14/03/2023 The fallout from the Silicon Valley Bank was slow to
start but the ripple effects are spreading this week. Here, Finalto’s Chief Markets Analyst,
Neil Wilson discusses the possible impact of the collapse, and the response of the US
regulators. Less It’s A Wonderful Life, more Apocalypse Now When George Bailey dipped into
his honeymoon funds to help get depositors through the weekend without closing the Building
and Loan company, he probably wished he had today’s incarnation of the FDIC, Federal Reserve
and US Treasury backing him. US regulators’ actions may have saved SVB depositors and
thousands of businesses, but the unintended consequences could be enormous. Was it a
bailout? Yes and no. Shareholders won’t be made whole, depositors will. In practice, it is
of course a bailout – when we discuss bailing out a bank we are not talking about the share
price (investors) but the deposits (customers) – preventing a run that mean depositors have
to take cents on the dollar. One thing is certain – there will be much debate about whether
US regulators should have done what they did. And another thing we can say is, whatever way
you cook it, the ingredients for the failure of SVB and wider fretting about the banking
sector is down to having a very long period of artificially low borrowing costs followed by
a very sharp increase in the cost of money. Moral hazard? There will be all kinds of
unanticipated consequences – or unintended perhaps; we can anticipate that things might
happen even we don’t intend them to do so. Several years ago, amid a very different banking
crisis, then Bank of England governor Mervyn King warned that bailing out banks would
undermine “the efficient pricing of risk by providing ex-post insurance for risky behaviour.
That encourages excessive risk-taking and sows the seeds of a future financial crisis.” This
kind of implicit insurance means “the next period of turmoil will be on an even bigger
scale”, Mr King warned. “The provision of large liquidity facilities penalises those
financial institutions that sat out the dance, encourages herd behaviour and increases the
intensity of future crises.” Is it the same this time? Have regulators intervened to prevent
contagion efficiently to make the banking sector stronger, or simply kicked the can down the
road again? There are several questions to ask, but I would argue the moral hazard here is
huge. Do depositors really work their way through the balance sheets of a top 20 bank? Would
it make any difference to the decision to park money with a particular bank? I’m not sure it
would which undermines the moral hazard case to a degree…so if in practice it makes no
real difference we are in to ideology – should regulators always bail out a bank that goes
belly up when its failure is going to hurt a chunk of businesses? In a practical sense – why
the hell not? The businesses were not doing anything risky – they were just parking their
money at an institution with a name that made it sound like if you were a tech start-up you
should probably be banking with them. These firms were not parking cash with SVB thinking:
“It’s fine we’ll get compensated if it goes under”. And SVB was not – on the face of things
-doing anything really risky, playing with crypto for instance: it was investing in
long-dated Treasuries. This should have been absolutely fine. But clearly the risk committee
was AWOL and they were victims of social media as depositors started running for cover. In
practice, I lean on the side that says there is a practical side to this and it’s not just
ideology – the decision by US regulators to make depositors whole does create real moral
hazard as they have effectively said they will insure all depositors. This is a de facto
major shift in policy towards bank failures. They cannot walk back from this position. Does
this encourage risky behaviour? How could it not? In fixing this situation at SVB, the US
regulators may have created much bigger systemic problems for themselves – more inflation,
more misallocation of capital etc. Is there a wider problem in the banking sector? It’s hard
to see the big banks really suffering here immediately – albeit there seems to be concerns
about some regional banks in the US that could ultimately spill over. The KRE regional banks
ETF tumbled more than 12% on Monday, First Republic dropped 62% but bounced on Tuesday. The
KBW Nasdaq bank index declined almost 12%. Big banks were also hit – Wells Fargo –7%, Bank
of America –6%, with JPM and GS taking less of a hit but still falling. The point is the Fed
and co have effectively backstopped every deposit so I don’t see what risk is left now
except in serious headwinds to earnings as the cost of deposits will rise and regulation
will surely tighten. International fallout: ECB policymaker Yannis Stournaras: “We don’t see
SVB having an impact on Eurozone banks or the Greek ones.” Not directly anyway. The Bank of
Japan also said the direct exposure of Japanese banks to SVB was limited. Nevertheless,
European bank shares and then Japanese banks have fallen sharply. Credit Suisse fell another
4% as it identified ‘material weaknesses’ in its financial reporting controls – never rains
but it pours for CS. Did regulators fail? Should they have spotted the risks at SVB and done
something about it? If that is the case, then you could argue that it is incumbent on them
to sort out the situation. Maybe the Fed didn’t factor financial stability risks into its
calculation enough when it embarked on this tightening cycle? I think that would be true –
inflation was seen as the greater ill. Does more lending go into shadow banking? We could
see more non-bank finance – more systemic risk not less. One of the reasons for the failure
was that SVB was not treated as systemically important when it clearly turns out it was.
Again, this could create greater challenges. HSBC – a smart move to take on SVB’s UK arm,
even if there might be risks ahead. Hard to see this as £1 badly spent with tangible equity
of £1.4bn… even if that is fairy dust. The Treasury and BoE will be pleased that a UK bank
has taken it on and not had to go cap in hand to a foreign entity. Coming ahead of the
Budget on Wednesday and in the wake of the LDI-inspired panic last autumn, UK regulators
should be pleased they fixed this before the market opened on Monday. For HSBC, it’s good
optics and probably good business – £1.4bn is a drop in the ocean. Clearly the UK arm was
way smaller and less complex so finding a private backer was more straightforward than it
was the US – where a painful track record also made banks averse to taking on SVB (JPM got
burned by taking on Bear Stearns and no one wanted to go down that route it seems). Fed –
what does it mean for the Fed? Well with one stroke they’ve just undone about 90bps in
tightening, which is some going even by the standards of a headless chicken. Markets have
said the Fed now backs off from hiking anything like as aggressively as anticipated just a
few days ago, so we get more, not less inflation. Socialising losses at SVB Fed-style only
eases financial conditions – we are seeing a huge move lower in bond yields which is exactly
the opposite of what the Fed’s tightening has aimed to achieve. This only makes it harder
for them and may ultimately need to do much more hiking than they would have needed to do
otherwise. Whether it’s a pivot nod or this, the Fed keeps undermining its hiking. Could the
Fed actually cut rates at its March meeting? Markets have repriced terminal rates
aggressively in the wake of SVB’s collapse and subsequent roiling of financial stocks. “In
reaction to looming financial stability risks, we now expect the Fed to cut rates,” Nomura
economists wrote Monday in a note. Barclays, Goldman Sachs and NatWest have called for the
Fed to pause rate hikes. If the Fed even pauses, let alone cuts, it’s inflation-fighting
reputation will be in tatters. Market pricing is at evens for 25bps or a pause. We saw how
the Bank of England was able to deliver emergency stimulus to prevent financial instability
without disrupting its longer-term monetary policy goals. The Fed can learn from the Bank of
England. The UK central bank successfully paused QT and distanced its emergency policy
actions last autumn from its longer-term monetary policy goals. The Fed needs to make it
very clear that it is doing one thing to fix a perceived emergency but that this has nothing
to do with its longer-term monetary policy goals. The next few weeks will certainly be a
bumpy road for the markets, and we’ll be keeping a close eye on any further fall out.
Grupo
