Everyone Has a Plan Until They Get Punched in the Mouth
At 8am on Friday morning, I sent an internal slack about what was happening at SVB, whose stock had plunged from $268 to $106. I was more worried about the run on deposits, $42B on Thursday alone. “I was at Wachovia when the same thing happened, and we went out of business in the course of two days. SVB will probably get to the other side of this, but there is a non-zero chance it ceases to exist as a bank before the weekend is over.
Unfortunately, SVB did not get to the other side. And they didn’t have all weekend - they had about five hours. SVB is the second largest bank failure in US history.
The jobs report came out at 8:30am and markets reacted, but an hour later when the stock market opened none of it mattered. SVB plunged further and trading was halted again. The PE and VC shops that had encouraged their portfolio companies to move their cash had suggested First Republic as an alternative. First Republic plunged 51% within 30 minutes of opening and trading on it was also halted. “If a Tech Guru suggested a bank, couldn’t that bank have the same challenges as SVB?” With friends like that, who needs enemies? I assume other Bay area banks were aggressively calling VC/PE shops begging not to be mentioned as a good place to park startup dollars…
Rates were already down 13-20bps across the curve when the job data hit. There were gyrations for an hour, and then the bottom fell out as soon as equities opened. The 2T fell 32bps on Friday, the biggest one day drop since the Financial Crisis.
The obvious concern is whether this is the first domino to topple. In that same 8am slack, I wrote, “I don't believe SVB is the canary in the coal mine the way Bear and Lehman were (banks you probably don't even recognize the names of today).” I do believe more banks could fail (or at least become very strained) while investors sniff out the next weak link, but I don’t believe it’s the entire banking system like it was in 2008.
I know too many bankers that have been complaining about the regulatory burden and ultra conservative stress testing to believe the biggest banks are at imminent risk. Specialized players like SVB and regional players that don’t have the same level of oversight are the most likely candidates in my mind (if any). All those money center RM’s that have been complaining about overly burdensome regulations will shift gears and brag about the safety of moving deposits to them now…
Friday reminded me that liquidity, like real estate, is all about location, location, location. I believe we will avoid a 2008 replay in large part because banks and large institutions are flush with cash. But that didn’t matter to SVB on Friday. Liquidity only matters if it can be accessed. You care about your liquidity, not total liquidity.
The primary culprit is likely SVB’s decision to go long the 10T at 1.50%. As rates surged, the value of those Treasury holdings plunged. When SVB announced a potential raise, the market asked, “Why?” Then it ran the math, realized a forced sell of those Treasurys would essentially wipe out SVB, and the rout was on. Even then, I suspect SVB could have survived if not for their “friends” at the VC/PE shops that sparked the run on their bank.
In October, I wrote about the UK pension meltdown. “As rates climbed, these pension funds were forced to liquidate their sovereign holdings. By selling, they put more upward pressure on yields, forcing more selling, and so on and so forth.” Sound familiar?
I continued with, “Does the Canary in the Coal Mine Have a British Accent?”: (Bottom Drops Out)
Although the Fed doesn’t want to blink, I believe it will have to if cracks like this continue to show. CNBC’s Ron Insana recounted a discussion with Fed Chair Greenspan about allowing Long Term Capital fail in the late 1990’s.
Greenspan agreed that he preferred to allow markets to handle LTC’s collapse, but “in practice it’s not a social experiment I’m willing to undertake.”
While Powell will continue hammering home the message the Fed won’t blink, the Chair doth protest too much, me thinks. Powell might have the stomach for a bear stock market and some job losses, but what about systemic financial risk?
We’ve been saying the will not cut rates this year as a result of economic weakness, eg unemployment goes up or stocks continue to fall. There are only two ways the Fed cuts this year:
- Inflation falls faster than expected
- Financial instability
I’ve been pretty adamant it is time for the Fed to shift gears and begin evaluating the impact of 5% of tightening in 12 months. I’m just a dumb state school kid, so I don’t get how a 50bps hike next week instead of a 25bps hike is what finally wins the war on inflation.
But I do know all that tightening hasn’t had a chance to work its way through the system. Bonds had their worst annual losses since the Great Depression (yeah, the one almost a hundred years ago) but the Fed keeps hiking and talking about resiliency while ignoring casualties. “That job market though!”
The yield curve has been inverted for almost a full year, which is an incredibly strong signal for a recession. An inverted yield curve does not try to predict the cause of the recession. People forget, but the curve was inverted prior to covid. “Oh, you’re telling me the yield curve predicted a pandemic?” No, obviously not. But an inverted yield curve suggests the economy is strained and will not survive a shock, whatever that shock ends up being.
The yield curve didn’t try to predict SVB’s collapse. Instead, it was saying, “If the Fed raises rates 5% in 12 months, there will be consequences even if we don’t know what those are today.” We now know one of those consequences is forced selling of low yielding bonds can wipe out a bank in less than 36 hours. What other consequences are on the horizon?
Most people, especially the youngins that didn’t live through it, think of the Financial Crisis as a singular event. I instead think of it as three different events:
- Summer 2007 – Bear Stearns subprime funds collapse. The proverbial canary in the coalmine. I remember our traders being far more worried about this than the WSJ or CNBC. One of our swaps traders told me, “A credit crisis creates the worst recessions.” I was in a meeting with the Carolinas CMBS sales guy and he said he had 17 deals in flight that were frozen up. At a bare minimum, he was going to have to re-trade them to get across the finish line (he later told me that 2 of those 17 accepted the re-trades and closed - the rest never did).
I can’t stress this enough – the Financial Crisis began for some of us in the Summer of 2007 even though most Americans didn’t know it. The trillion dollar question is whether Friday was that Bear Stearns moment.
- March 2008 – Bear Stears collapses. The Fed first agreed to bail out the venerable institution, then jk it rescinded the offer, then the Fed orchestrated a JPM buy out for $2/share (it was $93/share the month prior).
Looking back on it, the details almost seem quaint. A $25B bailout? Just $25B? Musk paid $44mm for a tanking social media platform. Also, there was time when the federal government didn’t bail everyone out? How’s that work?
You know who else held a lot of subprime mortgages? Wachovia. We had spent $26B in 2006 on a mortgage lender, Golden West, that had gotten fat and happy on pick a pay mortgages. The head of mortgages for Wachovia sat in an office at the end of our trading desks. I remember her telling us, “I’ve been here for 20 years and have been consulted on every acquisition this bank has ever made. Then we went and bought a mortgage company, and I was never once called.” Good call, Ken.
Random tidbit – I was at Legoland in Carlsbad, CA when Wachovia CEO Ken Thompson was forced out. Unfortunately, they did not have a Lego display of the financial system collapse.
- Fall 2008 – the you know what hit the fan. The Lehman failure kicked it off, another victim of the subprime fiasco. Others quickly followed suit. Game. Set. Match.
In 2008, there was a lot of discussion around moral hazard with a bailout. That led the Fed to initially pick and choose which firms to bail out before ultimately throwing in the towel and backstopping the whole darn thing. Moral hazard is a real concern, but so is contagion.
I’m not sure what lesson we teach depositors by allowing their cash to evaporate because an executive bought the safest asset class in the world. Like 2008, Powell and Yellen may talk tough initially, but I’m not sure how long they can hold that line if we have more days like Friday. Yellen was making the rounds Sunday morning letting everyone know there won’t be a bailout. Let’s see how she feels if we see more banks go under with a run on deposits.
They will preach stability. Trust. Heck, they probably still plan on hiking rates next week. But I’ve seen this playbook before.
Everyone has a plan until they get punched in the mouth.
Random Weekend Thoughts
It usually takes a while for the ripple effects to work their way through the system. You might be at Legoland a year from now when news breaks on a string of dominos that started Friday. Just because we don’t get bad news in the coming months doesn’t mean it isn’t bubbling its way towards the surface.
It was six months from the Bear Stearns collapse until the full-blown crisis. The UK pension fund collapse was six months ago.
The yield curve inverted June 2006, one year before the first Bear subprime fund collapse. Guess how long the yield curve has been inverted this time?
The yield curve un-inverted after the Fed started cutting rates three months after the first Bear subprime fund collapse. “The Federal Reserve cut the target on a key short-term interest rate by half of a percentage point Tuesday to 4.75% in a bold acknowledgement that the central bank is concerned the mortgage meltdown plaguing Wall Street and Main Street could hurt the economy.” (Interest Rates Slashed to Help Economy)
If the Fed cuts, markets may initially react positively, like this NYT’s article from 2007 highlighted, “Markets Soar After Fed Cuts Key Rate by Half a Point” (Markets Soar After Fed Cuts Key Rate)
Wachovia had several key leaders conveniently “retire” in the summer of 2008. They got paid handsomely and went home. Once we went under in October, I looked back on that as our own canary in the coal mine. SVB CEO Greg Becker sold $3.5mm in stock two weeks ago. The last sell order I could find for him prior to that was December 2021 (15 months ago). I have no clue why he sold either time, but the Dec 2021 could at least be chalked up to tax planning. The sale two weeks ago has no obvious explanation (although there could certainly be one). If executives start retiring or selling shares unexpectedly, you should be nervous.
My 2008 experience creates a bias. I assume it can happen all over again, so I probably overstate the risk. Binge watching The Last Of Us this weekend, a post-apocalyptic drama, probably didn’t help.
That job market though! Everything will be fine!
Is the easiest path to avoiding an SVB repeat simply allowing banks to pledge Treasuries as collateral in exchange for cash so they don’t have to sell?
How will regulators step in to stop the fear from spreading to small and midsize banks? Will they try to prevent deposits from ending up at just the largest five banks? Will they start holding smaller banks to the same standards as the huge banks? What is the impact of that?
There is a closed-door Fed meeting today. I don’t expect an emergency cut, but I do think they are talking about systemic risk.
The Fed is terrible at predicting cuts. Just because they aren’t talking about cuts doesn’t mean they aren’t coming.
Next week’s odds: 25bps (62%) and 50bps (38%)
May 3rd odds now price in 60% of no hike
Market year-end Fed Funds now < 5%
In the coming months, will the Fed need to halt QT to stabilize markets? Or will some sort of discount window concession suffice?
The Fed “encouraged” stronger banks to step up and buy failing banks in 2008, and if a buyer doesn’t emerge on their own over the weekend, I wouldn’t be surprised of more Fed “encouragement”.
Inverted yield curves should not be ignored
Penn State basketball making the Big 10 Conference Championship is the surest sign of the apocalypse I can think of
Bragging about resiliency using backward-looking metrics leads to overconfidence and mistakes
Forced selling to create liquidity is becoming a theme. Tech led off, bonds just left the on-deck circle, and real estate is in the hole.
Right now, this feels more like a liquidity crisis than a credit crisis, which is about the most positive spin I can possibly put on things
Raising rates 5% in a year breaks things
SVB was a very disciplined, highly regarded bank. They catered to risk takers, but weren’t known as huge risk takers themselves. You can do most things right and still lose.
Innovation will be impacted. Small businesses will be impacted. Payroll at startups will be impacted. The tech rout will continue. A lot of good people, including at SVB as well as the connected ecosystem, are going to lose their jobs through no fault of their own.
SVB’s longest relationships played a key role in its demise. Thanks for nothing.
Many of SVB’s 8,500 employees will be extremely grateful to know the US job market is the strongest in history. There are two job openings for every unemployed American – you will have your pick of jobs! Just ask the Fed and their JOLTS graph.
Last Week This Morning
- 10 Year Treasury at 3.70%
- German bund at 2.47%
- 2 Year Treasury at 4.59%
- LIBOR at 4.80%
- SOFR at 4.55%
- Term SOFR at 4.86%
- Nonfarm payrolls came in at 311K vs expected 225K – resiliency!
- Unemployment rate came in at 3.6% vs expected 3.4%
- Average hourly earnings MoM came in at 0.2% vs expected 0.3%, a 2.4% run rate
- Initial jobless claims came in at 211K vs expected 195K
CPI on Tuesday and inflation expectations on Friday would normally be huge data points, but will take a back seat to SVB, contagion fears, and the Fed response.