collapse of the Silicon Valley bank: opinion | Silicon Valley bank collapse makes everyone look terrible: The New York Times

Over the past week, an observation by Matt Klein, a financial journalist, has gone viral. “It was more of a case of ‘a bank run by idiots’ rather than a case of ‘a bank run by idiots,'” he wrote, referring to the collapse. Bank of Silicon Valley.

But why choose? Everyone involved in this looks terrible.

The regulators did nothing, although the troubles of Silicon Valley Bank were widely known. Bank managers have failed in their basic job of hedging the risk of higher interest rates. Mid-sized banks, including Silicon Valley Bank itself, have successfully lobbied Congress and the Trump administration for an exemption from rules that apply to banks that are too big to fail.

The venture capitalists provoked an unnecessary panic that destroyed the central institution of their own industry. The Federal Reserve ignored inflation too long, and the whiplash reaction to it became a risk factor in itself.

I don’t think that all these people, many of whom used to cope well with crises and uncertainty, are or have suddenly become idiots. Here is a broader interpretation: change makes us all fools, and we live in an era of change. In particular, there are three changes worth thinking about right now.

Low interest rates came to an end

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In his 2020 letter to investors, Seth Klarman, CEO and portfolio manager of hedge fund Baupost Group, wrote: “The idea of ​​sustainably low rates has permeated everything: investor thinking, market forecasts, inflation expectations. , valuation models, leverage ratios, debt ratings, affordability metrics, housing prices, and corporate behavior.” He went on to say that “By reducing downside volatility, preventing business failures and postponing the day of reckoning, such policies have convinced investors that risk has gone dormant or has simply disappeared.”

A point for Klarman.

The collapse of the Silicon Valley bank is inseparable from a long era of low interest rates. Silicon Valley specialized in banking for start-ups that had little or no income but were nonetheless full of cash — much of which came indirectly due to the huge increase in the Fed’s money supply.

Deposits at Silicon Valley Bank rose from $62 billion at the end of 2019 to $189 billion at the end of 2021. And the bank tried to act conservatively. He invested that money in what was considered the safest and most reliable investment in an era of low interest rates: U.S. Treasuries and other long-term bonds.

But, as financial historian Adam Tooze wrote, what this really meant was that they were “making a huge bet of more than $100 billion on interest rates one way.”

When interest rates rise, the value of bonds falls. It might not have mattered if Silicon Valley had properly hedged or diversified. But it’s not. Perhaps it wouldn’t matter if his customer base didn’t need a refund—and quickly. But it happened. As interest rates rose, those same startups couldn’t raise money so easily and needed to use their money. Thus, Silicon Valley Bank has been hit hard by higher interest rates on both deposits and investments.

In fairness, it should be noted that a rate increase was considered unlikely. Interest rates, with a few exceptions, have been on a downward trend for 40 years. Since 2009, they have often been close to zero and, adjusted for inflation, negative.

In April 2021, Richard Clarida, then Vice Chairman of the Federal Reserve, said low rate conditions were “a global phenomenon that is forecast and financial markets predict to continue in the coming years.”

In less than a year, the Fed will embark on one of its fastest rate hikes in history. At the same time, all types of assets that have soared to stunning valuations in recent years – stocks, cryptocurrencies, NFTs, Swiss watches – began to fall. As Edward Chancellor writes in The Price of Time, “The gap between finance and the real world is at the root of all big bubbles.”

The reason the Silicon Valley bank’s suffering has led to a broader panic that now encompasses banks with very different characteristics, such as First Republic and Credit Suisse, is that the Silicon Valley bank’s circumstances may have been specific, but its problem generalizes: financial the economy we’re in has been built on top of low interest rates.

If you ask the question, “Who owns the most long-term bonds and provides banking services mainly to tech start-ups in the Bay Area?” Not many institutions fit this description. If instead you ask: “Who planned to keep interest rates low and might be vulnerable now that they are rising?” there are many, many possible candidates.

The dangers of viral finance have emerged

John Maynard Keynes did not have the patience for the rational market myth. He wrote that stock selection was akin to a game “in which contestants must choose the six most beautiful faces from 100 photographs, with a prize awarded to the contestant whose choice most closely matches the average preferences of the contestants as a whole.” : so that each participant must choose not those faces that he himself finds the most beautiful, but those that, in his opinion, are most likely to please the other participants, all of whom look at the problem from the same point of view.

He believed that in the short term, finance had a lot to do with predicting what other people thought. But one difference between our era and Keynes’ era is that we have unlimited real-time access to what other people think. We don’t need to imagine which faces our competitors find the most beautiful. They talk about it constantly, loudly, their opinions are constantly ranked by likes and retweets.

There has been some debate about whether a Silicon Valley bank would have survived if a bunch of venture capitalists hadn’t driven each other into a frenzy in various group chats.

I’m not sure this is a useful question. You can’t disable group chats (and shouldn’t, to be precise). But digital information and digital banking means the bank is working can happen and spread to other institutions with astonishing speed.

As Gillian Tett noted in The Financial Times: “One notable detail in SVB the fiasco is that in a few hours last Thursday, about $42 billion (a quarter of SVB deposits) left the institution, mostly through digital means.”

And it’s not just about running away from banks.

Everything from the rapid rise and fall of crypto to the weird moment of meme stocks and the sudden crash of 2010 reflects the digital acceleration of finance. There is a question that has been on the brink of financial regulation for many years now: should we slow down the system to a speed that humans can work with?

No idea here fits all cases – a tax on financial transactions deters high-speed algorithmic trading, but doesn’t stop bank runs – but it’s worth questioning whether speed should be treated as a financial risk factor in its own right. .

Financial regulators caught up in the latest war

In 2015, Greg Becker, CEO of Silicon Valley Bank, testified before the Senate Banking Committee, arguing that Dodd-Frank’s financial regulations should be relaxed for banks like his.

If that’s not the case, Becker warned, the Silicon Valley bank “is likely to have to redirect significant resources away from financing companies that create jobs in the innovative economy to meet higher prudential standards and other requirements.” If only!

But Becker’s testimony is interesting to read not only for its grim irony.

It’s a debate about what makes a bank “systemically important,” a term for a financial institution that should not be allowed to fail. It’s an argument that has convinced the Trump administration, as well as nearly every Republican in Congress and a fair number of Democrats in Congress.

In his book The Money Problem, Morgan Ricks, an expert in financial regulation at Vanderbilt Law School, writes that the problem runs deep. Systemic risk, he says, “is not yet defined, let alone operationalized in any satisfactory way.” The legislators tried in the Dodd-Frank case to define it in terms of assets: $50 billion or more, and you pose a systemic risk.

Becker and senior executives at many other mid-sized banks argued that the limit was too low and too simplistic. You couldn’t be a systemic risk, they said, unless you were a big bank trying to do some exotic financial engineering.

“SVB, like our mid-sized banks, does not pose systemic risks,” Becker said. “We do not engage in market making, securities underwriting or other global investment banking activities. We also do not engage in complex derivatives or transactions, offer complex structured products, or engage in other activities that contributed to the financial crisis.”

Simply put, the idea here was that we know what a bank with systemic risk looks like: it looks like the banks and various other financial institutions that caused the 2008 crash. This is a classic case of waging the last war. But it’s ubiquitous.

As outrageous as a Silicon Valley bank was deregulated as systemically important, it is unclear whether regulators would have caught on to the bank’s problems even if Dodd-Frank had remained untouched. As Joseph R. Mason and Chris James Mitchener have pointed out, the Fed’s 2022 stress tests did not account for interest rate risks. He also fought in the last war.

At the time of the explosion, the assets of Silicon Valley Bank were about $200 billion. It was significant, but not huge.

As Becker said, she didn’t trade complex products or do anything similar to what brought the world economy to a crisis in 2008. Yet the regulators still declared it systemically important when it collapsed and backed up all its deposits. The government’s definition of systemic importance, which is even now enshrined in law, has proven to be false.

But it also applies to a broader perspective: banking is the most important form of public infrastructure that we masquerade as a private act of risk management.

The concept of systemic risk was meant to separate the quasi-public banks – the ones we would like to bail out – from the truly private banks, which can basically be left alone to manage their liabilities. But the lesson of the last 15 years is that there are no truly private banks, or at least we don’t know in advance which ones.