The Stability of the Financial System

Historical insight — Originally published March 17, 2023. Preserved as historical content; information may have changed.

Late Wednesday, Silicon Valley Bank announced Treasury sales and had begun the process of raising capital. The stock cratered on Thursday, customers began to pull funds, and Friday morning regulators closed the bank.

Over the weekend, the government shuttered Signature Bank. Like SVB, Signature, which had a presence in the crypto space, had a very large share of uninsured deposits.

In the wake of the unexpected failures, regulators have raced to contain the crisis.

The bedrock of the financial system is confidence. We hold funds in banks and money markets because we are confident we can withdraw those funds at any time. If confidence turns to panic, the system collapses.

Early actions taken to guarantee all deposits at the failed firms and the Fed’s announcement of a safety net for banks holding Treasuries are controversial, but early indications suggest they are working.

The short answer is “Yes.” Its aggressive campaign turned bank bond portfolios upside down.

Can a bank without loan-quality issues implode in less than 48 hours? Yes.

Meteoric bank growth, rising interest rates, unfortunate decisions by management, a mismatch of duration among its extremely safe assets and liabilities, regulator missteps, and panic led to the demise of a 40-year-old institution.

SVB was shuttered late Friday morning. Regulators likely were trying to salvage what was left of the bank, allowing for a possible sale or orderly liquidation of assets which would eventually (hopefully) return most deposits to uninsured depositors.

A buyer of SVB didn’t surface, which led the government to extend insurance to all depositors.

Bank customers were losing access to new funds via fundraising and began burning through cash at the bank, what SVG called an “elevated cash burn level.”

Late Wednesday in a SVB mid-quarter update, the bank said it had sold $21 billion in highly liquid, ultra-safe Treasuries.

Treasuries don’t have credit risk but are subject to interest rate risk. Rates have risen, bond values have fallen, and the bank took a $1.8 billion after-tax haircut on the sale.

SVB had lined up new financing, but the stock cratered on Thursday, scuttling its attempt to shore up its balance sheet.

Uninsured depositors, which accounted for almost 90% of its deposits (some estimates as high as Los Angeles Times analysis of uninsured SVB deposits), began to flee the bank.

The banking system is in better shape today than in the 2000s.

The speed of the failure was not the result of bad lending practices. Instead, it was a mismatch of duration coupled with falling bond prices (compliments of Fed rate policy).

In the days and weeks to come, we’ll get a better picture, probably faulting regulators and bank management.

SVB isn’t the only bank that’s been challenged by falling bond values.

The FDIC said banks had about $620 billion in unrealized losses as of the end of last year, according to the WSJ.

If held to maturity, it’s not a big issue.

If forced to sell, as SVB did, it could be catastrophic.

Following SVB’s demise, might bank depositors ‘shoot first, ask questions later?’

All deposit accounts at SVB and Signature Bank are insured, according to a Joint statement from federal banking regulators released by the Federal Reserve, the Department of the Treasury and the FDIC press release.

Shareholders and certain unsecured debtholders will not be protected.

Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law. In theory, taxpayers aren’t on the hook.

The Federal Reserve Bank Term Funding Program announcement.

It has been crafted to prevent the forced sale of bonds.

The loans will be collateralized by the bonds. The Fed should make money on the plan.

Bank runs are in no one’s interest.

Investors need some space and breathing room—a cooling-off period in the hopes cooler heads prevail. The situation is fluid, but the government appears to be successfully ring-fencing the failed entities.

SVB’s failure has exposed problems in the banking system that had been lurking under the surface.

The Fed and regulators failed to foresee last week’s crisis.

The Fed’s Bank Term Funding Program is designed to mitigate risk and prevent contagion.

While the situation is still fluid, early signs suggest that the government action taken are calming investor nerves.

CG Financial will continue to monitor issues around the banking system and other areas of the economy and markets to mitigate these issues for our clients. Feel free to reach out to your advisor to discuss this or any other topics on your mind.

Contact your financial professional at info@mycgfinancial.com or (877) 807-2079.

© 2023 Horsesmouth, LLC. All Rights Reserved. For the exclusive use of: CG Financial Services