are being indemnified against their own foolishness? They’re going to take more risks than they should. That’s the name of the game.
As I have previously stated, allowing investment banking and commercial banking to freely intermix is a bad idea. This is what Glass-Steagall was designed to prevent.
Investing is inherently risky, and there is no way to change that. Ask a PE Investor.
There is not enough liquidity to meet all financial obligations at once. In a fractional reserve system, a bank lends more money than it actually has. There is more money on ledgers than actually exists.
“They will do what they can get away with with impunity. ”
Right, so they have no behavioral standards or responsibilities, just what they can get away with. And these are the people we should not regulate according to some people.
Steve
People seem to be lining up on two sides like its a football game.
Capitalism is not based not upon altruism, but upon self interest checked and balanced by adversarial negotiating positions, regulation and tort law. That said, I have a lot of sympathy for steve’s position that the managers should have some sort of decency. It is certainly how our firm conducts itself.
On the other hand, Dave recognizes a hard truth. Self interest – or human nature – will give you SVB executives, and corrupted congresscritters. Shorter: regulatory capture. This is why I have so little faith in regulators. Every time we have a mess like this, and they come like clockwork, the answer is the politically expedient more regulation. Insanity and doing the same thing over and over etc.
I prefer liability for the managers, and smaller (ineffectual) government. It lulls people into a false sense of security. However, as Dave remarks, and as I did, where is the fraud to be prosecuted? SEC filings surely had portfolio holdings listed. I would prosecute for insider trading – it was blatant. There is no business judgment rule for that. (“reasonable man” standard).
The second issue management’s derelection of duty (my words) in holding long duration treasuries. Those are only “safe” when you ignore tenor/interest rate risk. I don’t believe for a second they didn’t know it. Any sophisticated person, financial or otherwise, should know it. But a solution of covering all depositors capital is a mistake. Moral hazard and such. And it really is a bailout by the general public: inflation and fee pas throughs. People need to heed that $250K limit; its the check and balance.
From comments:
“Investing is inherently risky, and there is no way to change that.”
Exactly. Everyone is not an “Accreddited Investor.” They need to heed FDIC limits. AI’s need to suffer consequences, not be bailed out.
“The rise in 10 year treasuries from 0.6% in Aug 2020 to 4.2% in Nov 2022 has the same effect on bond prices as going from 10% to 16% — which is slightly more then what Volcker did in Jun 1980 to Sept 1981.
Combine that in 1980, debt to GDP was 40% while in 2020, debt to GDP is 100%. i.e. the losses from the rise in interest rates is much larger because there is so much more of these “assets†sitting on banks and everyone else balance sheets.
By the way, the other thing is nobody would have modelled interest rates going down all the way to 0.6% in 2020 — that too defied economics 101.”
I think curious’ observation is spot on, and underappreciated. I only differ in that a wayward Fed, a hysterical Covid response and the idiocy of Modern Monetary Theory were well known in the public domain. This thing did not sneak up on us. Only people who listened to Joe Biden and Janet Yellen lie through their teeth about “transitory” inflation and subsidy, green deals etc etc didn’t see what was coming.
“And these are the people we should not regulate according to some people.”
Pretty rich coming from the guy who informed us that “we don’t care about ObamaCare restrictions, we’ll just find other things to bill.”
I know you tried to walk it back, steve. But I’ve never believed that at all. People don’t say something like that as if their mouths (or typing fingers) took over involuntarily. Spare us the morality lecture.
Lastly, I don’t think people appreciate a fundamental of credit. At some point we are not talking “loans.” We are talking investments. More like junk bonds or equity. I have no access to SVB’s loan portfolio, but the notion is that they were making advances to clients that were more risky than loans. That is management malfeasance.
No one seems to have taken my challenge seriously. If something is not against the law, what meaning does assigning blame to people who are looking out for their own best interest have?
Today’s world is a post-Christian, post-ethical, and post-decency one. Without fear of the law, fear of eternal damnation, or even a commonly accepted standard for right behavior, to what might you appeal to say that somebody did something wrong?
I’m not saying that I approve of it, like it, or subscribe to it. I’m saying that’s the way it is.
BTW, did the top management of SVB violate Sarbanes-Oxley? I believe they did. Sarbanes-Oxley remains pointless virtue-signalling. It is almost never enforced. Explain that.
“steve’s position that the managers should have some sort of decency.”
But its not just decency, its also looking out for the long term best interests of the corporation and shareholders. That’s their job. I have had offers that would have benefited our corporate leadership but would have harmed the long term function and growth. We turned those down.
Also, provider induced demand is real Drew. Always keep that in mind when talk about health care reform.
Steve
Steve has raised a very interesting and important question: why didn’t the shareholders exercise appropriate oversight? 98% of SVB’s shares are held by mutual funds and other institutional owners. By my back-of-the-envelope calculation around 40% of SVB was owned by various private equity organizations and the balance by mutual funds.
I don’t know the answer to the question. Perhaps Drew can cast some light on the subject.
My sole speculation would be moral hazard. They assumed that the management knew what they were doing. If that’s the case they failed in their fiduciary responsibility. That’s particularly true of the mutual funds that hold the majority of the stock.
Listened to some commentary earlier from a banker. His claim was that the run was so large that no bank would have been able to hold up. We know that banks dont keep 100% reserves. While it seems pretty clear this bank wasn’t taking actions to mitigate risk and management and shareholders should suffer accordingly, it does bring up the issue of a run large enough to collapse a bank that had made every effort to account for risk. Its back to the outlier discussion we have had in the past. Its not realistic to expect that people will be prepared for the true outlier events.
Steve
There is another factor I have been researching. What is the median deposit at SVB? Given the amount of SVB’s deposits, some of the anecdotes (Roku has a couple of hundred million deposited there?), and the statement that almost all of SVB’s deposits were uninsured it seems to me there’s more going on than we’ve been made aware of.
It may be that the federal government is preparing to “save” a handful of very large (and stupid/arrogant) depositors.
@Dave Schuler
I agree that we are in an amoral era, but this is simply a repeat of 1929 – 33. Those banks failed for the same reason – retail banks operating as investment banks.
Are you proposing that Roku divide its cash between 1,000 banks?
I’ve never looked at Roku’s books but I’m skeptical that a company with 3,000 employees needs to hold $150 million in cash.