March 11th, 2023: SVB’s failure: A Wake-up Call for the Federal Reserve I had been wondering when the Fed would receive its wake-up call that they were pushing interest rates too high. The Fed’s plan all along was to raise interest rates to fight inflation until something broke. That call came on Thursday when Silicon Valley Bank (SVB) announced that it was trying to raise $2 billion in capital due to losses experienced on its balance sheet and rising customer defaults. SVB, a prominent lender in the world of technology start-ups, collapsed when its customers panicked, forcing the federal government to step in. The 16th largest bank was taken over by the Federal Deposit Insurance Corporation, making it the second-largest failure in U.S. history and the largest since the financial crisis of 2008.
Fueled by successful start-ups flush with cash from venture capitalists, SVB invested a majority of the customer deposits in search of higher returns, heavily investing in long-dated Treasury bonds and mortgage bonds that provided stable returns when interest rates were low. Unfortunately, the bank invested significantly in bonds just before the Federal Reserve began increasing interest rates slightly over a year ago, and did not account for the possibility of quick and significant rate hikes. As a result, as interest rates increased, these investments lost their attractiveness compared to newer government bonds that offered higher interest rates. They also had trouble finding a buyer because many of the start-ups that they were lending too were experiencing financial trouble due to the slowing economy.
The situation may have been manageable if the bank’s customers did not demand their funds back all at once. Over the last few months, clients of the bank started to withdraw a larger portion of their deposits. As a result, the bank was forced to sell off some of its investments to meet redemption requests. In a surprising announcement on Wednesday, the bank revealed that it had suffered losses of nearly $2 billion as it was all but compelled to sell off some of its holdings to pay those redemption requests.
The bond market reaction to this bad news was to lower interest rates. The recent failure of SVB highlights the fact that the US banking system may not be as strong as we previously thought. If well-capitalized banks cannot survive in a 5% interest rate environment, then the Fed’s ability to fight against inflation will be severely limited. I believe that a narrative change is needed to shift people’s focus away from inflation and towards stabilizing the financial system. Controlling the unrelenting market volatility in interest rates and equity prices is just as important as lowering the inflation rate. Consumer prices are no longer rising as fast as last year, so we are much closer to a pivot by the Fed.
The big question now is whether this is the start of a much larger problem, as investors turn their attention to other financial institutions after the Fed’s recent steep rate hikes. There is a risk of contagion from SVB in smaller local banks, and it would be prudent for people to reevaluate where they are holding their money and the amount they are holding. If you have your money at a small local bank, I would recommend keeping bank deposits below the $250k limit. For those wondering about their investments held at TD Ameritrade, they are a member of the Securities Investor Protection Corporation (SIPC). Securities in your account are protected up to $500,000, which includes a $250,000 limit for cash. Additionally, TD Ameritrade provides each client $149.5 million worth of protection for securities and $2 million of protection for cash through supplemental coverage provided by London insurers. Investment companies are a much safer place to keep your cash.
While there is no exposure to regional bank stocks in your portfolio, they are looking much more interesting. I expect the larger banks will once again be the biggest beneficiaries of people seeking safety. For example, JP Morgan’s stock was up yesterday because they have done a much better job managing their fixed-income portfolio. The larger banks will continue to push out the smaller less diversified banks.
Additionally, it’s worth noting that while the failure of SVB may cause some short-term disruptions in the financial markets, it is not indicative of a systemic issue in the US banking system as a whole. The US banking system is generally considered to be one of the strongest in the world, with a high level of regulation and oversight designed to prevent systemic risk. SVB in particular had mismanaged its portfolio and was not a diversified bank. Many of the customers were start-up technology companies that were running into financial problems after the technology bubble burst.
The major unknown is what will be the impact on private equity firms and other customers of SVB. Hopefully, the government does the right thing and helps make whole all the customers of SVB. The failure serves as a wake-up call for the US banking system and the Federal Reserve, highlighting the potential risks of rising interest rates and the importance of maintaining a stable financial system. While there may be some short-term disruptions in the financial markets, it is important to remember that the US banking system is generally considered to be strong and resilient, with a high level of oversight and regulation. Looking ahead it will be interesting to see if investors jump back in immediately after prices fall, because now they have yet another chance to buy at lower prices. The good news is the Fed got it’s wake-up call this week and investors will welcome a less aggressive Fed.
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I had been wondering when the Fed would receive its wake-up call that they were pushing interest rates too high. The Fed’s plan all along was to raise interest rates to fight inflation until something broke. That call came on Thursday when Silicon Valley Bank (SVB) announced that it was trying to raise $2 billion in capital due to losses experienced on its balance sheet and rising customer defaults. SVB, a prominent lender in the world of technology start-ups, collapsed when its customers panicked, forcing the federal government to step in. The 16th largest bank was taken over by the Federal Deposit Insurance Corporation, making it the second-largest failure in U.S. history and the largest since the financial crisis of 2008.
Fueled by successful start-ups flush with cash from venture capitalists, SVB invested a majority of the customer deposits in search of higher returns, heavily investing in long-dated Treasury bonds and mortgage bonds that provided stable returns when interest rates were low. Unfortunately, the bank invested significantly in bonds just before the Federal Reserve began increasing interest rates slightly over a year ago, and did not account for the possibility of quick and significant rate hikes. As a result, as interest rates increased, these investments lost their attractiveness compared to newer government bonds that offered higher interest rates. They also had trouble finding a buyer because many of the start-ups that they were lending too were experiencing financial trouble due to the slowing economy.
The situation may have been manageable if the bank’s customers did not demand their funds back all at once. Over the last few months, clients of the bank started to withdraw a larger portion of their deposits. As a result, the bank was forced to sell off some of its investments to meet redemption requests. In a surprising announcement on Wednesday, the bank revealed that it had suffered losses of nearly $2 billion as it was all but compelled to sell off some of its holdings to pay those redemption requests.
The bond market reaction to this bad news was to lower interest rates. The recent failure of SVB highlights the fact that the US banking system may not be as strong as we previously thought. If well-capitalized banks cannot survive in a 5% interest rate environment, then the Fed’s ability to fight against inflation will be severely limited. I believe that a narrative change is needed to shift people’s focus away from inflation and towards stabilizing the financial system. Controlling the unrelenting market volatility in interest rates and equity prices is just as important as lowering the inflation rate. Consumer prices are no longer rising as fast as last year, so we are much closer to a pivot by the Fed.
The big question now is whether this is the start of a much larger problem, as investors turn their attention to other financial institutions after the Fed’s recent steep rate hikes. There is a risk of contagion from SVB in smaller local banks, and it would be prudent for people to reevaluate where they are holding their money and the amount they are holding. If you have your money at a small local bank, I would recommend keeping bank deposits below the $250k limit. For those wondering about their investments held at TD Ameritrade, they are a member of the Securities Investor Protection Corporation (SIPC). Securities in your account are protected up to $500,000, which includes a $250,000 limit for cash. Additionally, TD Ameritrade provides each client $149.5 million worth of protection for securities and $2 million of protection for cash through supplemental coverage provided by London insurers. Investment companies are a much safer place to keep your cash.
While there is no exposure to regional bank stocks in your portfolio, they are looking much more interesting. I expect the larger banks will once again be the biggest beneficiaries of people seeking safety. For example, JP Morgan’s stock was up yesterday because they have done a much better job managing their fixed-income portfolio. The larger banks will continue to push out the smaller less diversified banks.
Additionally, it’s worth noting that while the failure of SVB may cause some short-term disruptions in the financial markets, it is not indicative of a systemic issue in the US banking system as a whole. The US banking system is generally considered to be one of the strongest in the world, with a high level of regulation and oversight designed to prevent systemic risk. SVB in particular had mismanaged its portfolio and was not a diversified bank. Many of the customers were start-up technology companies that were running into financial problems after the technology bubble burst.
The major unknown is what will be the impact on private equity firms and other customers of SVB. Hopefully, the government does the right thing and helps make whole all the customers of SVB. The failure serves as a wake-up call for the US banking system and the Federal Reserve, highlighting the potential risks of rising interest rates and the importance of maintaining a stable financial system. While there may be some short-term disruptions in the financial markets, it is important to remember that the US banking system is generally considered to be strong and resilient, with a high level of oversight and regulation. Looking ahead it will be interesting to see if investors jump back in immediately after prices fall, because now they have yet another chance to buy at lower prices. The good news is the Fed got it’s wake-up call this week and investors will welcome a less aggressive Fed.