20/04/2023 The recent disappearance of four banks in seven days is simply the
latest iteration of the same story: positions pumped up on huge liquidity that couldn’t exit
due to the scarcity of collateral once the facts changed. The story began with the collapse
of the family office Archegos in March 2021. Somehow a relatively small and unknown hedge
fund managed to blow a hole in bank balance sheets of the scale of several billion dollars.
Credit Suisse (remember them)
lost
almost $6bn alone. Archegos’ prime brokers
triggered
its demise after all calling in margin at the same time on
profitable trades that turned bad. This is reminiscent of the cascade of margin calls that
hurt Melvin Capital, the London Metal Exchange, UK pension fund LDI strategies and crypto
firm FTX:
- Melvin Capital couldn’t post enough margin on the short squeeze in GameStop, only
managing to exit the position after it took a $2.75bn
capital
infusion
from Citadel and Point72. - The LME had to cancel trades after the outbreak of war in Ukraine squeezed a massive
short nickel position, noting in
its
update
of 10th March 2022: ‘the significant price moves during
the early hours trading activity had created a systemic risk to the market, including in
relation to margin calls, which if LME had not acted would have closed at levels far in
excess of those ever experienced in the LME market’. - Long term pension strategies couldn’t liquidate Gilt holdings fast enough to meet
overnight margin calls. As the Bank of England’s Sarah Breeden
noted
in her speech of 7th November 2022, “This is
the self-reinforcing spiral that the Bank intervened to prevent”. - FTX disappeared once the value of its FTT token
plummeted
, revealing a house of cards of fraud and greed.
And then came the ultimate liquidity mismatch: a bank run, where borrowing short and lending
long comes unstuck. For Credit Suisse the only question is why it took so long, whereas for
Silicon Valley Bank there came a triple whammy:
- The pandemic impaired the velocity of people, boosting tech company profits – but once
the fear eased off, some companies had overstretched themselves - Tech companies tend to have a high cash burn meaning that their deposits would likely
erode faster than other businesses once under pressure - The clue was in the name – SVB catered to a concentrated customer base who were highly
interconnected, quick to communicate, holders of large scale deposits and likely to act all
at the same time
All of these crises became existential because positions
couldn’t be covered without crystallising monumental losses. Where the institution involved
was deemed systemic, regulators stepped in. The LME effectively regulated itself by
cancelling the trades. The Bank of England bought time for the UK pension industry. The US
authorities created a one year collateral swap, taking on impaired assets at par value, to
help regional banks. But that isn’t the end of the story. These actions have long term
ramifications. Nickel trading on the LME is far more expensive and illiquid than it was:
as
of November last year
, average daily volumes were down 60% compared
with January 2022. LDI strategies will have to be more ready to meet collateral calls. The
Bank of England’s FPC now
wants
LDI strategies to be resilient to a shock to the yield curve of
250bps, at a minimum. 
Source: Bank of England
It is not just markets that have been affected by these regulatory changes. Let us not
forget the LDI debacle took out the leadership of the country. Liz Truss
wrote
in her 4,000 word op-ed for the Telegraph that she “was given
the starkest of warnings by senior officials that further market turmoil could leave the UK
unable to fund its own debt”. The subsequent personnel change shifted the economic
direction of the country, with “austerity” back into the political dialogue and every policy
now fully costed to the last penny. The US intervention has reopened a debate over deposit
insurance which itself puts depositors on edge. It is driving more deposits into the hands
of the systemically important institutions. That is not necessarily an issue given the
post-2008 reforms were designed to let a big bank go bust. But there is now a focus on banks
that are just-not-quite-small-enough-to-fail. Given the tweak to supervision for banks with
less than $250bn in assets, politicians scent partisan blood that blame can be laid at the
door of the Trump era for presiding over such a change. But the Federal Reserve and the FDIC
were directly warned about the systemic impact of this anomaly in a
letter
from the Systemic Risk Council in July 2019: “the Systemic
Risk Council (SRC) is concerned that these proposals are misdirected. The priority should
not be relaxing resolution planning but, rather, strengthening preparations for ensuring
that all large regional banks could be resolved in an orderly way, minimizing spillovers to
the economy and losses to the Deposit Insurance Fund. That is especially important at this
phase of the business and credit cycle.” As the late Queen memorably put it in the
aftermath
of the banking crisis of 2008, “if these things were so
large, how come everyone missed them?”. Even the post-financial crisis reforms that were
enacted to allow a global systemically important bank to fail were jettisoned by the Swiss.
Rather than activating resolution plans, the Swiss authorities forced through a merger
between UBS and the remnants of Credit Suisse, now leaving the country with just one even
bigger and even more systemically important institution. In doing so, they came up with a
set of emergency ordinances to get the deal through. There is layer upon layer of complexity
to these technical decisions but the upshot is that the Swiss Authorities just decided on a
plan at the last minute and went for it. Emergencies require expediency but the
inconsistency of their actions raises concerns that they have bent the rule of law. This now
increases the risk premium of investing into any Swiss asset. But that is not all. If the
Swiss can do it, who else? Investors are spotting the difference. The week after CS went
down, Chinese AT1 bank bonds traded above where they were before the UBS merger. Given the
Chinese state owns such a large chunk of its banks, investors know that they cannot afford
to let their banking system collapse. The price of AT1s now reflects the political risk
premium of that country. China is now more predictable than Switzerland. This is not a
banking crisis. It’s a crisis of capitalism. The pandemic opened the window to ripping up
the rule book when it comes to an emergency. Mandates to stay at home, wear masks, get
vaccines: liberal democracies have shifted the Overton window beyond what even its own
politicians initially thought possible. So although everyone is looking for the next domino
in a 2008 style banking crisis, the damage has already been done. Political risk premia on
liberal democracies has risen, even more so in those countries where the financial sector is
so important. This will remain in place for decades to come. The recent actions of the
authorities might have alleviated short-term pain but not for long-term gain. Quite the
reverse. The actions of the last few weeks have sown the seeds for greater uncertainty and
financial instability whatever happens next. 
Helen Thomas
CEO of BlondeMoney
