Over the weekend, I turned my attention to rapidly evolving financial fissures, fissures which may portend another Global Financial Crisis (GFC).
The earthquake’s tremors began over a week ago when Silicon Valley Bank (SVB) tried to raise 2 billion dollars US in new equity. Quickly, investors asked why this was necessary and large depositors ran for the exits. SVB’s broad tentacles through California’s tech sector brought more pressure as tech companies and wealthy individuals sought the exits. It was the second largest bank failure in U.S. history.
On Monday 13 March it was announced that the Vice-Chair of the Federal Reserve Board of Governors would lead a a review of the supervision and regulation of Silicon Valley Bank,
SVB’s problems stemmed from a bad decision last year to invest in long maturity U.S. treasuries just before the Federal Reserve Board began to move up rates quickly in its fight against inflation. For a detailed analysis of the failure go to Seeking Alpha.
The Federal Deposit Insurance Corporation moved quickly to take over the bank guaranteeing all of the depositors money. After that reassurance, attention was drawn to Signature Bank a New York-based “crypto bank with $100 billion U.S. in assets. That bank also failed last week and its assets are being bought by a subsidiary of New York’s Community Bancorp causing FDIC to estimate its losses at $2.5-billion U.S.
SVB was the nation’s 16th largest bank with about $210 billion US in assets. It was not designated or considered as a systemically important institution either domestically or internationally. Such banks are required to carry additional capital to do business. Why the FDIC and the Federal Reserve Board considered SVB to be so important as to guarantee all deposits above the $250,000 U.S. limit is a question.
Many analysts and commentators have questioned the necessity and wisdom of the full bailout of all of SVB’s depositors.
The problem
Deposit insurance, which was supposed to be the final solution to combat bank runs is anything but today. in the 2007 to 09 crisis, investment Banks became Banks to gain access to the Federal Reserves discount window.
It is clear as day today that banking institutions which lie Less on a wide public of small depositors, will always be vulnerable to bank runs because businesses and Individuals with tens of billions of dollars will always influence the government to protect their wealth.
And so, we are a back again at the prospect of socialism for the rich and capitalism for the poor. Private profit at public expense, etc etc.
Contagion
First Republics Bank
Attention then turned to other regional banks now thought to be vulnerable. It looked next door to First Republic Bank another California based regional lender. In response to worried depositors, on Sunday 12 March, First Republic Bank, also based in San Francisco issued a press release that it had strengthened and diversified its liquidity. Four days later the bank announced it had received a $30 billion U.S. lifeline of uninsured deposits from 10 private sector banks including JP Morgan, Wells Fargo, Bank of America and Goldman Sachs. Regions Bank is another San Francisco CA-based lender
Action by the largest U.S. banks reflects their confidence in the country’s banking system and helps ensure First Republic has the liquidity to continue serving its customers.
Parenthetically, it was Goldman Sachs which apparently took $21-billion U.S. in treasury paper off SVB’s hands. Did Goldman recommend the longer dated treasuries in the first place?
Founded in 1985, First Republic and its subsidiaries offer private banking, private business banking and private wealth management. First Republic specializes in delivering exceptional, relationship based service and provides a complete line of products, including residential, commercial and personal loans, deposit services, and private wealth management, including investment, brokerage, insurance, trust and foreign exchange services. Services are offered through preferred banking or wealth management offices primarily in San Francisco, Palo Alto, Los Angeles, Santa Barbara, Newport Beach and San Diego, California; Portland, Oregon; Boston, Massachusetts; Palm Beach, Florida; Greenwich, Connecticut; New York, New York; Jackson, Wyoming; and Bellevue, Washington.
At the end of December 2022, the bank reported $212-billion U,S. in assets which was up by $31-billion in assets from the prior year- a very rapid level of asset growth. FRB had $271-billion of assets under its wealth management division.
On Monday morning 20 March, First Republic’s shares were trading down 46 per cent.
In addition the Federal Reserve Board has offered to take discounted paper at par which ultimately weakens the strength of America’s central bank itself.
Europe and Credit Suisse
Earlier this week market attention shifted overseas to Credit Suisse. This was a very serious development because Credit Suisse is one of 30 globally systematically important banks with approximately $860-billion U.S. in assets. As such, Credit Suisse has tentacles in all major financial markets and financial capitals as a bank for the uber wealthy, global investment manager for the uber wealthy, and also is an investment bank.
Credit Suisse’s shares have fallen about 75% over the past year. 50 billion CHF (Swiss francs) for liquidity reasons was offered by the Swiss central bank and taken. According to Refinitiv, Credit Suisse shares are down in value by 70 per cent year to date. (11:50 a.m. MT, 20 March 2023). Will this infusion of cash help. who knows?
Ever since the soo7-2008 global financial crisis, the Zurich-based bank has paid vast fines and gone through other scandals and executive turnovers, restructuring etc. The bank’s principal investors are from the Middle East and could put more equity into the bank but this would require significant regulatory approval.
Cross-town rival comes to the rescue
Events are moving very quickly with UBS Group AG on Sunday 19 March acquiring Credit Suisse.
Credit Suisse shareholder will receive 1 UBS share for every 22.48 Credit Suisse shares held, equivalent to CHF 0.76/share for a total consideration of CHF 3 billion. UBS benefits from CHF 25 billion of downside protection from the transaction to support marks, purchase price adjustments and restructuring costs, and additional 50% downside protection on non-core assets. Both banks have unrestricted access to the Swiss National Bank existing facilities, through which they can obtain liquidity from the SNB in accordance with the guidelines on monetary policy instruments.
UBS shares are down from 20.74 CHF on 8 March, fell to !4.59 CHF in early trading and are currently trading at 17.33 CHF (12:45 p.m. MT)
This transaction is very reminiscent of the deal worked out between Bear Stearns, JP Morgan and the Federal Reserve in February 2008. Bear Stearns’ shareholders received $2 U.S. per share.
The Future
So who is next? there may be other regional banks which come under pressure. There is now rethinking as to whether the Federal Reserve will continue to raise rates which will continue to hurt institutions holding longer-dated interest-bearing paper.
From my vantage point there is a question mark as to what risks have arisen from the decade-long expansion of global debt at exceedingly low interest rates? Moreover, with the COVID pandemic came a massive expansion of central banks’ balance sheets as they helped finance enormous government deficits.
In 2021-22, we have had concerns about the Chinese financial system with land development financing. In July 2022, in order to combat uncertainty surrounding the Evergrande Group (burdened with $300-billion U.S. in in domestic and international loans) and other property development firms , the People’s Bank of China (central bank) pledged to issue 1-trillion yuan in what appears to have been a successful effort to prevent contagion in its financial system.
With global rates near zero for so long, there had been a growing risk appetite among institutional investors to earn higher rates of return through new, exotic financial products. This was true during the housing crisis, where mortgages became the source of an exploding industry in asset-backed securities.
What are the new assets that are eroding trust in the financial system?
Historically, banks runs and crises are associated with financial markets which have enjoyed a long period of gains and limited market turbulence. Financial market conditions are closely watched by the wide cadre of central banks, bank supervisors, deposit insurers, and securities regulators. A key aspect of any bank run turns on the banks’ ability to access liquidity when heavy deposit withdrawals are experienced. Each of the large systemically important global banks, which include TD Bank and the Royal Bank of Canada) must have an active liquidity management program. This entails knowing who their big depositors are, when these depositors are expected to withdraw funds, and the bank’s plans and capacity to liquidate short-term securities in order to pay out the depositor.
As mentioned, SVB had a serious mismatch of its deposit liabilities which were funded in a significant part by longer-term securities whose values fluctuate more as interest rates rise and fall. It would be ironic if our global financial system has a massive liability-duration mismatch. Asset-liability management is Banking 101 and if both small institutions and essentially is managing interest rate risks. It would be ironic that market price changes in U.S> treasuries and other gilted bonds issued by national governments.
At the present time this problem is being managed by the Federal Reserve which on 13 March announced a new Bank Term Funding Program (BTFP),
offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par (emphasis added).
When banks are embarrassed or found out, the regulator usually works with the bank to remedy the situation. Given the global financial systems simultaneous and instantaneous access to financial information, bank runs can literally occur in minutes, by the touch of a button as large depositors move money from one account to another.
As soon as markets become aware of a problem, a number of actions occur simultaneously. First, the bank’s share price falls dramatically further eroding confidence. Secondly, the market for credit default swaps, like the equities market, moves rapidly against the bank as few parties would bid to write insurance against a bank which may fail. At the same time, the systemically important banks and large institutional investors like pension plans and mutual fund complexes begin to analyze their position against the impugned institution.
While this is going on, the bank’s treasury department would be implementing its emergency liquidity protocol which means getting in touch with regulatory authorities to ascertain the position of these agencies and what their responses might be. The financial situation changes minute by minute as employees watch, often with horror, market movements. The bank’s board of directors would be called to review and approve regulatory responses or approve management recommendations, including selling certain parts of the business or applying for bankruptcy protection.
Could it be possible that longer-dated treasuries are 2023’s financial instrument of mass destruction? Surely not but investors and depositors should be prepared for continued volatility in financial markets.