The Tide Goes Out, and Silicon Valley Bank Already Drowned
In financial markets, the tide has been going out for a while and is still receding. To paraphrase Warren Buffett, we are starting to get a good look at who has been swimming naked. It isn’t pretty.
Silicon Valley Bank was suddenly and brutally exposed last week halfway up the beach, clutching to its nether regions the shrinking hand towel of a capital raise that was quickly snatched away by panicking depositors. After futile CPR efforts, the bank eventually collapsed into the arms of the regulatory lifeguards.
The crowd of cocky crypto kids ditched their designer swimsuits a while ago and now, with the surf rapidly retreating, are either going to be swept out to sea along with some of the financial institutions that supplied them or, like
find themselves in the custody of the beach patrol, trying to explain how exactly they paid for that pricey house overlooking the ocean.
It’s a good bet there will be more red-faced and imperiled financial nudists. Out there in the shallowing waters of the midsize banking sector, a handful of institutions are crouching lower and lower in a desperate bid to hide their shriveling assets. These are lenders that, during the zero-interest “new normal” era we were assured was infinite, relied on big, uninsured deposits for funding and then recycled the money into long-dated assets. As infinity shrank and interest rates rose in the past year, they’ve been squeezed on both sides of the balance sheet. On the liabilities side the big depositors are no longer quite so flush, and their federally unprotected hot money is seeking—with a tap on a smartphone app—safer harbor. On the asset side, the value of the Treasury bonds and mortgage-backed securities the banks hold has plummeted. The government’s move over the weekend to save even the uninsured deposits at SVB may help calm the waters.
In every financial crisis there’s a lot of tut-tutting from commentators about the risks of duration-mismatching your assets and liabilities, but in fairness that has always been how you make real money in banking. No one ever earned a living taking in free money from depositors and stuffing it in the bank vault. And while it seems that some of SVB’s risk managers might have better spent their time investigating hedging strategies rather than promoting social justice, it’s not as though they were funneling depositors’ funds into the accounts of distressed Nigerian princes or prospectuses for tulip bulbs. Who knew that 10-year Treasurys would be such a high-risk bet?
Which brings us to the big boys and girls in the water with egg on their faces and nothing below the waist—the so-called leaders responsible for our deepening mess, the ones who should be truly ashamed now that their vanity and complacency have been exposed. Imprudent bankers weren’t the only ones who believed the high financial tide was permanent.
You didn’t have to be an ironist to take grim enjoyment in the spectacle of a Senate hearing last week where Sen. Elizabeth Warren berated Jerome Powell, chairman of the Federal Reserve, for hiking interest rates to curb inflation, presumably raising unemployment in the process.
The senator who in word and deed has been insisting for years that federal authorities can keep pumping money into the economy is now furious that the central bank is trying belatedly to smother the inflation she helped generate. How dare he raise rates to restore stability?
It was like listening to an arsonist spitting outrage at the firefighter who has just ruined her collection of antiques with flame retardant.
The only problem with the analogy is that in this case the firefighter is as much to blame as the arsonist for the fire. For years the Fed under Mr. Powell—and his predecessor, now helpfully secretary of the Treasury—encouraged the belief that zero interest rates and quantitative easing to the tune of trillions of dollars in balance-sheet expansion was a riskless exercise that could easily be reversed without harm. When the logic of financial and fiscal incontinence asserted itself—as it always does—Mr. Powell and
repeatedly tried to convince us that the resultant inflation was “transitory.”
There will be more pain—some of it narrowly focused and more of it widely distributed throughout the economy.
We will get by as a society with the impoverishment of some bitcoin investors. We will even survive the collapse of a few second-division financial institutions.
But the tech firms and others whose money at Silicon Valley Bank is now inaccessible offer a reminder of the damage that the unraveling of overextended financial conditions can do to investment and entrepreneurship. And the new “new normal” (like the old normal) of mid-single-digit interest rates will surely reap a bitter harvest for millions more. On this at least Ms. Warren is right—it is a tragedy that the Fed has to put so many people out of work to kill the inflation it helped let rip.
That’s the difference between working for the government and working for yourself. When you’re an employee, a small-business owner or an enterprising investor, nothing spares your blushes—and hurt—when the tide goes out. But if you’re from the government, there’s always someone to hand you a fresh towel and help you back to safety.
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Appeared in the March 14, 2023, print edition.