A lot is written about Silicon Valley Bank (SVB) and what went wrong. There is finger pointing going around by regulators, industry watchers, and the media. At the end of the day, there is enough dirt to go around.
So what happened?
Let us start with the big elephant in the room, the Fed.
The Fed underwent a record pace of raising interest rates. This has taken a broken system and put a great deal more stress on it.
By raising interest rates, the value of bonds and notes collapsed. This means they because worthless as collateral. The ability to tap into financial markets was cut of to SVB since most of their holdings were longer term assets.
When deposits were pulled in what resulted as a bank run, SVB lacked the liquity to settle with other banks. It is at this point where it needed to enter the markets to cover the shortfall. This is what the international financial system steps in. Repo is where financial institutions turn to get the funding they need.
SVB was not a problem of assets, it was liquidity. This is a sign of what we discussed for more than a year. When there is a shortage of dollars, this is what happens.
We also hear accusations that SVB did not enage in proper risk management.
The company went after yield instead of spreading risk. This means that it overlooked buying the shorter dates securities, knowing they paid a much lower return. With interest rates barely above zero, bank executives were looking for the best return they could get. In this sense, they were operating more like a hedge fund than a depository institution.
One this accusation, SVB was guilty. It did not hedge its risk by accumulating a mix of securities where liquidity was improved.
Depository institutions have different requirements than other financial institutions.
Unlike hedge funds, depositors are not turning over their money in an effort to take on risk. The ability of the entity to return the money is something that is taken for granted. In the United States, up to $250K, this is guaranteed by FDIC.
Another issue with SVB was their lack of alignment of securities with deposits. Not all are the same. For example, the redemption time on a payroll account is different than grandma's savings. The latter might never be required, at least until she dies whereas the bank knows it will need the payroll money in a couple weeks.
The way this is balanced is to back the payroll accounts with liquidity. While the return is down, liquidity is provided. It should be evident that the bank sought return, completely ignoring the liquidity part of the equation.
This situation was exasperated by the fact that long dated bonds were off-the-run. That means when SVB went to access the market, there were few bids. This made raising the needed capital impossible.
One advantage to T-Bills is they are always on-the-run. Of course, when it is paying next to nothing in interest, the appeal is low.
Unless you need the liquidity. Then it is important.
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