The FDIC will provide unlimited deposit insurance for Silicon Valley Bank and Signature Bank and the Fed will accept depreciated securities at par value from banks seeking emergency funding.
TRW - Given the FRC downgrade, I'm curious what you think about the following. I understand that certain (think most?) credit agreements require the borrower to hold cash at an investment grade bank.
With FRC now rated junk, FRC's institutional depositors who have loan agreements in place may be required to move their cash to an IG bank. This could further pressure FRC deposits despite the government coverage backstop.
In other words, if this pressure from the depositor's loan agreements materializes, the government's coverage program could be useless in preventing further withdrawals since this is contractually required rather than psychologically driven. Very interested in your thoughts.
Note: the January IP shows 63% of deposits being business deposits... which would theoretically be the deposit pool subject to CA stipulations around cash being held at an IG bank.
I am not an American so this does not concern me directly, yet I very much sympathize with your outrage.
I think getting angry at bailouts is a necessary first step, but won't fix the problem. It's a systemic problem: the law treats deposits as risk-bearing loans, yet the public mostly believes deposits ought to be risk-free. Politicians, therefore, will always cave to pressure to bail out depositors. Also, bailouts are an "easy fix" for the systemic crisis risk (with very bad long-term incentive implications).
Professor John Cochrane has long ago outlined a systemic solution, and we should be shouting that this is what we want so that people stop accepting bailouts as a necessary evil.
Here's my inaccurate summary:
1. banks would be financed strictly by equity, would shoulder no bank-run risk.
2. bank deposits would be replaced with money market funds, that would be instantly convertible to cash.
3. if banks absolutely need to be credit-financed (equity is too expensive), let them get it through the intermediation of bank holding companies, which would issue equity and debt and buy bank equity.
implications:
- the banks themselves would never have to face a run. No need for a labyrinth of risk regulation. The bank's risk-taking can be regulated by its shareholders because the public is not on the hook.
- no more moral hazard, bail-outs are not necessary
- savers bear some risk of bank failure (more than now because there are no more bailouts), but now the risk is gradually and explicitly reflected in the price fluctuations of the money-market funds in their accounts.
Hoping that depositors would be competent bank risk analysts might not be a good plan. It does not seem to work politically, because the public rejects this assignment of responsibility and keeps giving depositors a free pass.
Cochrane's motivation, by the way, is preventing GFC-style systemic crisis. Avoiding both the pressure for bailouts and the heavy regulatory investment-risk-police are (very nice) side-benefits.
The artificial cap on insuring $250k deposit is vague and stupid.
Most people don’t chose banks after looking at financial statements of such banks, even sophisticated business people. It’s hard for even sophisticated investor’s to understand banks.
If people believe safety is garunteed by big banks, they will move money to big banks further eroding regional and small banks. These mega banks will pay less for deposits, effectively charging deposit insurance for large sums. So the spread between deposits at small bank and large banks is effectively your insurance rate. Just use that as a basis for large sum depositors insurace for say above $2 MM. what’s the point of $250k limit when some one with $2mm will open 8 accounts that are insured anyway. Depositors will be happy to pay some insurance to chose the bank they want to bank with based on factors they understand.
How about if companies want that safety net they need to bank directly with the Fed Gov a la postal banking? Withstanding that park it with the Fed Gov otherwise in treasuries that mature as needed
As I wrote in one of my articles over the weekend, there are no excuses. It is extremely simple to use treasury bills to limit exposure to banks for those who cannot or will not do due any diligence. Sweep accounts are also an option. Those startups that plopped tens of millions into svb have incompetent CFOs who should never be in a fiduciary role again.
Hi TRW, that's how I came across your substack. Your article over the weekend was linked by nakedcapitalism.com. That site also suggested that postal banking was the answer to this problem. I think that's worth harping on. If customers want a risk-free guaranteed service, then they should be parking their money with the Fed Gov: either as treasuries. Or with a postal bank. This should be shoved down congress's throat as the riposte to the risk-free guaranteed arrangement that FDIC and the Federal Reserve came up with. In particular, shove the postal bank down their throat, because they hairball coughed that up the last time around.
There are also sweep accounts that effectively increase FDIC coverage. There were many options for these clueless CFOs who exposed their startups to massive risk.
Perhaps it wasn't just an error of omission on their parts, keeping money in SVB was a covenant condition in cheap loans SVB extended to those companies. They got money cheaply, on the condition that they'd keep it in an SVB deposit until they needed it. Or so the claim goes.
I cannot say if it's true. This is where I read that:
“ A similar critique could be applied to the behavior of some subset of VCs on Twitter over the weekend, which at times seemed directed towards sparking bank runs in other regional banks, with the goal of forcing the FDIC to step in and make depositors whole, whether or not their funds were insured or not. It was pretty ugly to observe, but ultimately, it was successful: the FDIC, Treasury Department, and Federal Reserve stepped in.”
Do you think this dynamic of unrealized losses within the securities portfolio will spill into other industries like insurance? Understand the liability side is different and carriers wouldn't be forced to sell / realize these losses like SVB had to. But, looking at Prudential, for example, they have $31.7bn of unrealized losses in their AFS portfolio. that's against $17.2bn of book equity. *As of recent 10-K
I do not follow Prudential but a quick look at 10K indicates that the vast majority of their securities are carried at fair value, not amortized cost, so equity should be net of these unrealized losses. I don't think there is a parallel with SVB where equity was stated with securities at amortized cost rather than fair value. And as you say, insurance liabilities are different than demand deposits. The amount of time between receiving premiums and paying out claims can vary based on the type of insurance, but it's more stable than demand deposits than can vanish overnight.
TRW, would you mind sharing insights regarding this defacto "term lending facility"? Isn't this, ultimately, a form of QE? If so, this action is more fuel for the inflationary fires, right?
The Fed is willing to extend loans to qualifying institutions of up to one year in length and will accept collateral at par rather than fair value. Essentially this means that more liquidity will be provided to the banking system than would be the case if the collateral was valued at fair value. In the event of fleeing deposits, banks have the option of taking "held to maturity" securities to the Fed and obtaining a loan against that collateral on what appear to be favorable terms, so they can fulfill the demand for deposits.
This reduces the need for banks to sell those securities and crystalize the losses. So more "equity" will remain on their balance sheets as HTM securities are carried at amortized cost rather than fair value. What precipitated the SVB situation is that they had to sell some HTM securities and realize the losses.
I don't really see this as equivalent to QE, but I have not studied the mechanics of what the Fed is doing beyond reading the press release this morning and a few other articles.
What is absolutely despicable is manner in which many of the prominent venture capitalists (who are ostensibly libertarians) clamoured for the Government’s + FEDs intervention. As Buffet once said “Only when the tide goes out you discover who’s been swimming naked”.
With the contagion spreading to some brokerage firms now, is it still safe to let brokerages hold your stock certificates in “street name”? Was it ever safe?
I've thought about this in recent years but so far I have left my securities in street name. I use Vanguard and Fidelity and these are cash accounts (not set up for margin). The alternative is to hold securities in certificate form in a safe deposit box or via "direct registration" with a transfer agent. For example, Berkshire's transfer agent is EQ and they offer direct registration, as described in this document on Berkshire's website:
Direct registration is the equivalent of holding the certificate according to Berkshire, so I believe it. The downside of direct registration, from what I understand, is a relatively cumbersome process to transfer stock there. It involves medallion signature guarantees (not just notaries) and that's hard to obtain especially if you don't have local banking relationships.
I find the “no taxpayer funds” statement infuriating. Maybe there is some technical difference but when a governmental entity is demanding money from a business, calling it a special assessment rather than a tax is disingenuous.
Maybe this whole stupid episode will make these regional banks being once again subject to the same stress tests that the larger banks must go through. Since they are obviously “too big to fail”.
The irony here is that the Fed is bailing out some of the VCs who prompted the run on the bank.
Ultimately, over the next 10 years, the loss to the taxpayers will be minimal, as most of the assets will recover in price. Still the message is basically that losses are socialized....
The message being sent is that there is unlimited deposit insurance for a much wider range of banks than previously thought, and that the government is going to submit to intense pressure again in the future. That is going to be a very harmful signal in the long run.
I agree with you. If you look at history going back to the failure of Continental Illinois (I think Vockler was head of the Fed) the music has not really changed....perhaps we went from one singer to a full orchestra....
Interesting take. Thanks for sharing! How would you approach the situation differently from what Fed did?
TRW - Given the FRC downgrade, I'm curious what you think about the following. I understand that certain (think most?) credit agreements require the borrower to hold cash at an investment grade bank.
With FRC now rated junk, FRC's institutional depositors who have loan agreements in place may be required to move their cash to an IG bank. This could further pressure FRC deposits despite the government coverage backstop.
In other words, if this pressure from the depositor's loan agreements materializes, the government's coverage program could be useless in preventing further withdrawals since this is contractually required rather than psychologically driven. Very interested in your thoughts.
I’m not familiar with the situation at FRC so I’m hesitant to comment.
Makes sense - thank you! Interested in your perspective if you ever turn to FRC.
Note: the January IP shows 63% of deposits being business deposits... which would theoretically be the deposit pool subject to CA stipulations around cash being held at an IG bank.
I am not an American so this does not concern me directly, yet I very much sympathize with your outrage.
I think getting angry at bailouts is a necessary first step, but won't fix the problem. It's a systemic problem: the law treats deposits as risk-bearing loans, yet the public mostly believes deposits ought to be risk-free. Politicians, therefore, will always cave to pressure to bail out depositors. Also, bailouts are an "easy fix" for the systemic crisis risk (with very bad long-term incentive implications).
Professor John Cochrane has long ago outlined a systemic solution, and we should be shouting that this is what we want so that people stop accepting bailouts as a necessary evil.
Here's my inaccurate summary:
1. banks would be financed strictly by equity, would shoulder no bank-run risk.
2. bank deposits would be replaced with money market funds, that would be instantly convertible to cash.
3. if banks absolutely need to be credit-financed (equity is too expensive), let them get it through the intermediation of bank holding companies, which would issue equity and debt and buy bank equity.
implications:
- the banks themselves would never have to face a run. No need for a labyrinth of risk regulation. The bank's risk-taking can be regulated by its shareholders because the public is not on the hook.
- no more moral hazard, bail-outs are not necessary
- savers bear some risk of bank failure (more than now because there are no more bailouts), but now the risk is gradually and explicitly reflected in the price fluctuations of the money-market funds in their accounts.
Hoping that depositors would be competent bank risk analysts might not be a good plan. It does not seem to work politically, because the public rejects this assignment of responsibility and keeps giving depositors a free pass.
Cochrane's motivation, by the way, is preventing GFC-style systemic crisis. Avoiding both the pressure for bailouts and the heavy regulatory investment-risk-police are (very nice) side-benefits.
https://johnhcochrane.blogspot.com/2016/05/equity-financed-banking.html
The artificial cap on insuring $250k deposit is vague and stupid.
Most people don’t chose banks after looking at financial statements of such banks, even sophisticated business people. It’s hard for even sophisticated investor’s to understand banks.
If people believe safety is garunteed by big banks, they will move money to big banks further eroding regional and small banks. These mega banks will pay less for deposits, effectively charging deposit insurance for large sums. So the spread between deposits at small bank and large banks is effectively your insurance rate. Just use that as a basis for large sum depositors insurace for say above $2 MM. what’s the point of $250k limit when some one with $2mm will open 8 accounts that are insured anyway. Depositors will be happy to pay some insurance to chose the bank they want to bank with based on factors they understand.
How about if companies want that safety net they need to bank directly with the Fed Gov a la postal banking? Withstanding that park it with the Fed Gov otherwise in treasuries that mature as needed
As I wrote in one of my articles over the weekend, there are no excuses. It is extremely simple to use treasury bills to limit exposure to banks for those who cannot or will not do due any diligence. Sweep accounts are also an option. Those startups that plopped tens of millions into svb have incompetent CFOs who should never be in a fiduciary role again.
Hi TRW, that's how I came across your substack. Your article over the weekend was linked by nakedcapitalism.com. That site also suggested that postal banking was the answer to this problem. I think that's worth harping on. If customers want a risk-free guaranteed service, then they should be parking their money with the Fed Gov: either as treasuries. Or with a postal bank. This should be shoved down congress's throat as the riposte to the risk-free guaranteed arrangement that FDIC and the Federal Reserve came up with. In particular, shove the postal bank down their throat, because they hairball coughed that up the last time around.
There are also sweep accounts that effectively increase FDIC coverage. There were many options for these clueless CFOs who exposed their startups to massive risk.
Perhaps it wasn't just an error of omission on their parts, keeping money in SVB was a covenant condition in cheap loans SVB extended to those companies. They got money cheaply, on the condition that they'd keep it in an SVB deposit until they needed it. Or so the claim goes.
I cannot say if it's true. This is where I read that:
https://twitter.com/jonwu_/status/1634250770555219970
Insightful comment from Ben Thompson today.
“ A similar critique could be applied to the behavior of some subset of VCs on Twitter over the weekend, which at times seemed directed towards sparking bank runs in other regional banks, with the goal of forcing the FDIC to step in and make depositors whole, whether or not their funds were insured or not. It was pretty ugly to observe, but ultimately, it was successful: the FDIC, Treasury Department, and Federal Reserve stepped in.”
https://stratechery.com/2023/the-death-of-silicon-valley-bank/
The antics of the VC set , with an assist from Ackman this weekend, makes more sense with this end result in mind. Mission accomplished.
(Not endorsing all of that link, just that one comment on possible motives.)
Do you think this dynamic of unrealized losses within the securities portfolio will spill into other industries like insurance? Understand the liability side is different and carriers wouldn't be forced to sell / realize these losses like SVB had to. But, looking at Prudential, for example, they have $31.7bn of unrealized losses in their AFS portfolio. that's against $17.2bn of book equity. *As of recent 10-K
Curious to hear your thoughts - thanks!
I do not follow Prudential but a quick look at 10K indicates that the vast majority of their securities are carried at fair value, not amortized cost, so equity should be net of these unrealized losses. I don't think there is a parallel with SVB where equity was stated with securities at amortized cost rather than fair value. And as you say, insurance liabilities are different than demand deposits. The amount of time between receiving premiums and paying out claims can vary based on the type of insurance, but it's more stable than demand deposits than can vanish overnight.
That makes much more sense. Thank you for taking a look and for the quick response.
TRW, would you mind sharing insights regarding this defacto "term lending facility"? Isn't this, ultimately, a form of QE? If so, this action is more fuel for the inflationary fires, right?
I haven't read Matt Levine's newsletter yet today, but I scanned it and see that he's covered this topic better than I am likely to here. https://www.bloomberg.com/opinion/articles/2023-03-13/svb-couldn-t-ignore-its-losses-but-the-fed-can
The Fed is willing to extend loans to qualifying institutions of up to one year in length and will accept collateral at par rather than fair value. Essentially this means that more liquidity will be provided to the banking system than would be the case if the collateral was valued at fair value. In the event of fleeing deposits, banks have the option of taking "held to maturity" securities to the Fed and obtaining a loan against that collateral on what appear to be favorable terms, so they can fulfill the demand for deposits.
This reduces the need for banks to sell those securities and crystalize the losses. So more "equity" will remain on their balance sheets as HTM securities are carried at amortized cost rather than fair value. What precipitated the SVB situation is that they had to sell some HTM securities and realize the losses.
I don't really see this as equivalent to QE, but I have not studied the mechanics of what the Fed is doing beyond reading the press release this morning and a few other articles.
What is absolutely despicable is manner in which many of the prominent venture capitalists (who are ostensibly libertarians) clamoured for the Government’s + FEDs intervention. As Buffet once said “Only when the tide goes out you discover who’s been swimming naked”.
Socialize the losses, privatize the profits.
Smart people prefer rigged games. Stupid people prefer honest games.
Unfortunately, this is true in a society without any shame.
Sociopaths are not known for a sense of shame, and we are run by people whose behavior is indistinguishable from that of sociopaths.
Spon on. I have had the misfortune of dealing with sociopaths in my life and I see the parallels reading about business all the time.
Contemplate well The Iron Law Of Oligarchy and its corollary, The Iron Law Of Institutions.
I may not like the composition of our ruling classes, but they are what they are and they don't need or care for my approval.
With the contagion spreading to some brokerage firms now, is it still safe to let brokerages hold your stock certificates in “street name”? Was it ever safe?
I've thought about this in recent years but so far I have left my securities in street name. I use Vanguard and Fidelity and these are cash accounts (not set up for margin). The alternative is to hold securities in certificate form in a safe deposit box or via "direct registration" with a transfer agent. For example, Berkshire's transfer agent is EQ and they offer direct registration, as described in this document on Berkshire's website:
https://www.berkshirehathaway.com/brkshareholderinfo/transferagentinfo.pdf
Direct registration is the equivalent of holding the certificate according to Berkshire, so I believe it. The downside of direct registration, from what I understand, is a relatively cumbersome process to transfer stock there. It involves medallion signature guarantees (not just notaries) and that's hard to obtain especially if you don't have local banking relationships.
It's something I am still considering...
I find the “no taxpayer funds” statement infuriating. Maybe there is some technical difference but when a governmental entity is demanding money from a business, calling it a special assessment rather than a tax is disingenuous.
Equity holders and unsecured debt holders are wiped out but I agree with your sentitment as moral hazard created / increased for depositors
Maybe this whole stupid episode will make these regional banks being once again subject to the same stress tests that the larger banks must go through. Since they are obviously “too big to fail”.
The irony here is that the Fed is bailing out some of the VCs who prompted the run on the bank.
Ultimately, over the next 10 years, the loss to the taxpayers will be minimal, as most of the assets will recover in price. Still the message is basically that losses are socialized....
The message being sent is that there is unlimited deposit insurance for a much wider range of banks than previously thought, and that the government is going to submit to intense pressure again in the future. That is going to be a very harmful signal in the long run.
I agree with you. If you look at history going back to the failure of Continental Illinois (I think Vockler was head of the Fed) the music has not really changed....perhaps we went from one singer to a full orchestra....
Excellent and spot on.
Another helpful article. Thank you. Nice use of the word obviated! Cheers.