The specter of another financial crisis haunts the world

The scent is familiar.

A not too well-known financial institution enters into crisis.

The authorities call for calm.

Central banks mobilize.

Investors seek refuge.

Stocks fall.

Bonds go up.

Gold, too.

It smells, in short, of a financial crisis.

How deep this crisis is and how much this episode, marked above all by the fall of Silicon Valley Bank, affects the real economy is still unknown, but the effects are already palpable in the markets, in the expectations of rate rises of interest and even in political discourse.

The echoes of 2008 resonate in the messages that have followed the Silicon Valley Bank (SVB) crisis.

Just 15 years ago it was also said that Bear Stearns (and some canaries in the mine who died before it) was an isolated case and that the risk of contagion was limited, before the bankruptcy of Lehman Brothers gave the official starting signal to the Great Recession.

Will history repeat itself or

The central scenario remains one of limited impact, but in financial crises, like bank runs, there is something of a self-fulfilling prophecy.

The stock market crash of the US regional banks this Monday makes your hair stand on end.

The Deposit Guarantee Fund (FDIC), the Federal Reserve and the Treasury Department have pulled from the manual and have guaranteed the deposits of SVB clients, which amounted to some 175,000 million dollars, and those of Signature Bank, also fallen , of about 100,000 million.

Despite the moral hazard involved in covering all deposits (and not just those of less than $250,000, as is the norm), the authorities are aware that not guaranteeing them would have caused immediate contagion, dragging down other regional financial entities and generating a major crisis of confidence in the country's banking system.

“Americans can rest assured that our banking system is secure.

Your deposits are safe,” the president of the United States, Joe Biden, assured this Monday.

The authorities will do "whatever it takes," he added, using words similar to those used by ECB President Mario Draghi to defend the euro.

While promising whatever it takes, Biden repeats that there will be no losses for taxpayers, but that the cleanup will be financed with the fees that entities pay to the FDIC.

That's the first big difference from the 2008-style bailouts, paid for with public money.

The other is that although depositors are helped, there will be no bailout for investors from failed banks, whether they are shareholders or bondholders: “They knowingly assumed a risk and have lost their money.

This is how capitalism works,” Biden insisted this Monday.

Not only SVB shareholders and bondholders have lost their money.

Last week Silvergate, a small bank linked to cryptocurrency, and Signature Bank, a New York entity also close to the crypto world that was dragged down over the weekend, also fell.

The authorities may have prevented the flight of deposits, but they have not stemmed the flight of investors.

The market bets on who will be the next victim.

The first candidates are those that most resemble SVB, regional banks, especially in California, where the SVB crisis is also a reflection of a somewhat broader cycle change for technology companies.

The shares of the May 14 US bank, First Republic Bank, based in San Francisco, plunged more than 60% this Monday, despite the fact that the entity proclaimed that it had abundant liquidity.

Shares of other regional banks such as Western Alliance (Arizona), PacWest (California) and Zions (Utah) fell between 25% and 50%.

Charles Schwab, with about $350 billion in deposits,m fell more than 11%.

Around the world, banks, especially those perceived to be weaker, also suffered punishment from investors on Monday.

Crisis reports come from all financial corners of the planet, from a Swedish pension fund to an Australian technology company or a Japanese investment firm.

The fall of SVB

Silicon Valley Bank was a peculiar entity.

Founded in 1983 and headquartered in Santa Clara, California, in the heart of Silicon Valley, it grew to become the 16th largest bank in the United States by assets.

Living up to its name, it played an important role in the technology sector.

It was a reference bank for

the new emerging companies to which traditional entities were more reluctant to lend money.

The paradox is that it has not been the risk assumed in the technology sector that has sunk the bank, quite the contrary.

The business of a bank is to take deposits from those who have money to lend it to those who need it, but the technological companies were swimming in abundant liquidity in 2021 and the beginning of 2022. Low interest rates, financing rounds, IPOs, capital increases and Other financing channels meant that

did not request so many loans from SVB, but rather deposited multimillion-dollar amounts with the entity.

SVB decided to invest those short-term deposits for which it did not pay interest in safe long-term fixed income securities with some remuneration.

It seemed like a round deal, but interest rates began to rise.

Normally, for a bank, that interest rate increase is good.

Most of its loans to companies are at a variable rate and the rise in rates increases the income of the bank, which, meanwhile, can drag its feet when it comes to raising the remuneration of deposits.

In the case of SVB, rather than short-term, variable-rate corporate loans, there were long-term Treasury bonds and other fixed-income (read: fixed-rate) securities.

The price or value of the bonds moves in the opposite direction to the interest rates.

If rates go up, bonds are worth less.

In principle, they are only latent losses, on paper, as long as the bank keeps the bonds in its portfolio, but if it sells them, they materialize.

In parallel, the rise in rates drained the sources of financing for technology companies, which began to withdraw money from the bank.

In order to repay the deposits, SVB had to sell bonds and those notional losses were converted into real ones.

That, in addition, deteriorated its indicators.

The terrible management and communication of this situation last Wednesday and a failed operation to increase capital generated mistrust, so more depositors wanted to recover their money, fueling a vicious circle of deposit flight that no entity can resist.

The bank run has thus brought down a bank that decided to invest in safe assets.

The contagion

The problems spilled over to Signature Bank.

Both had in common that they had grown very strongly in deposits, most of which were uninsured.

And while SVB had startups

clients, Signature received deposits from cryptocurrency firms.

He had his own bank run.

To ward off the specter of a more serious financial crisis, the authorities have not only guaranteed deposits, but the Federal Reserve has also created a new liquidity mechanism for entities that may be affected by withdrawals of deposits by their customers.

They will be able to request funds from the central bank using their public debt securities at nominal value as collateral and thus will not have to sell them at a loss.

The idea of ​​this type of mechanism is that they are preventive or dissuasive: that is, that their mere existence prevents the leakage of deposits and makes their use unnecessary.

The fear of contagion is in the market, as Citi analysts explained this weekend: "Before SVB, we were already in a fragile environment with concerns in the market for banks about funding pressures, large unrealized losses in securities, and potential credit quality concerns in areas such as commercial real estate so the failure of SVB only feeds the narrative,” they said.

“While we believe the nature of SVB's business model is unique, we understand the concern about contagion risk in this fragile environment for smaller banks, especially those with large uninsured deposit bases, which is why a resolution It is important to restore trust.

It's more of a psychological issue.

The FDIC tried unsuccessfully on Sunday to find a buyer for Silicon Valley Bank, a solution that would have been cleaner and more surgical than blanket deposit insurance.

The efforts to sell the fallen bank to another entity that answers for the deposits continued this Monday without materializing and the option of a split was opening up.

The experts at Oxford Economics also support the limited risk thesis: “The collapse of SVB has been caused by specific factors that suggest that it is not necessarily an indication of broader risks to financial stability, but it is clear that the risks are increasing.

The SVB's client base was dominated by venture capital investors and

And it was uniquely ill-prepared to survive the Federal Reserve's aggressive rate hikes.

They had a particularly large proportion of their liquid assets in long-term securities, ”they explained this Monday.

"After suffering heavy losses in its investment portfolio due to rising rates, the lack of diversity among its client base led to a herd-driven exodus, exacerbating the run on the banks," they added.

copious losses

Although the SVB case was extreme, it was not unique.

Martin Gruenberg, the chairman of the FDIC, warned last week at a conference in Washington at the Institute of International Bankers that "the current interest rate environment has had dramatic effects on the profitability and risk profile of investment strategies." Bank financing and investment.

As a result of rising interest rates, assets with longer maturities bought by banks when rates were lower are now worth less than face value, he explained.

“The total of these unrealized losses, including available-for-sale or held-to-maturity securities, was about $620 billion at the end of 2022,” he said.

Although Gruenberg argues that banks are generally in a strong position (a long way from the solvency problems of 2008), part of his intervention was prescient: “Unrealized losses weaken a bank's future ability to meet needs unexpected liquidity.

This is because the securities will generate less cash when sold than originally anticipated, as the sale typically triggers a reduction in regulatory capital,” he said.

In the 2008 financial crisis, more than 450 banks failed in four years, from very small banks to large firms like Lehman Brothers and Washington Mutual.

break in types

To fight inflation, the Federal Reserve has undertaken the most aggressive rate hikes in four decades.

There's a saying on Wall Street that the Fed raises rates until it breaks something.

And it seems that he has already broken it.

For this reason, analysts who believed that there would be a 0.5 point rate hike at next week's meeting are now inclined to think that it will be 0.25 or that there will be no rise.

Goldman expects a pause "in light of the recent tensions in the banking system."

Previous cycles of rising official rates led to the junk mortgage crisis (2007), the collapse of the LGTM fund (1998) or the devaluation of the Mexican peso (1994).

The markets reacted yesterday with sharp movements in fixed income titles that reflect the change in scenario and even anticipate rate cuts sooner than expected.

Two-year government bond rates, for example, fell the most in 40 years.

Interestingly, this increases the value of the bonds and reduces the latent losses in the banks' portfolios.

Returning to the previous financial crisis, the rate hike by the European Central Bank in July 2008 is still remembered as the biggest mistake in the mandate of Jean-Claude Trichet.

Now, it is unclear to what extent a hypothetical break in monetary policy tightening would spill over to Europe as well.

Both the cryptocurrency and venture capital booms, especially in the tech sector, have been fueled by the ultra-cheap money available since the previous financial crisis.

Now, those same sectors become victims of the rise in rates.

supervision errors

The fall of the SVB has also opened the debate on the apparent supervisory errors that have allowed the situation to deteriorate to the point of irreducibility.

The Federal Reserve announced on Monday a review of the supervision and regulation of Silicon Valley Bank, in light of its bankruptcy, the result of which will be published before May 1.

“The developments surrounding Silicon Valley Bank require a thorough, transparent and expeditious review by the Federal Reserve,” Chairman Jerome H. Powell said in a statement.

“We need to be humble and conduct a careful and thorough review of how we supervise and regulate this company, and what we need to learn from this experience,” added Vice President of Supervision Michael S. Barr, who leads the company. revision.

President Biden himself referred to possible regulatory deficiencies in the intervention in which he stressed that all SVB and Signature Bank clients can rest easy because their deposits are protected.

“We must get a full explanation of what happened and hold those responsible accountable,” he said.

The president introduced the fall of both banks into the political debate by ensuring that some strict requirements that had been imposed on the entities during the presidency of Barack Obama (in which Biden was vice president) were abolished in the Donald Trump era.

Biden pointed out that the bailout will not cost taxpayers money, that managers will be fired, that shareholders and bondholders will lose their money, and that he will ask for financial regulation to be tightened.

On the board of the San Francisco Federal Reserve, in charge of supervising Silicon Valley Bank, sat the entity's former CEO.

On the board of the bankrupt Signature Bank was Barney Frank, who gave his name to the restrictive Dodd-Frank law of 2010. The congressman, signed by the bank in 2015, later supported relaxing regulatory requirements.

A legal change passed in 2018 freed Signature Bank from stricter supervision.

Frank is still listed on the bank's website as a director.

Of course, the bank no longer exists as such.

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