A Run on the Banks

Federal Reserve Chair Jerome Powell removes his glasses as he testifies before the House Committee on Financial Services on Capitol Hill in Washington on March 8, 2023. Anna Moneymaker/Getty Images

Commentary

On Mar. 9, Silicon Valley Bank (SVB) lost 60 percent of its value. It showed an aftertax loss of $1.8 billion. Silicon Valley is unique in that, since its inception, its primary target market has been the startup community in the Bay Area. As it expanded across the country, it targeted the startup market.

If you haven’t noticed, the startup market has taken a nosedive last year. Startup firms laid off thousands of people. Big Tech has also laid off thousands of people. The U.S. economy under President Joe Biden hasn’t been very good to it. Combine that with a rapid ramp up in the cost of borrowing by the Federal Reserve with no end in sight and the startup market is bleeding.

The startup economy will rebound someday, but it takes time. It takes time for people to program ideas and put them into motion. One derogatory phrase people use often when someone gets laid off is, “Learn to code”; but the simple fact is low-level commoditized coding jobs are being automated by machine learning and artificial intelligence. Just yesterday I saw the company Vauban release a way to setup an investment special purpose vehicle automatically using an Apple watch.

It looks like SVB was sitting on a pile of unhedged U.S. Treasurys. Instead of pricing in risk, the bank mispriced risk. How many other banks did the same? Since the close of the market on Mar. 9, Credit Suisse got a call from the Securities and Exchange Commission to delay issuing its 10-K. The entire public banking sector lost a total of $52 billion in valuation on Wednesday. Even the blue-chip banks were bloodied.

If you aren’t required to sell, you don’t realize the loss. But Wednesday’s price action reinforces the idea that even though you haven’t sold, you still have an economic loss. One thing that banks should have done is gone into the futures market and hedged their U.S. Treasury portfolio by selling futures and rolling the portfolio as the futures expired. It is unclear if they did that. Often, institutions get lazy. We saw that in 2008, although this will not be another 2008.

Banks saw a historical large percentage increase in deposits during COVID as the economy was shuttered and the U.S. government paid people not to work. Banks had no choice but to purchase U.S. Treasuries with that extra money. The problem was that when the economy reopened, inflation attacked with a vengeance due to all the government spending. The Biden administration increased the level of government spending in March 2021 by a trillion dollars. The Federal Reserve raised rates aggressively, and the banks were caught. That’s why this is not like 2008, although the root cause is similar. Both situations were due to terrible government policies.

It doesn’t help SVB that cryptocurrency bank Silvergate melted down at the same time. Confidence is something that is earned, and when one bank loses confidence, the entire network gets a little shade thrown on their confidence, even if they are well run. With each passing day, it is apparent that crypto companies are not well run, and many of them did business in the form of deposits with Silicon Valley.

First Republic is another big bank in the Bay Area that has competed aggressively with SVB for the startup market. It lost a lot of value, and I suspect its CEO will be talking to shareholders to shore up confidence soon.

Meanwhile, the economy keeps steamrolling on crushing businesses and individuals in its path. The administration released its new tax plan, doubling the tax on capital gains and raising the top rate to over 44 percent. Thankfully, a Republican Congress should kill it, and it will be dead on arrival, but it shows you where their minds are at. Plan accordingly. We are in for more rough sledding.