A weekend topic starting with the Epoch Times. “The Federal Reserve adopting a loose monetary policy—slashing interest rates and buying Treasurys—for an extended period can lead to ‘financial turmoil’ several years later, the central bank stated in a new paper. Economists at the Fed Bank of San Francisco published a new study, titled ‘Loose Monetary Policy and Financial Stability,’ (pdf) trying to determine whether accommodative conditions can lead to financial turmoil in the future. The researchers assessed long-term data to figure out if expanding money and credit can birth rampant speculation, raise household debt, and initiate an investment boom and ‘capital overhang.’”
“This was the first comprehensive study to extend the evidence that ‘monetary policy has implications’ for the stability of the U.S. financial system, authors noted. The study considered the dangers of ‘lower for longer monetary policy’ that can lead to the consequence of financial crises. ‘Are periods of persistently loose monetary policy more crisis-prone? This section argues that the answer to this question is in the affirmative. We see significant estimates in the medium term, that is around horizons of 5 to 10 years. Financial crises are predicted by loose monetary policy several years ahead.’”
From Worth. “Cenote Sagrado was a sacred pit, geologically a sinkhole in the ancient Mayan city of Chichen Itza Mexico. There, human sacrifices to the rain god Chaac were made. There is a direct connection between these ancient Mayan sacrifices and the Fed’s setting higher interest rates today. In Chichen Itza, the gods had to be appeased. Today it is the evil of inflation. Financial markets are our current gods. They must be kept happy. By raising interest rates in quick succession (to around 4.5 percent), the Fed is attempting to stamp out the rampant rise in asset prices, which they caused by lowering rates (to near zero) after the 2008 financial crisis and then again in 2020, to ward off a COVID recession or worse.”
“These moves spurred speculation in everything from used car dealer Carvana and meme stocks to multimillion-dollar Bored Ape NFT’s and Miami condos. This massive money supply dose also affected grocery store basics and rents nationwide, causing real pain to real people. It destroys savings and lowers the living standards of everyone whose income is from wages. No longer seized by agents of the Mayan chiefs, today’s sacrificial lambs are notified by emails from Meta, Alphabet, Microsoft, Amazon, Salesforce, and a hundred other companies hurling employees out of their office towers or work-from-home living rooms… into the sinkholes of unemployment.”
From The Hill. “How should Congress assess the Federal Reserve’s track record as an investor in residential mortgage-backed securities (MBS)? Regardless of Fed spin, it merits a failing grade. The Fed’s COVID-era intervention in the mortgage markets fueled the second real estate bubble of the 21st century. The bubble ended when the Fed stopped purchasing MBS and raised rates to fight inflation. While time will tell whether recent increases in home prices are reversed, the end of the bubble has already cost the Fed over $400 billion in losses on its MBS investments.”
“In a radical ‘temporary’ policy response to the 2008 financial crisis, the Fed began intervening directly in the mortgage market. Through a series of MBS purchases, the Fed’s MBS portfolio ballooned from $0 to $1.77 trillion by August 2017. The Fed subsequently altered policy and slowly reduced its MBS holdings. By March 2020, it held about $1.4 trillion in MBS.”
“When the COVID crisis hit in March 2020, the Fed decided to reinstate its 2008 financial crisis rescue plan. It resumed purchasing MBS as well as Treasury notes and bonds. By the time it stopped its purchases in the spring of 2022, it owned $2.7 trillion in MBS. The Fed had become the largest investor in MBS in the world. By spring 2022, it owned nearly 22 percent of all 1-to-4 family residential mortgages in the U.S. By Sept. 30, the date of the last available quarterly Fed consolidated financial statement, the Fed had lost $438 billion on its MBS investments. These losses will increase if the fight to subdue inflation requires still higher interest rates.”
From Business Today. “Industrialist Uday Kotak on Friday said that an accident like the recent Silicon Valley Bank (SVB) crisis was waiting to happen ‘somewhere.’ On Thursday, US-based Silicon Valley Bank shares dropped by 60 per cent, following which investors lost around $80 billion in value from bank shares. This triggered a market collapse not just in the US’s Wall Street but also in India. Kotak reacting to the development said: ‘Overnight developments in US banking: markets, analysts, investors underestimate the importance of financial stability for the balance sheet of a bank. When interest rates move up 500 bps from zero in a year, an accident was waiting to happen somewhere.’”
The Globe and Mail. “Silicon Valley Bank, a mainstay financier across the tech world, including a presence in Canada, was shut Friday by California’s Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation as receiver. The bank will reopen Monday and depositors will have access to insured deposits, though the amount is capped at US$250,000 per account. The shutdown of SVB stemmed from its decision in 2021 to pull back on lending and instead stash tens of billions into long-term, low-interest-rate mortgage-backed securities. But as interest rates rose, bond values fell, saddling SVB with a paper loss, which it crystalized when it was forced to sell some bonds for a US$1.8-billion loss.”
“‘It’s a sobering reminder that a financial institution is built on trust and confidence, not deposits and loans,’ said John Ruffolo, managing partner with Toronto-based technology financier Maverix Private Equity. ‘When that confidence drains away, the speed at which the organization falls is like a dam bursting.’ Mark McQueen, former head of Canadian Imperial Bank of Commerce’s innovation banking group, said ‘it’s such an unnecessary chain of events. I can’t believe it. It’s tragic.’”
From Forbes. “The broad sell-off was ‘undoubtedly an unwelcome reminder’ of the 2008 financial crisis, says Sevens Report analyst Tom Essaye, noting SVB scrambled and ultimately failed to stay afloat after it was forced to sell a bond portfolio at a $1.8 billion loss because higher interest rates pushed bond prices ‘far below’ where they were when purchased. ‘In [this new] interest rate environment, business models matter, profits matter and unrealistic projections of profitability 5 to 10 years down the road won’t cut it,’ says Chris Zaccarelli, chief investment officer for Independent Advisor Alliance. ‘There are a lot of companies and speculative bubbles that aren’t coming back from this round of Fed intervention.’”
The Associated Press. “Silicon Valley Bank, the nation’s 16th-largest bank, failed after depositors hurried to withdraw money this week amid anxiety over the bank’s health. It was the second biggest bank failure in U.S. history after the collapse of Washington Mutual in 2008. ‘This is an extinction-level event for startups,’ said Garry Tan, CEO of Y Combinator, a startup incubator that launched Airbnb, DoorDash and Dropbox and has referred hundreds of entrepreneurs to the bank. ‘I literally have been hearing from hundreds of our founders asking for help on how they can get through this. They are asking, ‘Do I have to furlough my workers?’”
“As part of the seizure, California bank regulators and the FDIC transferred the bank’s assets to a newly created institution — the Deposit Insurance Bank of Santa Clara. The new bank will start paying out insured deposits on Monday. Then the FDIC and California regulators plan to sell off the rest of the assets to make other depositors whole.”
“Bill Tyler, the CEO of TWG Supply in Grapevine, Texas, said he first realized something was wrong when his employees texted him at 6:30 a.m. Friday to complain that they did not receive their paychecks.TWG, which has just 18 employees, had already sent the money for the checks to a payroll services provider that used Silicon Valley Bank. Tyler was scrambling to figure out how to pay his workers. ‘We’re waiting on roughly $27,000,’ he said. ‘It’s already not a timely payment. It’s already an uncomfortable position. I don’t want to ask any employees, to say, ‘Hey, can you wait until mid-next week to get paid?’”
“Ashley Tyrner, CEO of FarmboxRx, said she had spoken to several friends whose businesses are backed by venture capital. She described them as being ‘beside themselves’ over the bank’s failure. Tyrner’s chief operating officer tried to withdraw her company’s funds on Thursday but failed to do so in time. ‘One friend said they couldn’t make payroll today and cried when they had to inform 200 employees because of this issue,’ Tyrner said.”
The New York Post. “Building managers at Silicon Valley Bank’s Manhattan branch reportedly called the police Friday morning after a group of tech founders showed up and attempted to pull out their cash. Police responded after a group of ‘about a dozen founders’ went to SVB’s Manhattan location on Park Avenue, journalist Eric Newcomer said in a Substack post. One of the founders was former Lyft executive Dor Levi, who provided Newcomer with text updates from the scene.”
“The incident was the latest indication of growing panic among investors linked to the tech lender, which warned of a cash crunch this week that sparked a run on the bank. SVB blocked Levi and others who gathered from entering the building. By around 9:20 a.m. ET, building officials ‘called the police’ and a pair of NYPD vehicles had arrived. Levi reportedly added that there were ‘more founders coming every minute’ before the police response. Similarly, dozens of clients lined up to empty their accounts from a SVB branch in Menlo Park, California — an area populated by venture capitalist offices — video posted to Twitter shows. The long line of founders stretched around the block, leaving the founders to wait in the sidewalk-less streets and in the pouring rain.”
From Business Insider. “‘This is the first sign there might be some kind of crack in the financial system,’ Bill Smead, the chairman of Smead Capital Management, a $5.5 billion asset manager, told The Wall Street Journal. ‘People are waking up to the gravity that this was one of the biggest financial euphoria episodes.’”
“A common denominator for Silicon Valley Bank and Silvergate — and indeed banks across the world — is that a series of interest-rate hikes from a hawkish Federal Reserve has drastically cut the value of the long-term bonds they bought before rates went up. Veterans of the 2007-08 financial crisis may remember the term ‘mortgage-backed securities.’ There are parallels with the situation facing banks today. This time the concern for banks isn’t risky mortgage-backed securities but the bonds they bought in the wake of the financial crisis.”
“Interest rates have shot up from their postcrisis lows, meaning lower-interest bonds bought before 2022 are worth less than they paid for them. Indeed, on Monday, the Federal Deposit Insurance Corporation said US lenders were sitting on about $620 billion of unrealized losses on securities such as low-interest bonds. The problem is, banks need to sell bonds to raise cash if customers decide to withdraw money en masse — the so-called bank run. And that was the crux of the problem for Silvergate and Silicon Valley Bank: They were forced to meet customer withdrawals by selling off low-rate bonds at a loss.”
“‘Lots of banks hold large portfolios of bonds, and rising interest rates make these less valuable,’ Russ Mould, an investment director at the stockbroker AJ Bell, said. He added that the situation at Silicon Valley Bank was ‘a reminder that many institutions are sitting on large unrealized losses’ on bond holdings. Mould said the ‘fire sale’ of Silicon Valley Bank’s bond portfolio raised broader concerns. ‘In a heavily interconnected banking industry,’ he said, ‘it’s not so easy to compartmentalize these sorts of events, which often hint at vulnerabilities in the wider system.’”