The Federal Reserve is in the unenviable position of fulfilling its mandate by crashing the economy. it’s not something like that wanna to do, as Fed Chairman Jerome Powell humbly admitted in his exchange with Sen. Elizabeth Warren (D–Mass.) last week. But it’s something that arrived as an inevitable result of the slowdown of an economy littered with monetary excesses and inflation. Wide monetary growth has been negative since late November, and interest charges on everything from business borrowing to credit cards to government spending possess debt have increased rapidly.
This cycle of increases, the fastest the Fed has undertaken in a generation, was always likely to break something. And break something they did over the weekend, from regulated stablecoins USDC and Gemini Dollar, which lost their peg to the dollar, to Silicon Valley Bank (SVB), which faced the second largest bank of US history. If one weren’t so hung up on labor markets, inflation numbers, and pronouncements from Congress, that’s probably the kind of stuff a monetary authority like the Fed is tasked with managing. Oops.
In Powell’s back and forth with Warren, the senator sharp to “things you can’t fix with high interest rates – things like price gouging, supply chain issues and the war in Ukraine”. No matter how little sense those arguments do, our favorite senator is accidentally right: monetary policy is about money, assets, and banks, with only limited (residual) influence on real markets.
Barking the wrong trees – unemployment, market power – Warren missed an opportunity to examine the things that are breakup. Around the same time she said those words and Powell defended the Fed action, SVB was desperately trying to raise new funds. The effort failed, and many tech investors, including Peter Thiel’s Founders Fund, drawn their mostly uninsured deposits to the bank as quickly as they could.
According to Bloomberg, the bank’s CEO, Greg Becker creditors requested during a call on Thursday to “support the bank as it has supported its customers for the past 40 years” – as if a bank run had ever been stopped by asking nicely.
SVB’s Treasury portfolio losses, thanks to the Fed’s rapid rate hikes, which crash the bond market last year – amount to billions of dollars in unrealized losses. Held-to-maturity accounting rules allow banks to ignore market value losses if securities are intended to be held to maturity. Of course, holding to maturity requires you to fund the securities in the meantime, which is next to impossible when your clients don’t think you’ll make it and instead demand to collect their deposits en masse.
If we ignore this accounting trick, Silicon Valley Bank was already “insolvent” by September last yearwhen unrealized bond losses exceeded its equity.
Towards the end of last year, some $25 billion in deposits soared as SVB customers emptied their bank deposits to weather the business pressures of inflation and a booming venture capital industry. disappear. Another $10 billion followed in the first months of 2023, and who knows how many managed to escape in the last few days…Fortune reports $42 billion only Thursday, before management threw in the towel on Friday and placed the bank in receivership from the Federal Deposit Insurance Corporation.
Since treasury bills are “risk-free” and therefore have lower capital requirements for banks to hold them, banks allocate more of their funds to them. This concentrates the risk of the banking system in a single interest rate sensitive security. SVB is simply the most extreme and reckless version of a risk present in most US banks. For reference, the rest of the US banking system has unrealized losses amounting to more than $600 billionabout 25 times more than the losses that just brought down SVB.
He does not fail to blame the regulators for having engineered such an unnatural banking market. Far from making banks “safe,” the regulatory system concentrates risk, with the alphabet soup of Fed liquidity facilities ready to print money to get out of trouble.
As Caitlin Long, CEO of Custodia Bank, underline on Saturday, this puts the Fed in a very delicate position: risk systemic bank runs, or undo the hikes and quantitative tightening that caused this mess, print money for even hotter inflation.
6/* on interest rates – Thursday/Friday’s mkt action means the bond market is already feeling the end of QT from the Fed, which has disproportionately sucked up deposits from community banks. Recognize, however, that a pivot from the Fed would keep inflation high. Trade-off between systemic bank run versus hot inflation — hot potato
— Caitlin Long ????⚡️???? (@CaitlinLong_) March 11, 2023
Most embarrassing of all, here’s what Michael Barr, the Fed’s vice chairman for oversight, said in a speech THURSDAY while the race was in full swing“The banks we regulate, on the other hand, are well protected against bank runs thanks to a robust set of prudential requirements.” Double-oops.
The stablecoins that Barr was against did indeed break over the weekend. The catch is that it’s those who have been transparently audited – whose sponsors have approached US regulators in recent years – who have broken their ankles. The eternal scapegoat Tether, shrouded in mysteryinvestigated and fined by the New York Attorney General in 2021, was trading at a premium of up to 3% on Saturday. Everything, it seems, is upside down.
By the magic ofheld until maturity“, maybe all the other banks can weather the storm and come out the other side without the same losses SVB were forced to book last week. It certainly becomes easier to accommodate subtitles in your books when the The Fed stands ready to finance them.
Hang on to your hat or, in this case, your bank account. Because Senator Warren is LAW on one thing: “The Fed has an abysmal track record of containing modest increases in the unemployment rate.”
And last week, something already broke.