March 14, 2023 • 33 mins
Silicon Valley bank collapsed at record speed. And the world is still trying to figure out what went wrong? How did a bank with a strong history, a strong brand, and a fairly conservative investment portfolio go belly up so fast? On this episode of the podcast, we speak with Dan Davies, a Managing Director of Frontline Associates, who previously worked as a bank analyst. He explains why the bank's customer base turned out to be so much more flighty than expected, and why the bank reached for yield buying long-dated Treasuries at a time of ultra-low interest rates. We discuss what to watch next, and why he's concerned that the initial salvo to stanch the bank run may not be enough.
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Speaker 1 (00:10):
Hello, and welcome to another episode of the Odd Lots podcast.
I'm Tracy Alloway and I'm Joe wisn't thal Joe. A
lot has happened in the past few days. I don't
even know where to start, really, yeah, I mean I
don't either, but I would say, look, the developments I
think related to Silicon Valley Bank, the speed of the
(00:33):
run and the speed of the response are extraordinary, and
it feels to me like this episode could change like
how banks work in this country. I mean, it's incredible.
It's like all deposits seeming like they're de facto guaranteed,
changing the collateral schedule so that banks don't have to
take a mark to market hit on some of their assets.
(00:54):
This is extraordinary stuff here, absolutely, And I am going
to start this particular Lots with the caveat which is
that obviously things are very fast moving and we're trying
to get some emergency episodes out as quickly as possible.
So this is our first entry into what I'm sure
will be very you know, a lot more on this topic.
(01:16):
But we are going to be speaking with Dan Davies.
He is a managing director at Frontline Analysts. He's also
a former regulatory economist at the Bank of England. He
was a banking analyst for a very long time and
the author of Lying for Money, which is a book
all about financial fraud, A very good book. I might add, Dan,
thank you so much for coming on. All thoughts. Oh,
(01:38):
thanks very much for having me. It's always news whether
people want to. I was going to say at short
notice as well, but we appreciate you coming on. So
why don't we just start with a very big picture question.
But how would you characterize the events of the past
week or so. I think what's happened is that we're
(01:58):
seeing why certain kinds of deposits are considered to be
hot money. At the end of the day, you've got
corporate deposits, which people like to think are sticky, and
wealth management deposits in signature in New York, which is
the other bank that's been shut down and taken over
(02:18):
by the FDIC this weekend, which people like to think
are sticky. But their big amounts of money. It's not
like a few thousand in the bank that people have
for their transactions. It's a sum of money that people
get worried about if they they're going to lose it,
and that means it can be sticky for a while,
but when it moves, it really moves. And that's why
(02:41):
most regulators don't let you fund long dated assets out
of that kind of deposits or put limits on your
ability to do it. So I didn't. So what was
this case with Silicon Valley Bank specifically, in which it
would I mean, not only did it accumulate an extraordinary
(03:03):
amount of a corporate deposit, but also highly all more
or less in sort of one industry. Yeah, I mean, well,
Silicon Valley Bank, according to everyone I've spoken to about it,
we're just very good at customer service with tech companies
in Silicon Valley. And there was no particular magic to
the business model. It's just they built themselves around that.
(03:26):
They did a lot of business on the golf course,
I'm told. And when you had a venture capital funded
startup which might easily have ten million dollars in the bank,
they would be the guys who would onboard you, easily,
give you a bunch of corporate credit cards for your
kind of teenage coders who've never had a credit card before,
(03:46):
and just generally look after you in a way. The
other banks weren't as sharp on the consumer customer service.
My wife used to be involved in a tech startup
in New York City, and she said, like every elevator
event where startups would like get money or like raised
from vcs, there are always just reps from Silicon Value Bank.
(04:07):
They're ready to like show people how to open up
an account like instantly, And that was just like part
of the process of raising VC money was basically part
and parcel with getting your Silicon Value Bank account, you know,
and being good at gathering those deposits. It means that
you gather a huge amount of those deposits. And then
through the last couple of years, when you had a
(04:27):
massive boom in terms of vcs putting money into their portfolio, companies,
they just got these huge inflows of deposits. So, I mean,
one of the most difficult things to manage your banking
is rapid growth. And in particular, you had rapid growth
in deposits at a time when interest rates were very low,
so you know, the actual equilibrium covering their cost of
(04:51):
business spread on these deposits. You know, they might have
had to pay negative fifty basis points of interest rates
and the company doesn't want to do that because it's
going to damage the franchise in the water. The company
certainly doesn't want to turn business away. So what they
end up doing is putting the money in how you
yield of securities, and to do that, you've got to
(05:12):
move out from the maturity curve. And this is the
sort of thing that are switched on Bank Supervisor ought
to be stopping you from doing right. So I do
want to get into the regulation aspect of it, but
before we do, just on SVB specifically, I mean, it
seems to me like you had these inflows of hot money.
(05:33):
You had a concentration of depositors in the tech industry
where money tends to be very volatile and momentum driven,
and certainly over the past year you can imagine a
lot of people were pulling stuff out, and so you
had the sort of classic asset liability duration mismatch. But
(05:54):
why didn't they hedge more? Because it would seem like
this was an obvious vulnerability just based on the dynamic
that I just described. Yeah, I think that's you know,
that's a really really good question that presumably they're going
to be asking themselves right now. And I think to
some extent, they haven't realized the extent to which their
(06:17):
customers were not separate entities in terms of their financial
decision making. So you know, you might have thought you
had some diversification there, but in fact, if all these
people are funded by the same few vcs, and all
those vcs are on the same WhatsApp group, they're actually
behaviorally this isn't a thousand guys with ten million each.
(06:41):
It's one big conglomerate of guys with ten billion. And
the real trouble was though, that their commercial incentives were
completely the other way. You've got these deposits. You're providing
this excellent customer service, which was the backbone of their franchise,
that costs a lot of money. So you've actually got
to do something that earns you a bit on the
(07:03):
asset side, or give up the business. And if you
start hedging out the risk, then you're hedging out the
return as well. And so you know, they could have
managed it more smarter. And I think you pointed to
a story showing that they had discussed internally whether they
should be reducing that risk position, but all of the
(07:24):
incentives were to push them in the direction of taking
that interest rate risk, and then obviously interest rates themselves
moved quite a bit faster than anyone was expecting, so
they were just caught on the wrong side of the trade. Yeah,
this was a story that I wrote with some of
our Bloomberg colleagues, but it sites internal documents from SVB
where they discussed this exact issue, and they were actually
(07:48):
talking about the need to reduce duration exposure, so exposure
to interest rates, and they had an estimated cost for
how much it would affect their net interest margin or
their earnings, and I think they say it was in
the millions of dollars, you know, eighteen million the first
year and then going up to thirty six million over
the next few years. And so it seems there was
(08:08):
a conscious decision not to actually do it. Absolutely. Yeah, Dan,
(08:28):
you know, one of the you mentioned that perhaps one
of the sort of analytical errors that either the bank
made or regulators made was not appreciating that they did
not actually have really thousands and thousands of depositors, but
actually just a handful of depositors who may have all
taken their cues from a small group of vcs and
a few WhatsApp rooms. The scale of the withdrawals that
(08:53):
have been reported on, particularly that happened on Thursday or Friday.
Is there any amount of sort of like um liquidity
requirements that could have satisfied them, because there's talking to like, oh,
they should have had more on hand, they should have
been treated, you know, some of the DoD frank requirements
should have been extended to a bank of that size,
(09:16):
But like, is there a level of run that can
happen in which no amount of like preparation can really
prepare for. Well, it's kind of difficult to know what
the counter factual was. Sure, just in share amounts of
numbers of the amount of money that left, there was
nothing that could have stood in the way of us. Yeah, okay,
that's correct. On the other hand, there's no quantum of
(09:39):
funds they could have had hanging around that would have
stood up to that kind of a deposit run. But
you have to ask whether the room would have been
so big or whether it would have happened at all
if they've managed financing more conservatively. Is the other part
of this is that it's not just the kind of
hot money on the deposit side. There were big unrealized
(10:02):
losses on the securities portfolio because they'd kept that interest
rate risk there. And if you're hanging around with an
unrealized loss on securities that's bigger than your shareholders funds.
You know, the former bank regulator in me says, if
you're doing that, then something bad is going to happen
soon or later. You know, it's not a good idea
to ever let yourself get into that position, right, So,
(10:26):
something I wanted to ask is just on the bond
portfolio losses, which have obviously garnered a lot of attention,
A lot of these were unrealized losses. They were on
bonds that were classified as held to maturity, which means
we're going to hold them into maturity, and so we
don't have to take mark to market losses on them
(10:47):
unless you know they're impaired in some way, because we
fully expect to get the money back, versus securities that
are usually held as available for sale, where because you
might sell them at any point in time, you would
mark them to market and those losses would show up
on your balance sheet. So, because of the proportion of
(11:08):
bonds held by SVB in HTM, and because of the
extent of the losses, there is now this concern about
broader debt and interest rate exposure in the banking system,
and especially at some of the smaller banks where they
might have been more pressured to generate net income margin
(11:30):
by taking additional duration exposure. Can you talk to us
about those concerns. How worried should we be about other
banks versus how much of that this is maybe an
SVB specific story where it's a mix of FLDY depositors
plus a lot of duration exposure. Yeah. Well, it's clear
(11:51):
that the Federal Reserve is concerned that it's not necessarily
confined to those two backs because this new facility they've
put up there, the bank term Finance program just looks
to me like a term finance program that's there for
the FED to say, if you've got any of these
kind of things, if you've got any of these problems
(12:11):
hanging around on your balance sheets, the Fed is put
together this term funding facility in order to allow banks
that have got some kind of problem or something on
their balk sheet that they need to get rid of
and trade out of those positions in a reasonably graceful
and orderly fashion. And you can tell that there this
(12:32):
is the concern because they've said that they will provide
funding against the face value or the power value of
any of these bonds, rather than the market value, which
could be thirty percent. Other How extraordinary is this, because
this to me seems like a huge, a pretty extraordinary
like intervention to say, okay, these you can pledge these
(12:53):
assets as clatter or potentially, as you said, thirty percent
higher than they're currently trading. And isn't this like a
deft actel capital injection? Basically it's it's not quite that.
But obviously, if you're sort of got bonders valued at
seventy and you're lending a hundred against it, then slightly
more than half of your loan, a third of your
(13:14):
loan is unsecured. It's not unknown for central banks to
lend unsecured in emergency situations. It would be a complete
departure if they started doing that in the normal course
of business. But this does look like it's a specific,
time limited hostility that's going to go on for a year,
(13:37):
and where I would expect that most of all the
borrowing that's ever going to be done moderate is going
to be taken out in the next couple of weeks.
You know, you touched on this earlier, but you can
you talk a little bit more about where regulators were
specifically for SVB. But I guess on the wider bond
exposure question, because it does seem like one of the
(13:59):
things that's emerging now is maybe the smaller banks, the
regional lenders, escaped some of the extra regulatory scrutiny that
was heaped on the larger systemically significant banks in recent years,
and so now they are more vulnerable to the threat
of both deposit flight and higher interest rates. Well, yeah,
(14:21):
they did. I mean, what basically happened is that in
the USA there were a couple of buzzle international standards
that were meant to address pretty much this exact risk,
which were only implemented for a very small number of
the largest internationally active banks. And a lot of that
(14:41):
appears to be because medium sized and community banks in
the USA have got a strong political lobby. Not running
this risk was, as we discussed, a threat to the earnings,
and so people decided that they were going to be
hard to get these things restricted to the very biggest banks,
and as a result, Silicon Valley Bank wasn't required to
(15:06):
calculate or report some of what I'd regard as the
key regulatory ratios with regard to its use of hot
money to financial liquid assets, and it's kind of high
quality liquid assets on HAPD. Those policies were just really
meant to be managed by the company itself and by
(15:27):
the company in discussion with its supervisor. But because there's
no hard and fast regulatory number being calculated there, it's
easy to lose track. And it seems that that's what's
happened Dan, just you know, sort of zooming out for
a second. And as someone who analyzes banks around the world,
how unusual is the sheer number of banks regional community
(15:50):
banks that exist in the United States relative to other
rich countries. It's not all known. It's not as extreme
as in Germany, where you have lots of with whats
and lots of really really small savings banks, but it
is quite unusual to have that much of the banking
system in small kind of local savings banks, you know.
(16:12):
And then you have these things like Silicon Valley Bank,
which grew so quickly that although it was a local
Silicon Valley and a local tech industry entity as recently
as four or five years ago, by the time both
last week it was the sixteenth biggest bank in the
United States of America by asset sis. So one of
(16:35):
the things that seems kind of inevitable now is the
idea that you are probably going to see some consolidation
of smaller banks and you are going to see more
money flowing into some of the big guys if there is,
you know, concern about the health of the banking system.
And I was just talking to one tech person just
this morning. He just got his oh, I should say,
(16:57):
we are recording this on Monday, March thirteenth, but he
just got some of his first wire transfer from SVB
out and he's moving it into JP Morgan. So that
seems kind of inevitable money going into the bigger gesibs.
And also maybe the smaller banks have to start raising
their deposit rates as they try to hold on or
(17:19):
compete for more customers. And yeah, I think so when
you have something like this, you're always going to see
what they call a flight to safety or a flight
to quality. And in the case of deposit runs like this,
because people look at the too big to fail banks
prosing that they've got a defacto guarantee despite the fact
(17:44):
that actually what we've seen in the case of the
Signature and Silt and Valley is that the fd I
see seems to be quite happy to extend coverage to
one insured deposits, even in this kind of second tier
and Signatures actually quite small bank, as long as they
are reasonably happy about the quality of the assets, and
(18:06):
as long as there is a decent cushion of unsecured bondholders.
Because obviously the bondholders in these banks are going to
be taking loss, it's they're covered in the way that
the latch depositors are. Well, this is a question I
was going to ask you, which is that, like, are
all deposits de facto now ensured at any size? Like
(18:27):
can you envision a scenario of future bank failure in
which depositors aren't made all? Or is this over if
if you're a depositor, you'll be insured. It's actually quite
unusual for depositors of any sort of fools money in
a bank resolution. Usually you have a cushion of bondholders
(18:47):
today and de facto deposits are considered to be senior
to bondholders. Can only think it's happened a couple of
times in the USA, and there are actually regulations on
the way to just generally say that you've got to
have a layer of bondholders in there, which are you know,
they're not going concerned capital, but they're an extra cushion
(19:08):
for the deposits. So I don't think anyone's ever really
thought of deposits of any sort as being money at risk,
you know, I mean, the depositors of Silicon Valley Bank
didn't think of their deposits as being money at risk
before Wednesday Thursday of last week. And it's turned out
that they were correct. It's turned out that they're getting
all of their money back. So one thing that I'm
(19:29):
still trying to get a handle on is this notion
that it's it's not as if banks do not have
access to emergency lending facilities, you know, before the events
of the weekend and the announcement of the new FED facility.
And this is something that Joe and I talked about,
I think just last month, the episode on banks tapping
(19:50):
the discount window. And you also have the possibility of
banks borrowing from the FHLBS, the federal homelan banks, and
yet it's teams like there was an issue at least
when it comes to SVB, But what could have happened there?
Why couldn't it tap more short term cash from either
(20:11):
the FHLBS or the discount window or was it the
case that you know, at some point no amount of
short term liquidity is actually going to cover the amount
of deposit outflows that the bank was seeing. I think
it's the second of those. Really, there did seem to
be something going along with the FHLB where just simply
Silicon Valley Bank was very large when you compared it
(20:34):
to the San Francisco Federal Homeland Bank for the Federal
Reserve and the other discount window operations. You have access,
but it's access against collateral. Previously to this week, it
was against collateral market value. So if you've got a
mark to market loss on that portfolio, you can only
raise money against a haircut on the market value. And
(20:57):
it's going to be the right collateral broad together in
the right place at the right time. So as you can,
you know, in ordinary situations, you can always deal with
the ordinary problems of banking. What you can't deal with
is something absolutely kind of off the chance, crazy like
we saw on Thursday and Friday last week. What does
(21:34):
it tell you if anything that no private buyer stepped up,
because as you said, you know, they had great customer service,
there's great product fit that seemed to really fit with
the valley. It seems like, you know, some banks probably
kind of offer commodity banking services and Silicon Valley Bank didn't,
and they seem to have some sort of unique franchise value.
(21:56):
A lot of people like the bank. What should we
read into the fact that there was no buyer and
also what is your take on whether it should have
been sold to a g SIB like a Chase, an
entity that could have easily absorbed it. I'm genuinely surprised
that didn't happen. The London operations, the UK subsidiary was
(22:17):
brought by HSBC over the weekend and it looks like
HSBC have brought themselves a small because it's obviously small
compared to the overall bank, but nice little local tech
banking business. The thing about banks is that when banks
(22:38):
go into resolution, all sorts of strange things start kind
of bubbling up, and things that you never knew were
going on tend to be uncovered. So people tend to
be a little bit risk averse. But yes, I'm surprised
that none of the big players felt that they could
buy this one, although you know that's still a possibility
(22:59):
over the coming which the FDIC is still, as I understand,
it's looking to sell this thing as a going concern,
as an operating business. So it might be that they'll
just keep on doing their due diligence by their time
and bid for it in the auction. So what are
you looking out for going forward? And in terms of
(23:19):
wider contagion, because you know, as I mentioned, it's Monday,
March thirteenth, there's a lot happening. There will, no doubt
be a lot of developments that have happened by the
time we release this episode, but for now, there are
quite a few bank stocks that are down, which you know,
maybe that makes sense because the Federal Reserve Facility, the
new one, is going to help in terms of some
(23:42):
of those bomb losses, but it's not necessarily going to
do anything for equity holders, and so there's an expectation
that banks will have to raise additional capital. But what
are you on the lookout for. I think I want
to look out for a real signs that the authorities
are taking this because the one thing we learned over
(24:02):
the kind of great financial crisis, and then again those
of us who are active in Europe learned it in
the euro crisis is that if you're dealing with the
crisis of market confidence, you need to bring the absolute
entire power of the state and the central bank to bear.
One thing I was quite disappointed seeing with the announcement
of these facilities was all of these announcements saying this
(24:25):
is not a bailout, send go, taxpayers money is at risk.
And I think that the market sees those things and
it doesn't go, you know how fiscally responsible, It sees
those things and thinks nobody's taking this seriously. What you
need is someone to do what Marry or Druga did
and come out to bang the table and say, this
is a bailout. Taxpayers money is at risk. We have
(24:48):
unlimited firepower. We will stop this thing in its tracks.
We will underpindle the good is of the US financial system.
And you know, it's always my view that with these
things always going to end up doing that. So you
might as well save yourself a couple of days heart
sake and do it right out of the gate. Right
Europe spent about you know, Angelo Merkel spent about three
(25:10):
years trying to avoid that and then it ended up
being massively costly in the end, is your view that
what has happened is it a bailout? And be like,
how do you even define that? Is it useful to
define that? Or if someone asked you, Dan, what's a bailout?
What is that? Well, I think people people have stopped
asking me what's a bailout? Keep giving them, you know,
(25:32):
I'll keep giving them the wrong answer, and yeah, it's
a bailout, and bailance are good. Bailance are almost always
the right thing to do. And there's a bailout just
means that the state steps in and provides insurance so
that something economically destructive doesn't happen. And lots of people
who did economics degrees start talking about moral hazard. But
(25:57):
I noticed that there's very few people who work in
the insurance business whose first concern right now is about
moral hazard. Also, very much doubt that anyone involved with
Silicon Valley Bank, even those that are getting paid back
at one hundred cents in the dollar, will look back
at this last week and regard it as a case
a moral hazard where they got looked after really well,
(26:19):
in a crisis, you just need someone to stand in
and show that they are managing it. And there's a
lot of my mind, really quite silly rhetoric about bailouts
because when it happens, it's kind of easy to do
a political speech about how you're against bailouts and how
you're in favor of saving money for the taxpayer, but
(26:43):
it doesn't actually solve anything. And the next time a
crisis comes around, it's still a crisis and it still
needs something to be done about it. And all that
happens is that that necessary corrective action takes longer to
execute because there's still people who think that they can
gain short termple of skill advantage by shouting about bailants.
(27:05):
And that's the story of the euro crisis, and I'm
very much hope that it doesn't happen in the USA
right now. Yeah, it just feels like at the height
of a crisis isn't necessarily the time to start addressing
systemic injustices and weaknesses. Dan, We're going to have to
leave it there. We very much appreciate you coming on
add Lots our Emergency add Blots episode for an emergency
(27:29):
banking crisis. So thank you so much. Thanks very much,
have a great rest of the day. So Joe, I
thought that was a really good summary of what's been
(27:51):
going on. There are a lot of moving parts, and
as I mentioned a couple of times, I'm sure we
are going to be talking about this for a long
time to come. But I thought dan point about how
this is and isn't a bailout was a really good one,
because yes, you know, in some sense depositors are being protected.
You know, the FED is flinging a lot of money
(28:13):
at this problem. But on the other hand, you are
seeing the bank stock reaction this morning, there is clearly
still a concern that even with the additional facility, banks
are going to have to go out and raise capital
and that's either going to be dilutive to shareholders or
wipe them out completely. And you know, Dan made the
point about when you're in crisis mode, you kind of
(28:36):
have to leave some of the issues of moral hazard
at the door, come back and solve them later, but
now might not be the best time. No, I thought
that was a great point that you like, you want
to like, oh, we're protecting the taxpayer, it's not a bailout.
It's not unlimited, there's finite. It's like exactly like if
(28:57):
you want to nip it in the bud, those are
the opposite of what you want to say. So I
think that's really interesting and maybe really telling about some
of the other bank stock weakness. And then just like
some of these interesting dimensions, you know, like about the
idiosync he I thought Dan described really well what made
Silicon Valley Bank unique, particularly having just a handful of
(29:19):
defective depositors. On paper, it looks like you have thousands
and thousands of depositors all around the world. In practice,
if they all have a few sort of top vcs
that they listen, they're all on the same what then
they only have a few deposit book face. And if
it's known that corporate deposits are much less sticky, then
you really like do create some like a flight risk? No. Absolutely,
(29:42):
to me, this is as much as sort of cultural
or social story as it is a financial one, where
you have this group of really tight knit depositors, all
of whom are talking to each other, are very plugged
in online, and also have a sort of tendency to
want to be first. I mean, you know you're talking
about Silicon Valley and move fast and break things and
(30:04):
all of that, Like they want to get out there
with the bragging rights about warning people of an impending
banking collapse, and so you know, to some extent they
were successful with that, but obviously they caused a larger problem.
And then I wouldn't want I don't want to underplay
the very subpar risk management. And I'm choosing my adjectives
(30:28):
very carefully here and I'm being very conservative and how
I describe this, But the hedging of the interest rate
exposure left a lot to be desired on the side
of SVB. Yeah, but you know, I do. I mean,
it was clearly mistakes were made, to say the least,
but like you, I get it right. It's like they
have a costly franchise to run because it's obviously so
(30:50):
high touch. You get this huge flight of capital inflows
at a time of very low interest rate when there
isn't yield. You have to pay for that high touch service.
So I do sort of in my mind, like at
least get why they felt this impulse which many banks
don't do, to like just go so far out on
(31:10):
the yield curve. Obviously turned out to be sort of
like catastrophic, but at least the story sort of like
fits together of why they ended up in that position. Well,
it's also interest rate exposure squared, right, because all your
depositors and everyone you're lending money to is in the
tech industry and they're massively affected by higher interest rates.
And at the same time, all your assets are in
(31:33):
long duration stuff that's also impacted by higher interest rates.
Seems to be a bad situation, very bad, and hopefully
for the broader economy, etc. Hopefully the unique badness of
that situation means it doesn't spread. But I think it's
way too early to know whether, you know, people would
(31:53):
just say, look, I don't want to have money in
a regional bank. What's the point I can be in chase.
So we'll see. Yeah, more to come, but for now,
we leave it there. Let's leave it there. Okay. This
has been another episode of the Old Thoughts podcast. I'm
Tracy Alloway. You can follow me on Twitter at Tracy
Alloway and I'm Joe wi Isn'tal. You can follow me
on Twitter at the Stalwart. Follow our guest Dan Davies,
(32:15):
phenomenal Twitter user at d squared Digest. Follow our producers
Kermen Rodriguez at Kerman Arman and Dash Bennett at Dashbot.
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(32:35):
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Hello, and welcome to another episode of the Odd Lots podcast.
I'm Tracy Alloway and I'm Joe wisn't thal Joe. A
lot has happened in the past few days. I don't
even know where to start, really, yeah, I mean I
don't either, but I would say, look, the developments I
think related to Silicon Valley Bank, the speed of the
(00:33):
run and the speed of the response are extraordinary, and
it feels to me like this episode could change like
how banks work in this country. I mean, it's incredible.
It's like all deposits seeming like they're de facto guaranteed,
changing the collateral schedule so that banks don't have to
take a mark to market hit on some of their assets.
(00:54):
This is extraordinary stuff here, absolutely, And I am going
to start this particular Lots with the caveat which is
that obviously things are very fast moving and we're trying
to get some emergency episodes out as quickly as possible.
So this is our first entry into what I'm sure
will be very you know, a lot more on this topic.
(01:16):
But we are going to be speaking with Dan Davies.
He is a managing director at Frontline Analysts. He's also
a former regulatory economist at the Bank of England. He
was a banking analyst for a very long time and
the author of Lying for Money, which is a book
all about financial fraud, A very good book. I might add, Dan,
thank you so much for coming on. All thoughts. Oh,
(01:38):
thanks very much for having me. It's always news whether
people want to. I was going to say at short
notice as well, but we appreciate you coming on. So
why don't we just start with a very big picture question.
But how would you characterize the events of the past
week or so. I think what's happened is that we're
(01:58):
seeing why certain kinds of deposits are considered to be
hot money. At the end of the day, you've got
corporate deposits, which people like to think are sticky, and
wealth management deposits in signature in New York, which is
the other bank that's been shut down and taken over
(02:18):
by the FDIC this weekend, which people like to think
are sticky. But their big amounts of money. It's not
like a few thousand in the bank that people have
for their transactions. It's a sum of money that people
get worried about if they they're going to lose it,
and that means it can be sticky for a while,
but when it moves, it really moves. And that's why
(02:41):
most regulators don't let you fund long dated assets out
of that kind of deposits or put limits on your
ability to do it. So I didn't. So what was
this case with Silicon Valley Bank specifically, in which it
would I mean, not only did it accumulate an extraordinary
(03:03):
amount of a corporate deposit, but also highly all more
or less in sort of one industry. Yeah, I mean, well,
Silicon Valley Bank, according to everyone I've spoken to about it,
we're just very good at customer service with tech companies
in Silicon Valley. And there was no particular magic to
the business model. It's just they built themselves around that.
(03:26):
They did a lot of business on the golf course,
I'm told. And when you had a venture capital funded
startup which might easily have ten million dollars in the bank,
they would be the guys who would onboard you, easily,
give you a bunch of corporate credit cards for your
kind of teenage coders who've never had a credit card before,
(03:46):
and just generally look after you in a way. The
other banks weren't as sharp on the consumer customer service.
My wife used to be involved in a tech startup
in New York City, and she said, like every elevator
event where startups would like get money or like raised
from vcs, there are always just reps from Silicon Value Bank.
(04:07):
They're ready to like show people how to open up
an account like instantly, And that was just like part
of the process of raising VC money was basically part
and parcel with getting your Silicon Value Bank account, you know,
and being good at gathering those deposits. It means that
you gather a huge amount of those deposits. And then
through the last couple of years, when you had a
(04:27):
massive boom in terms of vcs putting money into their portfolio, companies,
they just got these huge inflows of deposits. So, I mean,
one of the most difficult things to manage your banking
is rapid growth. And in particular, you had rapid growth
in deposits at a time when interest rates were very low,
so you know, the actual equilibrium covering their cost of
(04:51):
business spread on these deposits. You know, they might have
had to pay negative fifty basis points of interest rates
and the company doesn't want to do that because it's
going to damage the franchise in the water. The company
certainly doesn't want to turn business away. So what they
end up doing is putting the money in how you
yield of securities, and to do that, you've got to
(05:12):
move out from the maturity curve. And this is the
sort of thing that are switched on Bank Supervisor ought
to be stopping you from doing right. So I do
want to get into the regulation aspect of it, but
before we do, just on SVB specifically, I mean, it
seems to me like you had these inflows of hot money.
(05:33):
You had a concentration of depositors in the tech industry
where money tends to be very volatile and momentum driven,
and certainly over the past year you can imagine a
lot of people were pulling stuff out, and so you
had the sort of classic asset liability duration mismatch. But
(05:54):
why didn't they hedge more? Because it would seem like
this was an obvious vulnerability just based on the dynamic
that I just described. Yeah, I think that's you know,
that's a really really good question that presumably they're going
to be asking themselves right now. And I think to
some extent, they haven't realized the extent to which their
(06:17):
customers were not separate entities in terms of their financial
decision making. So you know, you might have thought you
had some diversification there, but in fact, if all these
people are funded by the same few vcs, and all
those vcs are on the same WhatsApp group, they're actually
behaviorally this isn't a thousand guys with ten million each.
(06:41):
It's one big conglomerate of guys with ten billion. And
the real trouble was though, that their commercial incentives were
completely the other way. You've got these deposits. You're providing
this excellent customer service, which was the backbone of their franchise,
that costs a lot of money. So you've actually got
to do something that earns you a bit on the
(07:03):
asset side, or give up the business. And if you
start hedging out the risk, then you're hedging out the
return as well. And so you know, they could have
managed it more smarter. And I think you pointed to
a story showing that they had discussed internally whether they
should be reducing that risk position, but all of the
(07:24):
incentives were to push them in the direction of taking
that interest rate risk, and then obviously interest rates themselves
moved quite a bit faster than anyone was expecting, so
they were just caught on the wrong side of the trade. Yeah,
this was a story that I wrote with some of
our Bloomberg colleagues, but it sites internal documents from SVB
where they discussed this exact issue, and they were actually
(07:48):
talking about the need to reduce duration exposure, so exposure
to interest rates, and they had an estimated cost for
how much it would affect their net interest margin or
their earnings, and I think they say it was in
the millions of dollars, you know, eighteen million the first
year and then going up to thirty six million over
the next few years. And so it seems there was
(08:08):
a conscious decision not to actually do it. Absolutely. Yeah, Dan,
(08:28):
you know, one of the you mentioned that perhaps one
of the sort of analytical errors that either the bank
made or regulators made was not appreciating that they did
not actually have really thousands and thousands of depositors, but
actually just a handful of depositors who may have all
taken their cues from a small group of vcs and
a few WhatsApp rooms. The scale of the withdrawals that
(08:53):
have been reported on, particularly that happened on Thursday or Friday.
Is there any amount of sort of like um liquidity
requirements that could have satisfied them, because there's talking to like, oh,
they should have had more on hand, they should have
been treated, you know, some of the DoD frank requirements
should have been extended to a bank of that size,
(09:16):
But like, is there a level of run that can
happen in which no amount of like preparation can really
prepare for. Well, it's kind of difficult to know what
the counter factual was. Sure, just in share amounts of
numbers of the amount of money that left, there was
nothing that could have stood in the way of us. Yeah, okay,
that's correct. On the other hand, there's no quantum of
(09:39):
funds they could have had hanging around that would have
stood up to that kind of a deposit run. But
you have to ask whether the room would have been
so big or whether it would have happened at all
if they've managed financing more conservatively. Is the other part
of this is that it's not just the kind of
hot money on the deposit side. There were big unrealized
(10:02):
losses on the securities portfolio because they'd kept that interest
rate risk there. And if you're hanging around with an
unrealized loss on securities that's bigger than your shareholders funds.
You know, the former bank regulator in me says, if
you're doing that, then something bad is going to happen
soon or later. You know, it's not a good idea
to ever let yourself get into that position, right, So,
(10:26):
something I wanted to ask is just on the bond
portfolio losses, which have obviously garnered a lot of attention,
A lot of these were unrealized losses. They were on
bonds that were classified as held to maturity, which means
we're going to hold them into maturity, and so we
don't have to take mark to market losses on them
(10:47):
unless you know they're impaired in some way, because we
fully expect to get the money back, versus securities that
are usually held as available for sale, where because you
might sell them at any point in time, you would
mark them to market and those losses would show up
on your balance sheet. So, because of the proportion of
(11:08):
bonds held by SVB in HTM, and because of the
extent of the losses, there is now this concern about
broader debt and interest rate exposure in the banking system,
and especially at some of the smaller banks where they
might have been more pressured to generate net income margin
(11:30):
by taking additional duration exposure. Can you talk to us
about those concerns. How worried should we be about other
banks versus how much of that this is maybe an
SVB specific story where it's a mix of FLDY depositors
plus a lot of duration exposure. Yeah. Well, it's clear
(11:51):
that the Federal Reserve is concerned that it's not necessarily
confined to those two backs because this new facility they've
put up there, the bank term Finance program just looks
to me like a term finance program that's there for
the FED to say, if you've got any of these
kind of things, if you've got any of these problems
(12:11):
hanging around on your balance sheets, the Fed is put
together this term funding facility in order to allow banks
that have got some kind of problem or something on
their balk sheet that they need to get rid of
and trade out of those positions in a reasonably graceful
and orderly fashion. And you can tell that there this
(12:32):
is the concern because they've said that they will provide
funding against the face value or the power value of
any of these bonds, rather than the market value, which
could be thirty percent. Other How extraordinary is this, because
this to me seems like a huge, a pretty extraordinary
like intervention to say, okay, these you can pledge these
(12:53):
assets as clatter or potentially, as you said, thirty percent
higher than they're currently trading. And isn't this like a
deft actel capital injection? Basically it's it's not quite that.
But obviously, if you're sort of got bonders valued at
seventy and you're lending a hundred against it, then slightly
more than half of your loan, a third of your
(13:14):
loan is unsecured. It's not unknown for central banks to
lend unsecured in emergency situations. It would be a complete
departure if they started doing that in the normal course
of business. But this does look like it's a specific,
time limited hostility that's going to go on for a year,
(13:37):
and where I would expect that most of all the
borrowing that's ever going to be done moderate is going
to be taken out in the next couple of weeks.
You know, you touched on this earlier, but you can
you talk a little bit more about where regulators were
specifically for SVB. But I guess on the wider bond
exposure question, because it does seem like one of the
(13:59):
things that's emerging now is maybe the smaller banks, the
regional lenders, escaped some of the extra regulatory scrutiny that
was heaped on the larger systemically significant banks in recent years,
and so now they are more vulnerable to the threat
of both deposit flight and higher interest rates. Well, yeah,
(14:21):
they did. I mean, what basically happened is that in
the USA there were a couple of buzzle international standards
that were meant to address pretty much this exact risk,
which were only implemented for a very small number of
the largest internationally active banks. And a lot of that
(14:41):
appears to be because medium sized and community banks in
the USA have got a strong political lobby. Not running
this risk was, as we discussed, a threat to the earnings,
and so people decided that they were going to be
hard to get these things restricted to the very biggest banks,
and as a result, Silicon Valley Bank wasn't required to
(15:06):
calculate or report some of what I'd regard as the
key regulatory ratios with regard to its use of hot
money to financial liquid assets, and it's kind of high
quality liquid assets on HAPD. Those policies were just really
meant to be managed by the company itself and by
(15:27):
the company in discussion with its supervisor. But because there's
no hard and fast regulatory number being calculated there, it's
easy to lose track. And it seems that that's what's
happened Dan, just you know, sort of zooming out for
a second. And as someone who analyzes banks around the world,
how unusual is the sheer number of banks regional community
(15:50):
banks that exist in the United States relative to other
rich countries. It's not all known. It's not as extreme
as in Germany, where you have lots of with whats
and lots of really really small savings banks, but it
is quite unusual to have that much of the banking
system in small kind of local savings banks, you know.
(16:12):
And then you have these things like Silicon Valley Bank,
which grew so quickly that although it was a local
Silicon Valley and a local tech industry entity as recently
as four or five years ago, by the time both
last week it was the sixteenth biggest bank in the
United States of America by asset sis. So one of
(16:35):
the things that seems kind of inevitable now is the
idea that you are probably going to see some consolidation
of smaller banks and you are going to see more
money flowing into some of the big guys if there is,
you know, concern about the health of the banking system.
And I was just talking to one tech person just
this morning. He just got his oh, I should say,
(16:57):
we are recording this on Monday, March thirteenth, but he
just got some of his first wire transfer from SVB
out and he's moving it into JP Morgan. So that
seems kind of inevitable money going into the bigger gesibs.
And also maybe the smaller banks have to start raising
their deposit rates as they try to hold on or
(17:19):
compete for more customers. And yeah, I think so when
you have something like this, you're always going to see
what they call a flight to safety or a flight
to quality. And in the case of deposit runs like this,
because people look at the too big to fail banks
prosing that they've got a defacto guarantee despite the fact
(17:44):
that actually what we've seen in the case of the
Signature and Silt and Valley is that the fd I
see seems to be quite happy to extend coverage to
one insured deposits, even in this kind of second tier
and Signatures actually quite small bank, as long as they
are reasonably happy about the quality of the assets, and
(18:06):
as long as there is a decent cushion of unsecured bondholders.
Because obviously the bondholders in these banks are going to
be taking loss, it's they're covered in the way that
the latch depositors are. Well, this is a question I
was going to ask you, which is that, like, are
all deposits de facto now ensured at any size? Like
(18:27):
can you envision a scenario of future bank failure in
which depositors aren't made all? Or is this over if
if you're a depositor, you'll be insured. It's actually quite
unusual for depositors of any sort of fools money in
a bank resolution. Usually you have a cushion of bondholders
(18:47):
today and de facto deposits are considered to be senior
to bondholders. Can only think it's happened a couple of
times in the USA, and there are actually regulations on
the way to just generally say that you've got to
have a layer of bondholders in there, which are you know,
they're not going concerned capital, but they're an extra cushion
(19:08):
for the deposits. So I don't think anyone's ever really
thought of deposits of any sort as being money at risk,
you know, I mean, the depositors of Silicon Valley Bank
didn't think of their deposits as being money at risk
before Wednesday Thursday of last week. And it's turned out
that they were correct. It's turned out that they're getting
all of their money back. So one thing that I'm
(19:29):
still trying to get a handle on is this notion
that it's it's not as if banks do not have
access to emergency lending facilities, you know, before the events
of the weekend and the announcement of the new FED facility.
And this is something that Joe and I talked about,
I think just last month, the episode on banks tapping
(19:50):
the discount window. And you also have the possibility of
banks borrowing from the FHLBS, the federal homelan banks, and
yet it's teams like there was an issue at least
when it comes to SVB, But what could have happened there?
Why couldn't it tap more short term cash from either
(20:11):
the FHLBS or the discount window or was it the
case that you know, at some point no amount of
short term liquidity is actually going to cover the amount
of deposit outflows that the bank was seeing. I think
it's the second of those. Really, there did seem to
be something going along with the FHLB where just simply
Silicon Valley Bank was very large when you compared it
(20:34):
to the San Francisco Federal Homeland Bank for the Federal
Reserve and the other discount window operations. You have access,
but it's access against collateral. Previously to this week, it
was against collateral market value. So if you've got a
mark to market loss on that portfolio, you can only
raise money against a haircut on the market value. And
(20:57):
it's going to be the right collateral broad together in
the right place at the right time. So as you can,
you know, in ordinary situations, you can always deal with
the ordinary problems of banking. What you can't deal with
is something absolutely kind of off the chance, crazy like
we saw on Thursday and Friday last week. What does
(21:34):
it tell you if anything that no private buyer stepped up,
because as you said, you know, they had great customer service,
there's great product fit that seemed to really fit with
the valley. It seems like, you know, some banks probably
kind of offer commodity banking services and Silicon Valley Bank didn't,
and they seem to have some sort of unique franchise value.
(21:56):
A lot of people like the bank. What should we
read into the fact that there was no buyer and
also what is your take on whether it should have
been sold to a g SIB like a Chase, an
entity that could have easily absorbed it. I'm genuinely surprised
that didn't happen. The London operations, the UK subsidiary was
(22:17):
brought by HSBC over the weekend and it looks like
HSBC have brought themselves a small because it's obviously small
compared to the overall bank, but nice little local tech
banking business. The thing about banks is that when banks
(22:38):
go into resolution, all sorts of strange things start kind
of bubbling up, and things that you never knew were
going on tend to be uncovered. So people tend to
be a little bit risk averse. But yes, I'm surprised
that none of the big players felt that they could
buy this one, although you know that's still a possibility
(22:59):
over the coming which the FDIC is still, as I understand,
it's looking to sell this thing as a going concern,
as an operating business. So it might be that they'll
just keep on doing their due diligence by their time
and bid for it in the auction. So what are
you looking out for going forward? And in terms of
(23:19):
wider contagion, because you know, as I mentioned, it's Monday,
March thirteenth, there's a lot happening. There will, no doubt
be a lot of developments that have happened by the
time we release this episode, but for now, there are
quite a few bank stocks that are down, which you know,
maybe that makes sense because the Federal Reserve Facility, the
new one, is going to help in terms of some
(23:42):
of those bomb losses, but it's not necessarily going to
do anything for equity holders, and so there's an expectation
that banks will have to raise additional capital. But what
are you on the lookout for. I think I want
to look out for a real signs that the authorities
are taking this because the one thing we learned over
(24:02):
the kind of great financial crisis, and then again those
of us who are active in Europe learned it in
the euro crisis is that if you're dealing with the
crisis of market confidence, you need to bring the absolute
entire power of the state and the central bank to bear.
One thing I was quite disappointed seeing with the announcement
of these facilities was all of these announcements saying this
(24:25):
is not a bailout, send go, taxpayers money is at risk.
And I think that the market sees those things and
it doesn't go, you know how fiscally responsible, It sees
those things and thinks nobody's taking this seriously. What you
need is someone to do what Marry or Druga did
and come out to bang the table and say, this
is a bailout. Taxpayers money is at risk. We have
(24:48):
unlimited firepower. We will stop this thing in its tracks.
We will underpindle the good is of the US financial system.
And you know, it's always my view that with these
things always going to end up doing that. So you
might as well save yourself a couple of days heart
sake and do it right out of the gate. Right
Europe spent about you know, Angelo Merkel spent about three
(25:10):
years trying to avoid that and then it ended up
being massively costly in the end, is your view that
what has happened is it a bailout? And be like,
how do you even define that? Is it useful to
define that? Or if someone asked you, Dan, what's a bailout?
What is that? Well, I think people people have stopped
asking me what's a bailout? Keep giving them, you know,
(25:32):
I'll keep giving them the wrong answer, and yeah, it's
a bailout, and bailance are good. Bailance are almost always
the right thing to do. And there's a bailout just
means that the state steps in and provides insurance so
that something economically destructive doesn't happen. And lots of people
who did economics degrees start talking about moral hazard. But
(25:57):
I noticed that there's very few people who work in
the insurance business whose first concern right now is about
moral hazard. Also, very much doubt that anyone involved with
Silicon Valley Bank, even those that are getting paid back
at one hundred cents in the dollar, will look back
at this last week and regard it as a case
a moral hazard where they got looked after really well,
(26:19):
in a crisis, you just need someone to stand in
and show that they are managing it. And there's a
lot of my mind, really quite silly rhetoric about bailouts
because when it happens, it's kind of easy to do
a political speech about how you're against bailouts and how
you're in favor of saving money for the taxpayer, but
(26:43):
it doesn't actually solve anything. And the next time a
crisis comes around, it's still a crisis and it still
needs something to be done about it. And all that
happens is that that necessary corrective action takes longer to
execute because there's still people who think that they can
gain short termple of skill advantage by shouting about bailants.
(27:05):
And that's the story of the euro crisis, and I'm
very much hope that it doesn't happen in the USA
right now. Yeah, it just feels like at the height
of a crisis isn't necessarily the time to start addressing
systemic injustices and weaknesses. Dan, We're going to have to
leave it there. We very much appreciate you coming on
add Lots our Emergency add Blots episode for an emergency
(27:29):
banking crisis. So thank you so much. Thanks very much,
have a great rest of the day. So Joe, I
thought that was a really good summary of what's been
(27:51):
going on. There are a lot of moving parts, and
as I mentioned a couple of times, I'm sure we
are going to be talking about this for a long
time to come. But I thought dan point about how
this is and isn't a bailout was a really good one,
because yes, you know, in some sense depositors are being protected.
You know, the FED is flinging a lot of money
(28:13):
at this problem. But on the other hand, you are
seeing the bank stock reaction this morning, there is clearly
still a concern that even with the additional facility, banks
are going to have to go out and raise capital
and that's either going to be dilutive to shareholders or
wipe them out completely. And you know, Dan made the
point about when you're in crisis mode, you kind of
(28:36):
have to leave some of the issues of moral hazard
at the door, come back and solve them later, but
now might not be the best time. No, I thought
that was a great point that you like, you want
to like, oh, we're protecting the taxpayer, it's not a bailout.
It's not unlimited, there's finite. It's like exactly like if
(28:57):
you want to nip it in the bud, those are
the opposite of what you want to say. So I
think that's really interesting and maybe really telling about some
of the other bank stock weakness. And then just like
some of these interesting dimensions, you know, like about the
idiosync he I thought Dan described really well what made
Silicon Valley Bank unique, particularly having just a handful of
(29:19):
defective depositors. On paper, it looks like you have thousands
and thousands of depositors all around the world. In practice,
if they all have a few sort of top vcs
that they listen, they're all on the same what then
they only have a few deposit book face. And if
it's known that corporate deposits are much less sticky, then
you really like do create some like a flight risk? No. Absolutely,
(29:42):
to me, this is as much as sort of cultural
or social story as it is a financial one, where
you have this group of really tight knit depositors, all
of whom are talking to each other, are very plugged
in online, and also have a sort of tendency to
want to be first. I mean, you know you're talking
about Silicon Valley and move fast and break things and
(30:04):
all of that, Like they want to get out there
with the bragging rights about warning people of an impending
banking collapse, and so you know, to some extent they
were successful with that, but obviously they caused a larger problem.
And then I wouldn't want I don't want to underplay
the very subpar risk management. And I'm choosing my adjectives
(30:28):
very carefully here and I'm being very conservative and how
I describe this, But the hedging of the interest rate
exposure left a lot to be desired on the side
of SVB. Yeah, but you know, I do. I mean,
it was clearly mistakes were made, to say the least,
but like you, I get it right. It's like they
have a costly franchise to run because it's obviously so
(30:50):
high touch. You get this huge flight of capital inflows
at a time of very low interest rate when there
isn't yield. You have to pay for that high touch service.
So I do sort of in my mind, like at
least get why they felt this impulse which many banks
don't do, to like just go so far out on
(31:10):
the yield curve. Obviously turned out to be sort of
like catastrophic, but at least the story sort of like
fits together of why they ended up in that position. Well,
it's also interest rate exposure squared, right, because all your
depositors and everyone you're lending money to is in the
tech industry and they're massively affected by higher interest rates.
And at the same time, all your assets are in
(31:33):
long duration stuff that's also impacted by higher interest rates.
Seems to be a bad situation, very bad, and hopefully
for the broader economy, etc. Hopefully the unique badness of
that situation means it doesn't spread. But I think it's
way too early to know whether, you know, people would
(31:53):
just say, look, I don't want to have money in
a regional bank. What's the point I can be in chase.
So we'll see. Yeah, more to come, but for now,
we leave it there. Let's leave it there. Okay. This
has been another episode of the Old Thoughts podcast. I'm
Tracy Alloway. You can follow me on Twitter at Tracy
Alloway and I'm Joe wi Isn'tal. You can follow me
on Twitter at the Stalwart. Follow our guest Dan Davies,
(32:15):
phenomenal Twitter user at d squared Digest. Follow our producers
Kermen Rodriguez at Kerman Arman and Dash Bennett at Dashbot.
Follow all of the Bloomberg podcasts, some to the handle
at podcasts, and for more Odd Lots content, go to
Bloomberg dot com slash odd Lots, where we'll post the transcripts.
(32:35):
Tracy and I blog, and we have a weekly newsletter.
Go there sign up for it. Thanks for listening.
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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