Silicon Valley Bank Failure: Who is "Indulgence" and Who is "Costly"

【Special Attention】

The most shocking news for Americans in recent days has been the collapse of the Silicon Valley Bank. On March 3, local time, Silicon Valley Bank, a star bank in the United States, which mainly provides financing services for start-ups, was suddenly announced to take over and declared its collapse at the de facto level, which was regarded as the largest bank failure since the 10 financial crisis, causing global attention.

Starrise Starfall: "Great release of water" after extremely fast turn

In fact, as of the end of last year, the 16th-ranked bank in the United States also had more than $2000 billion in assets and more than $1700 billion in deposits. From selling assets, encountering a run to being forced to stop trading, Silicon Valley Bank was taken over and entered bankruptcy liquidation in just 48 hours, becoming the second largest bankruptcy default in US history. Since then, panic has spread around the world.

Some people attribute the bankruptcy of Silicon Valley Bank to "individual cases", but the logic behind its thunderstorm can see the inevitability caused by a universality - the "Waterloo" of Silicon Valley Bank is largely due to the "willfulness" of US monetary policy in recent years.

The overall business model and operating conditions of Silicon Valley Bank are not much of a problem, neither soundness nor assets are "toxic", and the capital adequacy ratio is also good. Just March 3, the bank was listed on Forbes' annual list of America's best banks for the fifth consecutive year and was named to Forbes' inaugural Financial All-Star list. However, the bane of "star collapse" has long been growing in the shadows.

Since 2020, the Fed has embarked on a new round of "unprecedented" "big release", not only reducing interest rates to 0, but even promising "uncapped" quantitative easing. Against this background, the US stock market rose sharply, and there was a "strange phenomenon" that production and output were "stopped" due to the epidemic, while market wealth increased greatly. There has been a boom in tech financing, with loans and VC lines for startups growing rapidly, and deposits at Silicon Valley Bank, the friendliest bank for tech startups, skyrocketed. From June 2020 to December 6, bank deposits skyrocketed from $2021 billion to $12 billion.

The influx of customer funds into Silicon Valley banks corresponds to the growing demand for asset allocation. Due to extremely low market interest rates, Silicon Valley Bank has increased its allocation to securities. Between 2020 and 2021, Silicon Valley Bank's portfolio investment and total assets increased by 3.40 times and 1.98 times, respectively. As of December 2022, 12, the bank's total assets were approximately $31 billion, of which 2120% were fixed income securities. Although the income of these securities is not high, there is still a stable interest rate differential income compared to the deposit interest rate in the context of "big water release".

All policies have consequences, and indulgence comes at a cost. The "big water release" has brought extremely high inflation, which not only affects the United States, but also drags down the world. As Fed Chairman Jerome Powell repeatedly said that "inflation is only temporary" and missed the opportunity to curb inflation early, inflation was more severe and stubborn than expected, and the Fed had to raise interest rates steepest in 2022 years in 40. When Silicon Valley banks allocate securities such as U.S. Treasuries, almost all large U.S. financial institutions believe that the probability of interest rates rising above 2% in the future is very low.

But the swift shift in monetary policy was beyond everyone's expectations. In just one year, from March 2022 to February 3, the Fed raised interest rates 2023 times in rapid succession, including 2 consecutive rate hikes of 8 basis points, with a cumulative increase of 4 basis points, and the federal funds rate reached the range of 75.450%~4.5%. This round of rapid and large rate hikes is extremely rare in the history of the Fed. By March 4 this year, the yield on 75-year Treasury bonds soared to 3%, while the 8-year fixed-rate mortgage rate rose to more than 4%.

This means that, on the one hand, the Treasury bonds and mortgage-backed bonds (MBS) held by Silicon Valley Bank have essentially depreciated significantly; On the other hand, the funding environment for technology companies has changed dramatically, and high inflation has led to increased cash expenditures for startups, so they have begun to continuously withdraw their savings for operations. Under such pressure from both internal and external parties, it led to a scene that people saw over the weekend: Silicon Valley banks urgently need liquidity, and can only realize the actual losses of bonds with "floating losses" on the books, which leads to market panic, and eventually forms a run on the bankruptcy.

The core issue: U.S. monetary policy

The most important question is, where exactly is the core problem of the incident? Have the so-called risks or even crises passed? There will not be only one risk point for systemic pressures brought about by policy issues. Market sentiment is so fragile that it is not a day's cold. It must be noted that the core problem is also the monetary policy of the United States, the Fed immediately tightened after the "big release", and at the same time may face not only the double balance of suppressing inflation and maintaining growth, but also the third blade of debt.

The Fed's rate hike cycle has always been the backdrop to crises, because from boom to crisis, in many "this time different" stories, debt is always the same sword of Damocles – not known when it will fall, but it will fall.

A Silicon Valley bank may not form an overall crisis, but the logic behind its lightning explosion is still brewing and fermenting in the market. Overall, securities account for about 25% of the total assets of the U.S. banking industry, and according to the Federal Deposit Insurance Corporation (FDIC), by the end of last year, these securities had a market-value loss of about $6200 billion, which is still manageable overall, but the risk will be higher for some small and medium-sized banks. That is, not Silicon Valley banks, but possibly other banks; With Silicon Valley Bank, there may be other banks as well.

Thanks to regulatory reforms following the global financial crisis, the U.S. financial system is currently relatively stable, but risk factors are rapidly accumulating. The bankruptcy of Silicon Valley Bank also reflected a rather fragile market sentiment, which fortunately happened over the weekend and global markets were on hold.

Ahead of Monday's Asian market open, the United States hurriedly announced a corresponding "bailout" policy in an attempt to calm market runoff expectations and prevent panic from spreading further. After the Federal Reserve, the US Treasury and the FDIC came forward, US President Joe Biden also made a speech to calm market sentiment and try to raise positive expectations.

However, as soon as the market opened, investors did not buy it, and they began to worry that a similar scenario would spread to other banks, starting with the First Republic Bank (FRC), then the customer United Bank (CUBI) and other 9 banks, and even affecting the stability of the entire US commercial banking system. Although the "bailout" measures temporarily lifted the market "crisis alarm", the sharp decline of bank stocks after the opening of the market fully exposed the difficulty of market confidence. Despite bottoming out the next day, the panic index continued to rise. The US Silver Gate Bank and Signature Bank have also gone bankrupt.

Although this run is resolved, this knock-on reaction may still be inevitable. Public anxiety about small and medium-sized banks is likely to deepen, and with rising interest rates, the loss of deposits from small banks may accelerate.

Moreover, the causes of the crisis have not been eliminated, and under strong suppression, the accumulated pressure may be even greater. At present, inflation in the United States and many major economies around the world remains high, and the Fed has expressed a more hawkish attitude before the collapse of the Silicon Valley Bank. On March 3, Fed Chairman Jerome Powell also said during a hearing in the US Congress that the Fed may raise the federal funds rate to a higher level than expected at a faster pace, and the market expects the rate hike to be longer and possibly more intense. After the fall of Silicon Valley Bank, many people began to expect that interest rate hikes would slow down or end. However, inflation is there, and if the rate hike is stopped, it will not only mean halfway, but also undone, and the future may be tougher, and the Fed may also face credit bankruptcy. If interest rates continue to rise, it means that asset price adjustments represented by the US stock market and bond market will continue, investors may continue to suffer large-scale losses, and the resulting capital losses and liquidity pressure may once again trigger the risk of bankruptcy and liquidation of financial institutions.

Quench your thirst: a bigger crisis or on the road

In addition, although the US government's rapid intervention in this crisis has been unanimously touted by the US media, it is not difficult to see that it is "stretched" upon careful analysis.

The bailout package is mainly the Bank Term Financing Program (BTFP). Loans to banks, savings associations, credit unions, and other qualified depository institutions for up to one year by creating a new bank term financing program, secured by U.S. Treasury bonds, agency debt, and mortgage-backed securities, and other qualifying assets that will be valued at face value. In other words, Silicon Valley Bank's securities assets that need to be sold at a discount can be sold without a discount. This seems to feel a bit like "knowing why today". Holders of other U.S. Treasuries, MBS, etc. may be able to do the same in the future. It's just that this means that the United States has taken out national credit as an endorsement to be a "gold hand", disrupting market prices to some extent. Although it is in the name of "marketization", it is tantamount to another small "release of water".

Like modern Western monetary theory, which was once fully accepted in the past, "releasing water" once seemed to be a panacea for all problems, so the so-called term mismatch has long been widespread everywhere, in addition to banks but also pensions, bond funds, and so on. A stubborn inflation "unexpectedly" broke the carnival that money can "release water" forever.

Is Silicon Valley Bank alone? The thunderstorm of British pensions, the Credit Suisse turmoil, the run on Blackstone and bond defaults are still at hand. The "junk debt" in the easing period will always reveal the lead of debt explosion under the magnifying glass of high interest rates. Looking at it today, the longer the price distortion of the inversion of US Treasury yields exists, the more it may be necessary to use a more violent fluctuation to restore normalcy.

The Federal Reserve is often referred to as the "central bank of the world" because of the dollar's global status. The target of the Fed's policy is only the US economy, but its costs are often borne by the whole world, and the side effects and risks of the Fed's policy will spill over to the global market. On March 3, European stocks opened sharply lower, with the three major stock indexes falling by about 15%. Credit Suisse plunged.

In the cycle of aggressive interest rate hikes by the Federal Reserve, although Europe faces recession and regional conflicts, it has to follow the tightening policy and bear the high inflation caused by the previous "big water release"; If interest rates continue to rise, emerging markets and developing countries may also re-erupt into monetary financial crises.

After an early and slow rate hike, the Fed suddenly rushed in, the world had to follow suit, and then constantly worried about when the crisis and recession would come, and market expectations became increasingly fragile. Moreover, in the post-pandemic era, the world is eager to recover its economy and return to the pre-pandemic state of global trade, investment and exchanges as soon as possible. However, based on its own rising trend of conservatism, the United States has constantly narrowed circles, built separation walls, continuously created regional instability, and continuously introduced various sanctions documents and plans, which has cast a thick shadow on the world economic recovery and made it difficult to restore market confidence, which may have become a hotbed of crisis.

The 2008 financial crisis is not far away, and crises always come by surprise. All crises stem from price distortions, and all crisis "management" that further exacerbates distortions is nothing more than a risk accumulation to quench thirst, and even bigger crises may already be on the way.

(Guangming Daily Author: Wan Zhe, researcher at the Belt and Road College, Beijing Normal University)