On today’s show we’re taking another look at what is happening in banking and at some of the risks that are inherent.

The leaders at SVB made a strategic error. They failed to hedge their interest rate portfolio. After years of low interest rate policy and continued guidance from the Federal Reserve of another two years of low interest rates, the bank felt confident in buying long term bonds. These long bonds made up 89% of their securities portfolio, which ultimately left the bank in an illiquid situation where they could not convert bonds to cash without a financial impact. Last week the bank declared a $2B loss on the sale of securities. But In total, the value of their securities portfolio was down $17B on paper if they had to liquidate it all today.

Over the weekend, the Fed put an emergency tool in place to help similarly affected banks, regardless of size. If a lender has a bond that is in their “hold to maturity” category on their balance sheet, the Fed will allow the bank to borrow against that collateral at full face value.

Under the current rules, the banks are allowed to treat US treasuries as good as cash when calculating their reserves on deposit. Clearly a long bond that is trading at a discount in the market is not the same as cash as the folks at SVB found out.

It’s too bad that it’s too late for SVB.

The Fed’s actions over the weekend should be enough to restore the confidence in the banking system and prevent another similar run on mid-sized banks.

In aggregate, the entire US banking system is sitting on a huge pile of bonds that have fallen in value at a time when the Federal Reserve is reducing its balance sheet.

It is an issue that isn’t just concentrated in one or two banks: The FDIC has said that across all banks, there were about $620 billion in unrealized losses as of the end of last year. That number has likely increased since the start of the year.

So the big question on everyone’s mind is, “Is the banking system safe?”

The answer is, “We don’t know”. If we see depositors withdrawing cash on a large scale, the banking system could still fail, even with the measures introduced by the Fed this past weekend.

The logical mind says that the Fed has backstopped the banks and there should be no further concern.

But we have continued to see panic buying of Treasuries and T-Bills. The yield on the 6m TBill fell by 50 basis points on Monday morning and the 1 year TBill fell 63 basis points. The buying frenzy continued throughout the day on Monday. So much for logic prevailing. It seems that depositors are responding emotionally and pulling cash out of the bank and putting excess cash in short term Tbills.

Back in 2008, the toxic debt was subprime loans that were of low quality. This time, the toxic debt is supposedly the highest quality US Treasuries. If SVB is in trouble, then so is everyone else. If the Fed thinks they can wallpaper over it, they are extremely naive.


Host: Victor Menasce

email: podcast@victorjm.com