In this episode, Adam and Ryan to discuss:
Links:
AppliedMMT.com
AppliedMMT on Twitter
Douglas (@MMTmacrotrader) on Twitter
Disclaimer: The content of this podcast is for informational purposes only and should not be construed as financial or investment advice. The views and opinions expressed in this podcast are those of the hosts and guests and do not necessarily reflect the official policy or position of any associated employers or organizations. Listeners should consider their financial circumstances and consult with a professional advisor before making any investment decisions
In this episode, Adam and Ryan to discuss:
Links:
AppliedMMT.com
AppliedMMT on Twitter
Douglas (@MMTmacrotrader) on Twitter
Disclaimer: The content of this podcast is for informational purposes only and should not be construed as financial or investment advice. The views and opinions expressed in this podcast are those of the hosts and guests and do not necessarily reflect the official policy or position of any associated employers or organizations. Listeners should consider their financial circumstances and consult with a professional advisor before making any investment decisions
The content of this podcast is for informational purposes only and should not be construed as financial or investment advice. The views and opinions expressed in this podcast are those of the hosts and their guests. They do not necessarily reflect a position of any associated employers or organizations.
Adam Rice:Hello, everyone, I am Adam rice, and you're listening to Episode Eight of the applied MMT podcast. If you like the podcast, please subscribe. If you're listening on YouTube, it would be great if you could like or comment. And again, thank you for listening. In today's episode, we discuss the recent SVB bank crisis and the fallout from it. We hope this provides you some additional perspective on what happened, especially through an MMT lens. Again, thanks for listening, and I hope you enjoy. All right, big week this week. Ryan, I know I mean, a million people out there have their takes on what happened with SBB. I think this is a little bit over my head. But I would love to hear your take, you know, through an MMT lens on what happened with SBB. And I guess we can just jump off from there.
Ryan Benincasa:Sure, yeah. And ya know, no, definitely not a quiet week. Before I get into that, I just want to say it must be. So I went to the the JPMorgan high yield conference, you know, a week and a half ago. And the last time I had gone to that conference was late February 2020, and COVID kind of, you know, appended all of our all of our worlds right after that. And so I just find it kind of funny that almost, you know, the next time I go to the conference, because I was kind of excited. There was talk about the the debt ceiling and the trillion dollar coin and stuff at the conference. So I had taken notes and sent some tweets about that and was kind of, you know, raring to talk about that a little bit. But then, you know, the this Silicon Valley Bank, this $200 billion assets bank 16th largest the United States failed a couple a couple of days. Or last last Thursday, we're recording this. On Wednesday, March 15. So, Adam, my, my take on the situation? Well, first of all, I don't know why I don't know about you like it. Have you ever seen more bad takes on Twitter ever, about this whole thing?
Adam Rice:No, I haven't. It's been pretty sad. I think it's kind of I think it's just an indictment of social media overall, it's just like anyone can chime in, you know, people who don't understand this stuff at all can chime in, and appear to be pretty authoritative. And I think that's, you know, the entire problem with social media.
Ryan Benincasa:So I can, that is very well said, I completely agree with that. The way you know, really bad tics can get magnified on social media is a major problem. I would also just say that this is a this is somewhat of an indictment on our, like, on the brother, institutions of our of our country, right, the fact that people don't really understand how banking work works is a massive failure of more of myriad institutions of our academic institutions of, you know, are of the government of Wall Street of the media. And, you know, so hopefully, what we're doing here is trying to help people understand how these things work a little bit better than, than what you typically hear from more mainstream sources, but getting back to the topic at hand, Silicon Valley Bank, so my understanding of the situation is that this was a rather unique bank to say the least. It experienced enormous growth, you know, with it with the post COVID Boom. And it was actually had this kind of unique model where they invested they would make loans. Probably what many would consider to be on the riskier end of the of the credit spectrum? So they held up, you know, a portion of their book in, in loans to kind of, you know, Silicon Valley, you know, disruptive so called technology company. He's that. And some of them. Like, I heard that they were pretty big into subscription line, subscription lines for VC funds and stuff. So that, to me seems fairly safe, actually. But regardless, they would make loans to Silicon Valley companies. And they used up a huge portion of their assets. Or they are for a large portion of their assets they purchase long dated US Treasury securities and agency mortgage backed securities, both of which are guaranteed by the full faith and credit of the United States government. The Yeah, the agency mortgage bonds, I don't know if that's a, an explicit or an implicit guarantee, but they're there. They're, I mean, they're guarantee I mean, the Fed was literally has been buying them as part of its QE for programs for a long time. So essentially, you know, this was by what Mae would consider to be a, a safe bank, right, they are doing what they're supposed to do, they're making loans to, you know, entrepreneurs and, you know, kind of riskier ventures, but, but nonetheless, they had a large portion of their assets invested in credit risk free paper issued by the United States federal government, and as we know, because of MMT, the government cannot run out of dollars to service the, the, you know, its debt. So, you know, essentially those securities are credit risk free. And so, what ended up happening was a few things number one, I guess SVB frequently wrote or covenants in their loans to their to their the people that they would lend to that those people would have to bank with SVP as depositors. And so, if we step back for a sec, I mean, I mean, Adam, how hilarious is like, literally, we can see how, you know, when banks create, when banks lend money, they simultaneously create deposits, I mean, we see these with these guys.
Adam Rice:Right, right.
Ryan Benincasa:And so, a lot of the bank's depositors were, you know, people from Silicon Valley venture capitalists, you know, people that you know, would control it would be controlling stakeholders in venture capital funds that oversees portfolios of companies and advises them. And so, and, and part of again, you know, SCB is the only bank that would lend to them, and as part of the agreement would require them to do their deposit banking with them. And so, you have this sort of unique situation where you have a very concentrated depositor base concentrated in every way you can think of industry, you know, geography. So, you know, these are kind of people with that operate in a somewhat herd like mentality. And so what ended up happening was, the bank had large mark to market losses on its on its portfolio of treasuries and agency MBS because of the Feds rapid rate hikes which they have, you know, incorrectly assumed would help stem inflation, but in fact, it's, as we know, it's been up to this point, it's been adding to inflation. And so the Fed decided to jack up rates and crushed the value of this banks, credit assets, and so you know, the that into the bank's capital, right If so you basically have you have available for sale securities, and you have hold to maturity securities. And, you know, the available for sale securities, my understanding was that they were actually trying to rotate, they're trying to sell and realize a loss, and then rotate into higher yielding assets. And, you know, in order to do that, they needed to raise capital to sort of plug the hole that would be created by realizing the loss on their, on their available for sale securities portfolio. And so, you know, they're trying to do a, you know, a capital raise, I think it was like two and a quarter billion of like, convert deals, what they're looking at, they had an anchor, apparently, a guy came in with like a, you know, a $500 million order. And, you know, Goldman Sachs was trying to was trying to place the rest of the deal. And the combination of the realized losses of on the FS portfolio, and the so called held to maturity portfolio was sufficient to spook the banks depositors who decided that they were going that, that they were in trouble. And, you know, they advised all their portfolio companies to pull their funds out of Silicon Valley Bank, and subsequent and this sort of hysterical kind of panic ensued, where, you know, VCs, were getting on Twitter, and screaming and shouting for everyone to, to get out, get their money out of SVB, apparently, the Wall Street Journal came out with an article saying that there was a whole group of people, you know, kind of in that in the tech VC community that were out, I think, skiing in Montana, and, or maybe with Jackson Hole, and they're on a bus, and everyone was sort of frantically on their phone, apparently pulling funds out. And then once they got all their funds out, they all celebrated, I guess, in this bus out on the slopes, in Jackson, so that just kind of goes to show how so the bank again, this thing had, I think, um, I think it had something like 190 billion in deposits and lost 42 billion of deposits in a single day. And ran out of liquidity. It had already been borrowing from the the Federal Home Loan Bank, which is sort of like a quasi fed for regional banks. So they have already used up a significant portion of their of that credit line that they have available. And they just they weren't able to meet all of these depositors, withdrawal requests, and the bank subsequently failed. Now, well, a lot of people would say is that the bank, you know, they'll point to like the the held to maturity securities portfolio and say, Well, you know, the bank was insolvent, blah, blah, blah. The reality is the bank held securities that were issued by the federal government, if those securities had no default risk, so, if, if the all of the depositors hadn't decided to, you know, induce a bank run, I mean, this is like, this was like a coordinated you know, kind of attack on SBB. And, and all these all these people pulled their money out at the same time and cause the banks to collapse. I mean, that literally, there would there is no, there is no other explanation as to why the bank collapse other than its depositors decided to run. And that's something that I think is very important to, to emphasize here. And we actually tweeted at Professor Morgan Rex, who we've mentioned previously, in this show, who wrote the book, the money problem, and you know, goes into a deep dive into bank runs. And well he points out is that credit quality is not necessarily what causes depositors to run. It's he equates you know, the situation that depositors are into what's called, it's part of like, like game theory and and, you know, it's called a coordination game. Yeah, an example being the stag hunt I've ever heard the stag hunt.
Adam Rice:I haven't actually.
Ryan Benincasa:Okay, here let me just let me just read really quick that what the what the stag hunt game is, this is from Wikipedia. So, in game theory, the stag hunt describes a conflict between safety and social cooperation. The stag hunt problem originated with philosopher John Jacques Rousseau, in his discourse on inequality. In the most common account of this dilemma, which is quite different from Russo's two hunters must decide separately and without the other knowing whether to hunt a stag or a hare. However, both hunters know the only way to successfully hunt the stag, is with the others help, one hunter can catch a hare alone with less effort and less time, but is worth far less than a stag and has much less meat, it would be much better for each Hunter acting individually to give up total autonomy and minimal risk, which brings only the small reward of the hair. Instead, each Hunter should separately choose the more ambitious and far more rewarding goal of getting the stag thereby giving up some autonomy in exchange for the other hunters cooperation and added might this situation is often seen as a useful analogy for many kinds of social cooperation, such as international agreements on climate change interesting. And the stagnant difference differs from the prisoner's dilemma in that there are in the prisoner's dilemma there are two pure strategy Nash equilibria. One where both players are Excuse me. In the stag hunt, there are there are two pure strategy Nash equilibria. While we're both players cooperate, and one where both players defect in the prison in the prisoner's dilemma, in contrast, despite the fact that both players cooperating. The only pure Nash equilibrium is when both players choose to defect. So I think that's that's really important here is to just emphasize that the optimal outcomes come for bank depositors when they either all stay or when they all run. And so that's ultimately what led to SPVs downfall is that its depositors decided to to run. Right, and there's really no other and that was the and because of this sort of chaos that was created by these people getting on the airwaves, and that blew up the the securities deal, right, they were trying to raise capital, right, they they went to the capital markets, and they tried to raise capital, and they failed because of this sort of run risk that that was, again, created. It was a narrative that was deliberately created by the depositors of the bank, there is no other if they hadn't done that the bank would have raised capital, and would have kept operating and we wouldn't be going through this extremely stressful period right now, and have to deal with the social cost of, you know, a, you know, an important institution that's been around for four decades that has been a partner to the, you know, the brother, West Coast, tech industry, and they essentially, you know, that that institution is now gone. And, you know, these people who were depositors of the bank, essentially, not, not only did they not only did they, you know, stab it in the back, they step they shot themselves in the foot. And what I find interesting too, is okay, let's, let's assume for a moment that, you know, you're you're a client of this bank, And let's say you've borrowed from them, and you're positive, you're a depositor with them, you hold deposit account with them. And they and you're worried about the credit quality of the bank or something or like the solvency or what have you. Right. What does that say about you, as a depositor? Who decides to run? Right, the actual loans are, are, were made to you? Yeah. Right. And that's what I think is so important for people to understand that, you know, like, the way that that, you know, banks are such employees are so important to our, to our social fabric and to capitalism itself, is that the actual, the actual credits, are this in this case, were the same people that held deposits. Right. And then we're saying that this is this is built on shaky credits. Right.
Adam Rice:That is interesting. I hadn't thought about it that way. Right. Yeah, totally. So quick question for you. So after the SBB issue, all the other regional banks were affected, is that because they had similar credit profiles, and there was a fear that depositors would behave the same way once they examined the bank's assets and liabilities.
Ryan Benincasa:So more the latter less the former? Yeah, again, that the only fear was that there would be, you know, similar runs on these regional banks. You know, to the extent that depositors are worried about the, you know, the credit quality of the assets in the portfolio, or the bank's capital position, I mean, here's what I think people need to think about, too, is that depositors aren't, are not privileged, do not have privileged access to the banks, you know, to the nonpublic information of the of the bank's portfolio of assets. And so, I mean, Silicon Valley Bank, correct me if I'm wrong, I think it had, like, maybe a week before it collapsed. I think it had like a market cap of like 16 billion or something like that. I think that's right. Yeah. So you're telling me that this thing had six a $16 billion market cap? And that all those investors and and that doesn't even include the preferred the preferred shareholders? You know, the bondholders who own the subordinated, like, the the essentially, all forms of the bank's capital structure? Right? They didn't really seem to be too concerned. I mean, it has a$16 billion market cap, right, it was plenty, it had plenty of capital resources available to it. So I could see a, it. It's reasonable for me to see, okay, like, I've been told in subsequent days, oh, well, if you see a bank down 70% in a day, and you have uninsured deposits, you might think to yourself, hey, like, maybe I should just move my deposits to a different bank. Like that's pretty scary. You know, because of the bank doesn't have a ton of capital resources. Under again, you're on the line. If you're a depositor of the bank, you're on the liability side and essentially, any credit losses or or realized losses in securities portfolio or any losses would be in first you know, absorbed by everyone beneath you, right. So, the first priority claimants are the insured depositors. The next priority are are the uninsured depositors, the next priority are the general creditors, and the next priority would be like preferred and common stockholders. So, the way it works is the bank incurs losses, those are so those losses are supposed to be absorbed by first by the owners, the stockholders and then the preferred and then and then, you know, the bondholders and then and then like only, you know, until sufficient losses have have chewed away at at all, you know, all through that capital structure would Would that then, you know, potentially eat into the uninsured the pot There's sort of face value of their deposits. And, you know, this argument, again, this argument has been made that, oh, well, you know, they were hiding losses in the health maturities. Portfolio, well, it's like, well, those assets are held to maturity for a reason. And the reason is that they don't want to sell them. So, and selling them would require them to raise more capital, but this thing had 16 billion a $16 billion market cap. It's not like it was out of capital resources, right. So it makes no fundamental sense. If you are a long term, shareholder, and all these VCs love to talk about how, you know, they're long term focused, and visionaries and blah, blah, blah, you know, if you are truly long term focused, then everything that Silicon Valley Bank did, on the acid side of its balance sheet was perfectly reasonable, it invested in it loan to companies that it believed were, you know, important sort of innovative and entrepreneurial businesses that were disruptive and going to be successful in the long term. And it also purchased credit risk free treasury and agency MBS securities that were long duration, again, long term focus. So the shareholders, you know, of this bank were were likewise, you know, supposedly, long term focused, it wasn't until this, these short term focused, VCs decided to pull their money out these depositors that blew up the bank, right, and there's just simply no other, you know, people can go and sort of defend, you know, the actions of the of the VCs that pulled the money out. But at the end of the day, if they had done that the bank, again, this was it was very well capitalized, it had a massive market cap, it had access to capital, there's no reason that should have failed. You know, for anyone that was long term enough focus now, I'm not saying that you would have generated a good, you know, financial return, if you had held the bank, but, you know, there's no guarantees in life. And, and, oh, but except for the guarantee that the US Federal Government cannot run out of dollars. That is, that is a guarantee, that's definitely a guarantee. That's definitely a guarantee. But but my thing is like, that's not like the all this stuff about the held to maturity portfolio, the none of that led to the fall of, of Silicon Valley Bank, well led to the fall of Silicon Valley Bank, with Silicon Valley Bank, getting in bed with the wrong people with the wrong partners, who thought they were thought they were acting in their own self interest. But in reality, it were acting against their own self interest, right, by forcing this fulfilling prophecy. Yes, exactly. But I think it is important to emphasize it, that they thought they were acting in their own self interest. But in doing so, they were contributing to it's sort of like, I mean, I mean, there's so many analogies out there, but like, you know, masking is like a, you know, like a social kind of, you know, contentious thing that gets people going these days, it's like, well, you know, I'm going to exercise my, you know, free free liberty to not wear a mask, it's like, okay, well, guess what, you know, by not by, you know, not wearing a mask when we're dealing with a global pandemic, and there's people dying from COVID and stuff, especially during the surge times, you're actually making things worse for yourself, because, you know, people are dying. Hospitals are overrun, you know, it's straining are real resources, we're not, the economy's not gonna be able to grow as much, you're gonna get more bottlenecks, you're gonna get fewer workers available to, you know, to work, and that's going to lead to inflation. So yeah, there's a lot of social consequences that come with, you know, bit behaviors that are supposedly, you know, in in pursuit of your self interest, like people think they're pursuing their self interest, but they're really just shooting themselves in the foot. And that's exactly what I think happens here. Does that all makes sense? And is that do you kind of see see things sort of similarly?
Adam Rice:Yeah, I mean, that makes a lot of sense to me. And I appreciate the explanation. I am not as in the weeds on this stuff as you are. I don't think I have nearly as deep and understanding of how commercial banks work. But that does make sense to me. And it sounds like that's what happened here. So thank you for that explanation. Ryan. I think there's a million different directions we could go, but I actually do have to run. So we can pick this back up next week for sure. And hopefully we don't get some kind of financial crisis in the meantime.
Ryan Benincasa:Yeah, hopefully. All right. Well, this is great. Awesome stuff. Well, good luck out there, Adam and yet we'll be back soon.