“Let’s talk about the important story here, which is the fact that Silicon Valley Bank came under pressure because of something very elementary, and frankly not so much their fault,” Tawil told Sputnik on Friday.
SVB fell victim to the Federal Reserve’s policy of raising interest rates too high, too fast, according to the observer.
“What banks usually do is they take in deposits and they make loans. Most of the capital is usually held in some very safe instruments, like United States Treasury debt,” Tawil explained. Consequently, SVB bought as many of these very low yielding Treasuries as they could with the depositary funds they had on hand to at least slow if not stop the inflationary depreciation of the cash they had on hand.
“As we know, the Federal Reserve has hiked rates a lot and people are getting very concerned about interest rates going even higher. Therefore, those bonds, because they had such low yield to them, became worth less and less over time. Now, if a bank holds securities and the capital they have on hand because of those securities is worth less, the bank needs to come up with more money because they have constant testing and monitoring by the banking regulators of how much money, or how much cash and liquid securities they have on hand versus the deposits that they owe to depositors," the expert said.
"And unfortunately, they got to a point where the draw down on the value of those Treasury securities they held was so great that they needed to put up more and more money, which meant they needed to go ahead and sell those Treasuries at a loss, because interest rates are going higher."
This resulted in a spiraling crisis in which whatever cash SVB could get from Treasuries would be handed over to depositors, and the bank would need to sell off even more of the lower valued bonds to come up with the cash.
“At some point it got out, in this age of social media and easy communication that we live in, that things were getting somewhat fragile over at the bank, and all of a sudden, we have this big run on the bank where lots of depositors are scared to keep their money there because they don’t know how long the bank is going to be around for,” Tawil explained.
The observer reiterated that based off publicly available information, SVB’s failure wasn’t the result of it being poorly run, any sort of financial impropriety, or fraud. Depositors simply “got the sense that the bank was on shaky grounds…and ran to withdraw their money, and the overwhelming demand for deposits put the bank under strain to the point where the bank regulator in California needed to go ahead and step in to take over the bank.”
Fed’s Wrecking Ball
SVB’s collapse is indicative of a couple things, Tawil says.
“First off with respect to Silicon Valley, it’s indicative of the slowdown there. I think in the wake of a low interest rate environment being over, easy money not being so easy anymore and these startups not getting capital so easily anymore, it means that there aren’t increasing deposits into Silicon Valley Bank. In other words, if there was more money coming in, they wouldn’t have had this problem. Unfortunately these venture capital-funded companies had to take money out. They’re firing employees, they’re shrinking, they’re obviously not doing as well as they were before, their investors aren’t investing as much money. Therefore there is a general slowdown going on in Silicon Valley, and frankly it’s going on all across the country,” he said.
“But on top of that there is another broader point to be made, which is that the Fed’s interest rate hikes are hurting investors that have invested previously in government securities that were yielding a lot less. That puts a strain on every bank. Every bank owns Treasuries; instead of having the money sitting in cash they want it to earn some form of return, but unfortunately it’s not earning as much of a return as if you’d put the money in to work today. Therefore, the Treasuries you bought six months ago or 12 months ago are worth less today. You’ve lost as a bank on that investment."
"That is an additional theme that we need to think about, which is – the Fed raising rates has knock-on effects not only on people who are borrowing money today but for people who went ahead and lent money at lower rates months ago,” Tawil stressed.
The expert said SVB’s failure was “astounding” in the sense that it was the largest bank collapse since the 2007-2008 crisis, but transpired in a space of 24 hours.
It also remains to be seen whether the collapse will cause a domino effect of bank failures, Tawil said.
“The sector has been rattled. Other regional banks like SVB, although not the exact same in terms of being so focused on Silicon Valley and venture capital, have been similarly rocked by way of speculation about their health and regarding their stock price. At a number of banks their stock was down 20 percent or more today. But they all have a different mix of business, different types of depositors, different types of assets that they’re exposed to. So there’s no way of knowing yet if we’re going to see these types of failures, but the difficulty that happened over the last 24 hours with the Silicon Valley Bank certainly puts everybody on edge.”
Biden’s ‘Dysfunctional’ Response Predictable
Asked to predict how the Biden administration and Congress will respond to the crisis, Tawil suggested that unfortunately, the prospects don’t look good.
“Let’s be absolutely clear: we have a dysfunctional White House, we have a dysfunctional Congress and that’s a big part of the problem. There is nothing that gets done in Washington except at points of emergency – this is an emergency because of the failure of a top 20 bank. What will Congress do? Congress will hold hearings, so they’ll go ahead and grill executives a) for the benefit of the public, and b) for their own egos. The president may come out and say ‘well, we were able to contain this to just one bank,’ or he may be able to go ahead and strike up the agenda that this is all about the venture capitalists…But frankly I don’t expect anything substantive to be done out of Washington,” he said.
Comparable to Bankman-Fried and FTX?
Tawil emphasized that SVB’s failure illustrates a a “much more fundamental” problem in the US financial sector than the recent collapse of Sam Bankman-Fried’s FTX Ponzi scheme, although the causes were very different (Fed policy hitting an apparently legally upright bank vs bald-faced fraud), because SVB’s collapse could undermine faith in the entire banking system.
Speaking before lawmakers last Tuesday, Fed Chairman Jerome Powell said “the ultimate level of interest rates is likely to be higher than previously anticipated,” and that if warranted, the Federal Reserve will be “prepared to increase the pace of rate hikes.”
In light of SVB’s collapse, further rate hikes could be disastrous, Tawil warned, saying even more banks could collapse and depositors and investors left out in the cold.
“I think Powell is in a pretty precarious position. Thankfully for him, the decision [on rates] is two or three weeks away. Imagine if it was next week, on the heels very quickly of this bank failure. Is he going to try to explain away this bank failure and say the Fed really had nothing to do with it, and that these guys really shouldn’t have been invested in the things they were invested in and they just weren’t prudent? Or [reach] the conclusion that…rates went too high too quickly for these banks to be able to recalibrate their balance sheets in order to go ahead and be able to hold together their business?"
"The banking business is not meant to be a high stakes business. You’re supposed to take in deposits at a certain interest rate, you’re supposed to lend out money at a higher interest rate and make a spread in between and that’s your profit. It’s not swinging for the fences. And Powell and the Fed should certainly not be in the business or have the agenda of ‘we’re going to raise rates and kill inflation no matter how many banks we need to destroy along the way.’ That would be awful,” Tawil summed up.