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The Collapse Of SVB Portends Real Dangers

Authored by Jeffrey Tucker via The Epoch Times,

https://www.theepochtimes.com/the-collapse-of-svb-portends-real-dangers_5115178.html

Thus far in this 3-year fiasco of mismanagement and corruption, we’ve
avoided a financial crisis. That’s for specific reasons. We just had
not traveled there in the trajectory of the inevitable. Are we there
yet? Maybe. In any case, the speed of change is accelerating. All that
awaits is to observe the extent of the contagion.

The failure of the Silicon Valley Bank (SVB), $212 billion in assets
until only recently, is a huge mess and a possible foreshadowing. Its
fixed-rate bond holdings declined rapidly in market valuation due to
changed market conditions. Its portfolio crashed further due to a
depositor run. And it all happened in less than a few days.

It’s all an extension of Fed policy to curb inflation, reversing a
13-year zero-rate policy. This of course pushed up rates in the middle
and right side of the yield curve, devaluing existing bond holdings
locked into older rate patterns. Investors noticed and then depositors
too. The high-flying institution that specialized in providing
liquidity in industries that have lost their luster suddenly found
itself very vulnerable.

In addition, the bank was exposed with a portfolio of collateralized
mortgage obligations and mortgage-backed securities. But with rates
rising, those are coming under stress too as high leverage in housing
and real estate become untenable amidst falling valuations. Borrowers
are finding themselves under water and that in turn adds to stress on
lenders.

And where did SVB, and the entire banking industry, get the funds to
bulk up their portfolios with such debt holdings? You guessed it:
stimulus payments. Billions flooded in and it had to be parked
somewhere making some return. At the time it seemed like a good deal,
until Fed policy changed.

A house of cards comes to mind. But perhaps a better metaphor is a
game of billiards in which every move introduces a cascade of new
issues. Lockdowns prompted immense government spending which produced
debt that was quickly monetized and eventually caused inflation,
prompting the Fed to reverse course with the largest/fastest rate
increases in history.

This destabilized (or restabilized) production structures away from
the right side of the yield curve toward the left, shifting capital in
search of return to the consumer-goods sector. Labor has begun to
follow, thus creating a surplus of resources in information tech and a
shortage in retails.

It was always naïve to think that this shift would take place without
touching the banking institutions that shoveled leverage in the
direction of industries that thrived during lockdowns but are cutting
back massively now.

These banks are exposed in speculative ventures from which capital is
fleeing. Their asset portfolios were tied, as usual, to a continuation
of the status quo that stopped continuing, so investors and depositors
are fleeing to safety.

Could the Fed have anticipated this? Probably. But what choice did it
have? Again, this entire mess traces first to lockdowns and second to
Ben Bernanke’s preposterous policies as Fed Chair in 2008. He imagined
that he would fix a financial crisis by abolishing a natural force
like interest rates on bonds. Then he pulled a fancy trick of keeping
his “quantitative easing” off the streets by having the Fed pay more
for deposits than the same money could earn in markets.

What was the problem? The problem was that capital is never still. It
is always on the hunt for return. It found it in Big Tech and internet
media, bolstered by seemingly infinite resources for advertising and
hiring. This further caused an absolute gutting of normal rates of
saving simply because there was no money in it. This situation
persisted for a good 13 years.

Jerome Powell took over the Fed with the determination to put an end
to the nonsense. He hoped for a soft landing. But then came the
pandemic lockdowns. He was called upon to provide funding for the
idiocy of a panicked Congress that spent many trillions as fast as
possible, which only perpetuated lockdowns.

Everything seemed fine for a while, as it always does, but by January
2021, the bill came due in the form of roaring price inflation. The
Fed had to reverse course dramatically. Starting at zero, it had to
get federal funds rates to equal or exceed price increases (the
terminal rate). It is not there yet so it has no choice but to barrel
ahead.

The rate increases of course drew capital out of the industries that
thrived over the lockdown period and back to retail and consumer
goods. But meanwhile, the yield curve responded, as it must. From 30
days to 30 years, every bond offering was repriced, causing
institutions holding old bonds to look like chumps. This is where SVB
found itself, with a suddenly declining market valuation.

The coup de grâce was depositor behavior. In the search for safety,
cash has found the return on short-term Treasuries far more attractive
than speculative ventures. The flight to safety doomed the bank and
its many partners in the financial industry. It’s a huge wake-up call
for the whole of markets. No one in the industry is sitting
comfortably today.

My concern here is that people will look at all these disasters in
isolation. They are not isolated. They trace to the catastrophic
decision in 2020 to lock down and fund those policies with money that
did not exist until it was created.

That decision doomed the Fed’s plans to unravel its previous stupid
policies and thus set us on the course toward calamity.

At this point, I’m sorry to report, no one is in a position to stop
anything. Markets can be ferocious under these conditions. Markets are
not all knowing but once they lose trust, there is no stopping the
stampede of incredulity. There is no one at the Fed who can stop it
and no wise managers at the top who can patch things up.

Take note of the collapse of bank stocks only hours after regulators
took over SVB. My friends, we could be in for a wild ride. Stay safe.