This post originally appeared on March 13, 2023
Over the past few days, we’ve seen the failure of Silicon Valley Bank ($SIVB) and Signature Bank ($SBNY) as well as a government decision to bail out the deposit accounts with more than $250K. That’s in excess of FDIC regulations and was described by officials as not a bailout despite being a bailout. We were also told that the system remains sound except that the actions taken needed to be taken to prevent failure of the well-operating system.
Because no one learned anything in 2008, we have an incredible cascade of failures. We’re going to catalogue several of them for you here. Please note that this isn’t schadenfreude where people take joy at the misfortunes of others. This is a warning. Once you see that the same errors were made by the same people and institutions, our hope is that you never extend your trust to those individuals and organizations again. Like many Americans, I’m angry because we’re going to get the bill for this nonsense.
The Sell Side:
We’ve been regularly critical of the sell-side because they pretend to offer investors stock ratings. However, those ratings are not intended to be honest. They are advertising for the investment banking services of the analysts’ firms. Despite some glaringly obvious problems with Silicon Valley Bancorp’s business model, when the company failed, only one of the 17 analysts who covered the company had a sell rating.
That’s right – when a company that failed and was closed by regulators, only one of 17 indicated a problem. Congratulations to Morgan Stanley on this one. And if you’re reading research from any of the other 16 firms who covered $SIVB, we hope it’s for entertainment value.
We were all assured in 2008 that the bank bailouts were unfortunate and wrong, and a one-time thing necessary to keep the whole system from collapsing. Janet Yellen and the regulators can keep saying this isn’t a bank bailout and celebrate that the bank execs will lose their jobs and shareholders will lose their money. But they’re bailing out most of the depositors. The best part is they’re claiming a bailout of the completely stable banking system was necessary to ensure no one lost confidence in the system.
Half of Twitter spent the weekend insisting that no one should be held responsible for losses in their accounts because the regulators hadn’t sounded the alarm. We’d like to know why anyone STILL trusts the regulators to sound the alarm before disaster strikes.
Our suggestion is to give Janet Yellen and the Federal Reserve a hot dog stand. When they show they can be responsible with that, we can consider something with greater responsibility.
The Risk Team at Silicon Valley Bancorp:
The Chief Administrative Officer at $SIVB was the CFO at Lehman before the 2008 collapse. You’d think that would be the lede here, but somehow, that’s not even the worst of management malfeasance. The bank’s Head of Financial Risk Management & Model Risk appears to have been focused on issues of a deeply personal nature.
I don’t care what people do in the privacy of their own home. But this bank failure was caused by billions of dollars of losses because no one at Silicon Valley understood duration risk. The person who was supposed to be monitoring and evaluating this kind of risk was otherwise engaged.
One of the more remarkable parts of the 2008 financial crisis was that despite epic levels of bad debt in the system, the ratings agencies still rated everyone investment grade. The reason for this was because the companies that Moody’s rates pay for the rating. The system is that corrupt and full of conflict.
Somehow, 15 years later, we’re still seeing the same behavior out of the same companies in the same system. As late as Friday, Moody’s rated $SIVB investment grade. Last Wednesday, they downgraded Silicon Valley, but kept it investment grade. Finally, on Friday, they downgraded to speculative (junk). At this point, the bank was heading to closure.
There was much garment rending on Twitter over the weekend by the thought that if depositors weren’t bailed out, then thousands of “normal” people would go without paychecks. These were supposedly the smart, creative start-up engines of Silicon Valley who were going to have to go without paychecks through no fault of their own.
This is not accurate.
First, businesses fail all the time. When they do, people lose their jobs. It’s not pretty and can be a terrible blow. But if people want the stratospheric upside of start-up riches, then they’re going to have to take the risk of business failures.
Second, the companies that had hundreds of millions of dollars of deposits had CFOs who should have known better. The problems at $SIVB weren’t so hard to figure out. But executives at their client companies were incentivized to ignore the problem. The bank enticed them with above-market interest rates, special mortgages, and lines of credit they couldn’t get elsewhere.
Over the last couple of years, I’ve ignored everyone who tried to convince me to lend out my Bitcoin for 8% – 20% “risk free”. I explained to people that there was no “free money” and the reason you could get such great “free” returns was because you were taking counter-party risk. $SIVB clients ignored the risk of banking at one institution with both industry and asset concentration problems. They got paid for that risk. Now that it didn’t work out, they want someone else to cover their losses.
Finally, the entire money-losing startup ecosystem was created and funded by more than a decade of zero interest rates. As people had no opportunity to earn yield, they did more and more risky things to get some sort of return. That combined with trillions of dollars of “stimmies” flooded the investment market and made funding money-losing operations seem like a good idea. The Federal Reserve tightening that so many think caused this banking problem is actually the solution to the problem they started 15 years ago.
Literally every institution and warning system that failed in 2008 is still failing in the same way. As always, there’s no point in getting upset. However, we recommend withdrawing all trust from every one of these institutions until they demonstrate an ability to do their jobs with some degree of seriousness.
If you have questions about this subject or report, I’m reachable at IR@DeepKnowledgeInvesting.com.
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