The guest commentary below was written by written by Daniel Lacalle. This piece does not necessarily reflect the opinions of Hedgeye.
The Silicon Valley Bank Collapse Is a Direct Consequence of Loose Monetary Policy.
The second largest collapse of a bank in recent history after Lehman Brothers could have been prevented. Now, the impact is too large, and the contagion risk is difficult to measure.
The demise of the Silicon Valley Bank (SVB) is a classic bank run driven by a liquidity event, but the important lesson for everyone is that the enormity of the unrealized losses and financial hole in the bank’s accounts would have not existed if it were not for ultra-loose monetary policy. Let us explain why.
As of December 31, 2022, Silicon Valley Bank had approximately $209.0 billion in total assets and about $175.4 billion in total deposits, according to their public accounts. Their top shareholders are Vanguard Group (11.3%), BlackRock (8.1%), StateStreet (5.2%) and the Swedish pension fund Alecta (4.5%).
The incredible growth and success of SVB could not have happened without negative rates, ultra-loose monetary policy, and the tech bubble that burst in 2022. Furthermore, the bank’s liquidity event could not have happened without the regulatory and monetary policy incentives to accumulate sovereign debt and mortgage-backed securities.
The asset base of Silicon SVB read like the clearest example of the old mantra: “Don’t fight the Fed.” SVB made one big mistake: Follow exactly the incentives created by loose monetary policy and regulation.
What happened in 2021? Massive success that, unfortunately, was also the first step to its demise. The bank’s deposits nearly doubled with the tech boom. Everyone wanted a piece of the unstoppable new tech paradigm. SVB’s assets also rose and almost doubled.
The bank’s assets rose in value. More than 40% were long-dated Treasuries and mortgage-backed securities (MBS). The rest were seemingly world-conquering new tech and venture capital investments.
Most of those “low risk” bonds and securities were held to maturity. They were following the mainstream rulebook: Low-risk assets to balance the risk in venture capital investments. When the Federal Reserve raised interest rates, they must have been shocked.
The entire asset base of SVB was one single bet: Low rates and quantitative easing for longer. Tech valuations soared in the period of loose monetary policy and the best way to hedge that risk was with Treasuries and MBS. Why would they bet on anything else? This is what the Fed was buying in billions every month, these were the lowest risk assets according to all regulations and, according to the Fed and all mainstream economists, inflation was purely “transitory,” a base-effect anecdote. What could go wrong?
Inflation was not transitory and easy money was not endless.
Rate hikes happened. And they caught the bank suffering massive losses everywhere. Goodbye bonds and MBS price. Goodbye tech “new paradigm” valuations. And hello panic. A good old bank run, despite the strong recovery of the SVB shares in January. Mark-to-market unrealized losses of $15 billion were almost 100% of the market capitalization of the bank. Wipe out.
As the famous episode of South Park said: “…Aaaaand it’s gone.” SVB showed how quickly the capital of a bank can dissolve in front of our eyes.
The Federal Deposit Insurance Corporation (FDIC) will step in, but it is not enough because only 3% of the deposits of SVB were less than $250,000. According to Time Magazine, more than 85% of Silicon Valley’s Bank’s deposits were not insured.
It is worse. One third of U.S. deposits are in small banks and around half are uninsured, according to Bloomberg. Depositors at SVB will likely lose most of their money and this will also create significant uncertainty in other entities.
SVB was the poster boy of banking management by the book. They followed a conservative policy of adding the safest assets — long-dated Treasury bills — as deposits soared.
SVB did exactly what those that blamed the 2008 crisis on “de-regulation” recommended. SVB was a boring and conservative bank that invested the rising deposits in sovereign bonds and mortgage-backed securities and believed that inflation was transitory as everyone except us, the crazy minority, repeated.
SVB did nothing but follow regulation and monetary policy incentives and Keynesian economists’ recommendations point by point. SVB was the epitome of mainstream economic thinking. And mainstream killed the tech star.
Many will now blame greed, capitalism and lack of regulation but guess what? More regulation would have done nothing because regulation and policy incentivize adding these “low risk” assets. Furthermore, regulation and monetary policy are directly responsible for the tech bubble. The increasingly elevated valuations of non-profitable tech and the allegedly unstoppable flow of capital to fund innovation and green investments would never have happened without negative real rates, and massive liquidity injections. In the case of SVB, its phenomenal growth in 2021 is a direct consequence of the insane monetary policy implemented in 2020, when the major central banks increased their balance sheet to $20 trillion as if nothing would happen.
SVB is a casualty of the narrative that money printing does not cause inflation and can continue forever. They embraced it wholeheartedly, and now they are gone.
SVB invested in the entire bubble of everything: Sovereign bonds, MBS and tech. Did they do it because they were stupid or reckless? No. They did it because they perceived that there was exceptionally low to no risk in those assets. No bank accumulates risk in an asset they believe has considerable risk. The only way in which a bank accumulates risk is if they perceive that there is none. Why do they perceive it? Because the government, regulators, central bank, and the experts tell them so. Who will be next?
Many will blame everything except the perverse incentives and bubbles created by monetary policy and regulation and will demand rate cuts and quantitative easing to solve the problem. It will only worsen. You do not solve the consequences of a bubble with more bubbles.
The demise of Silicon Valley Bank highlights the enormity of the problem of risk accumulation by political design. SVB did not collapse due to reckless management, but because they did exactly what Keynesians and monetary interventionists wanted them to do.
This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap. This piece does not necessarily reflect the opinions of Hedgeye.