In the Financial Times yesterday, Gillian Tett blamed the collapse of Silicon Valley Bank on regulators “fighting the last war”:
Thus it has been easier for everyone in the system to talk about the last war — ie credit risk — while ignoring the elephant in the room. Doubly so since the Basel regulatory framework assigns a zero risk weighting to government bonds, precisely because they are supposed to be super safe.
While there’s an element of truth to the cliché about fighting the last war, the idea the Basel Framework regulators were unconcerned with interest rate risk is false, as I pointed out to her on Twitter.
Gillian, "Interest Rate Risk" appears 96 times in the Basel Framework, comparable to "Liquidity Risk" (99 times). You can search for yourself here: https://t.co/V1RBYLM5Dn
Tett responded by doubling down, but obviously the BIS regulators were aware of interest rate risk.
The BIS framework considers government bonds to be zero credit risk, not zero interest rate risk, and has plenty to say about limiting Interest Rate Risk in the Banking Book ("IRRBB"), e.g., below. pic.twitter.com/35gVWaqxTG
The problem is that Silicon Valley bank did nothing to hedge its interest rate risk, as I wrote over the weekend (“Could Your Bank Be Next?“):
Could SVB Have Prevented This?
Sure. They could have hedged their interest rate risk. Why didn’t they? I don’t know, but it looks like the Head of Financial Risk Management & Model Risk at their UK subsidiary had other priorities, such as heading the LGBTQ+ employee resource group and helping to spread awareness of lived queer experiences, partner with charitable organizations, and above all, create a sense of community for our LGBTQ+ employees and allies.
The Wall Street Journal agreed with my suggestion that the bank’s focus on wokeness/diversity likely distracted from its risk management:
This is real from the WSJ why SVB failed:
… besides 91% of their board being independent & 45% women, they also have “1 Black,” “1 LGBTQ+” and “2 Veterans.” I’m not saying 12 white men would have avoided this mess, but the company may have been distracted by diversity demands. pic.twitter.com/eIfGiwh679
At the risk of fighting the last war, a couple of ideas seem worth considering here.
Raising the FDIC deposit insurance limit from $250k to whatever would cover most small businesses, while increasing the deposit insurance assessments (insurance premiums) sufficiently to fully pay for it. As economist Justin Wolfers has noted, there have been fewer bank runs in the deposit insurance era. And since the government just bailed out depositors with more than $250k in their accounts anyway, why not make the policy explicit, and raise the necessary resources for it?
Make bank insiders put more skin in the game, so they have less incentive to socialize the costs after privatizing profits. Claims that the government didn’t bailout bank management and insiders because management got removed and insiders’ equity went to zero elides all the money (including from scheduled insider stock sales) that bank insiders collected for years. A simple way to do this would be to hold their bonuses and proceeds from stock sales in escrow for a year, and make them forfeit those monies if their bank fails within a year.
Fighting Inflation While Saving Banks
The point of the meme above is that if the Fed continues to raise rates to fight inflation, it will put more banks that haven’t managed their interest rate risk competently at risk of collapse. But there’s another way to fight inflation without raising rates: by raising taxes, particularly in a regressive (broad-based) way. After all, if the government giving people money is a cure for disinflationary recessions, taking money from them is a cure for inflationary periods. Indeed, this is what Modern Monetary Theory (MMT) calls for during periods of high inflation.
President Biden could squint into a TV camera, and tell his fellow Americans that the government is temporarily raising the payroll tax by 2% or something like that, ostensibly to shore up Medicare, but with the real purpose being to take money out of workers’ pockets so they have less to spend.
Of course, I don’t expect the government to do this, which highlights a big flaw in MMT: it’s a lot easier, politically, to give money to the masses than to tax it back from them.
Since The Government’s Not Doing That…
Since the government isn’t doing any of that, on our trading Substack, we took advantage of the bounce yesterday to bet against a few banks that have some similar weaknesses as Silvergate Capital, Silicon Valley Bank, and Signature Bank.
Taking advantage of today’s rally to bet against a few banks that have some similar vulnerabilities as $SI, $SIVB, & $SBNY. https://t.co/uePET5GOut
Specifically, we identified a few regional banks with these characteristics:
Deposits comprise more than 80% of its liabilities.
Deposits less than $250k (the FDIC deposit insurance limit) as a % of total deposits. I replaced Tier One Leverage Ratio with this, because this seemed more relevant to the recent bank crashes. This figure was 39.7% for Silvergate Capital (SI), 19.8% for First Republic Bank (FRC), 6.2% for Signature Bank (SBNY), and 2.7% for Silicon Valley Bank (SIVB). All three names I ended up with (including my original name) had percentages less than Silvergate Capital on this metric.
A Piotroski F-Score of 2 or less. The two new names I found have Piotroski F-Scores of 1, even worse.
Failing Portfolio Armor’s test of options market sentiment. All three names failed this test.
I went into more detail in that post about the meaning of those metrics, but as I mentioned there, there doesn’t seem to be one metric alone that’s sufficient to isolate banks worth betting against. Hence our use of a few combined. If you’d like a heads up next time we enter or exit a trade, feel free to sign up for our Substack/occasional email list here.
