Silicon Valley Bank and Moral Hazard

Dedicated to diversity and regulated/supervised by a San Francisco Fed that was dedicated to diversity (see also “San Francisco Fed elevates a gay woman — its vice president — to the top job” (LA Times, 2018)), Silicon Valley Bank is being described as a casualty of its own wokeness. A friend who used to run a multi-$billion investment fund sent me this article by an economist, which attributes the need for an FDIC bailout… to the existence of the FDIC. Some excerpts:

The wrong way to think about moral hazard

Deposit insurance gives bank executive an incentive to take socially excessive risks. In some cases the risks won’t pay off. But that doesn’t mean executives don’t have an incentive to take excessive risks.

Things didn’t pan out for SVB. But that doesn’t mean their executives made an unwise gamble. It’s very possible that SVB’s strategy had a very high expected payoff, and they were simply hit by bad luck (rising interest rates.) Of course from a social perspective their decisions may have been bad, but not necessarily from a private perspective. “Heads I win, tails part of my losses are borne by taxpayers”. Of course I’d take more risk with those odds.

… back in the 1920s people cared a great deal about bank safety. Banks knew this, and managed their balance sheets far more conservatively than do modern banks. That’s why big city banks used to look like massive Greek temples; they had to convince depositors that they had the capital to survive hard times. The vast majority of big banks survived the Great Depression. US GDP in 1929 was about $100 billion and deposit losses during the Great Depression were $1.3 billion. Today, a 50% fall in NGDP (as in 1929-33) would wipe out almost our entire banking system. Modern bankers are far more reckless “despite” regulation. The negative effects of deposit insurance are far more important than the positive effects of regulation.

How do we get to Yglesias’s utopia [of more big banks]? Abolish deposit insurance (he wouldn’t agree). You’ll see a massive shift of deposits toward the larger, more diversified banks, making our system resemble the Canadian system.

FDR opposed deposit insurance, as he (correctly) feared it would create moral hazard. Unfortunately, Congress refused to listen to his good advice.

“FDIC fees are not a tax on the public.” Yes, they are.

“We aren’t bailing out bank executives”. No, we are not bailing out SVB executives, but we are (implicitly) bailing out their competitors.

I disagree with that last statement. The executives at SVB got to keep all of their big earnings from the big years that they had due to their aggressive risk-taking. Mary C. Daly gets to keep her $500,000+/year (including benefits) SF Fed compensation from incompetently supervising SVB. When things fell apart, none of these people had to pay anything back to the FDIC. It is the chumps with low-interest accounts at conservative banks who are left to pay.

Separately, I’m shocked that McKinsey wasn’t involved somehow in SVB! How can there be a group of elites robbing the peasants without McKinsey’s assistance? At least one of the usual suspects was there… “How Goldman’s Plan to Shore Up Silicon Valley Bank Crumbled” (WSJ):

Silicon Valley Bank executives went to Goldman Sachs Group Inc. in late February looking for advice: They needed to raise money but weren’t exactly sure how to do it.

Soaring interest rates had taken a heavy toll on the bank. Deposits and the value of the bank’s bond portfolio had fallen sharply. Moody’s Investors Service was preparing for a downgrade. The bank had to reset its finances to avoid a funding squeeze that would badly dent profits.

While few could have predicted the market’s violent reaction to the SVB disclosures, Goldman’s plan for the bank had a fatal flaw. It underestimated the danger that a deluge of bad news could spark a crisis of confidence, a development that can quickly fell a bank.

Goldman is the go-to adviser to the rich and the powerful. It arranges mergers, helps companies raise money and devises creative solutions to sticky situations of the financial variety—a talent that has made the firm billions.

Yet, for SVB, Goldman’s gold-plated advice came at the steepest possible cost. SVB collapsed at warp speed in the second-largest bank failure in U.S. history, setting off a trans-Atlantic banking crisis that regulators are working furiously to contain.

How big was the failure compared to the investments that are needed to build things with silicon? SVB’s pre-coronapanic/free-money-shower value was about $13 billion. A single Samsung fab is on track to cost 25 billion Bidies: “Samsung’s new Texas chip plant cost rises above $25 billion” (Reuters). The bump due to inflation in this one factory, according to the Reuters article, is in the same neighborhood as the SVB market cap, at least in nominal dollars.

We’re not hearing much about Signature Bank’s failure. For 8 years up to and including its seizure by the FDIC, Barney Frank was on the board: “Barney Frank defends role at Signature Bank: ‘I need to make money’” (FT):

FT says that Barney Frank made about $2 million by serving on the board of failed bank. None of that will be clawed back by the FDIC…

16 thoughts on “Silicon Valley Bank and Moral Hazard

  1. “But that doesn’t mean their executives made an unwise gamble. It’s very possible that SVB’s strategy had a very high expected payoff, and they were simply hit by bad luck (rising interest rates.) ”

    Patrick Boyle said SVB had nearly all of their value locked up in very-low-interest bonds that matured in 5+ years and that isn’t the standard practice (since it’s unnecessarily risky).

    • A lot of banks have long bonds but they also have time and energy to hedge against interest rate swings, which SVB and its diversity-minded regulator couldn’t be bothered with.

    • In terms of interest rate hedges:
      ” In December 2021, SVB had about $10 billion of interest rate swaps.
      Probably way too little to hedge the entire interest rate risk, but that’s not my point.

      In their financial statement, they show a clear understanding of what these swaps are for (red box below).
      Fast forward to December 2022, and basically ALL these hedges are gone.
      This is not just ignorance: a vast use of accounting tricks and a voluntary reduction of hedges.”

      In the middle of that, if I recall it was April 2022, their Chief Risk Officer left. It seems natural to wonder if she left due to being concerned about questionable things going on, or if the folks left behind really were clueless. They didn’t have a replacement until Jan. 2023.

      It seems like private deposit insurance that would risk weight premiums and have incentive to check on things might be the answer, with the caveats I haven’t researched the idea in depth to consider flaws. Just because the government took on the task doesn’t mean it needs to. One obvious concerns is of course the risk they’d expect the government to bail out the insurance fund if needed so it would also have flawed incentives. Regardless it seems like some private mechanisms should be able to be created to provide incentive for someone to keep an appropriate eye on things.

      Cato and other sources suggest that changes in regulation didn’t absolve the federal agencies from monitoring what was going on in ways they obviously didn’t do.

      That said: its unclear how many banks could stand up to the same % run, $42+ billion in one day forcing them to dig into their HTM (hold to maturity) holdings that weren’t marked to market: which it sounds like forces the entire pool to be marked to market when that category of assets is touched. It sounds like they might have been able to find a way to stay afloat: if they hadn’t triggered a panic, which is why insiders agree with my first reaction to it being the CEO’s PR about the issue that triggered the run:
      “‘Absolutely idiotic’. SVB insider says employees are angry with CEO”

    • “ A lot of banks have long bonds but they also have time and energy to hedge against interest rate swings, which SVB and its diversity-minded regulator couldn’t be bothered with.”

      Yes, banks have long-term bonds (and hedge interest rates). Boyle talks about that in the video.

      SVB “only” had long-term low-interest bonds.

  2. And then they say US is a capitalist society. How is this not pure socialism if all the banks are effectively owned and run by the state when they’re “too big to fail”?

  3. High interest rates were not just bad luck. Interest rates were kept artificially low. Govt spending was being ramped up, as if no one had to pay for it. The party could not last forever. Everybody knew that.

  4. Nonsense: “Deposit insurance gives bank executive an incentive to take socially excessive risks.”
    Fate of executives of failed bank if Fed has to step in and cover depositors many is not much better if Fed would not cover depositors losses, everything else being equal..

  5. If you trivialize, debase and jettison the morals, there ain’t no “moral hazard!”

  6. The bank failure per se is not very interesting. The bank wealthy depositors’ behavior is a true enigma. How could the Roku CFO, for example, not use widely available instruments to manage cash risks and avoid a potential loss (that has been prevented by the government bailout) ? Saying that he was stupid does not really explain this sort of behavior. Anticipating smartalec comments, he could not predict government intervention either.

    Interestingly, the WSJ writes: “SVB was lenient when it came to underwriting loans, according to founders and investors, which allowed the bank to dominate the venture debt business and underwrite transactions that larger banks deemed too risky.”

    One could speculate that the loan part of the SVB assets is perhaps of dubious quality which made the PNC abandon the auction.

    • What does Roku do? Shows a bunch of movies? A teenager can run Roku out of parents’ basement.

  7. The lesson learned during the financial crisis was that execs should get a large share of their compensation in stock that vests over time.

    If they blow up the bank, a large part of their pay from the last several years disappears.

    In the case of SVB’s CEO, his compensation from 2022 was $9.9M, broken down as $1M salary (cash), $1.5M bonus (cash), and $7.3M in stock and stock options.

    That’s around 75% stock, which seems like decent to me.

    * For all the Warren fans who hang out on this blog, in her NYTimes editorial, she conveniently missed/hid the fact that these bonuses were in stock

    “Finally, if we are to deter this kind of risky behavior from happening again, it’s critical that those responsible not be rewarded. S.V.B. and Signature shareholders will be wiped out, but their executives must also be held accountable. Mr. Becker of S.V.B. took home $9.9 million in compensation last year, including a $1.5 million bonus for boosting bank profitability [ … ] We should claw all of that back, along with bonuses for other executives at these banks.”

    So she’s claiming we claw back worthless stock.

    I might be wrong, but I always assume that Warren is smart enough to know better, so this is just straight deception.

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