First thing’s first: the financial system is much better capitalized than it was in 2007. The extreme leverage no longer exists within major financial institutions and regulations are far more restrictive.
With that said, in 2007 most people thought the financial system was sound then too.
Lesson: Listen to all sides of the story and be skeptical of both the bulls and bears.
What happened to Silicon Valley Bank?
Over the past two days, Silicon Valley Bank has hit front page news and just hours ago was shut down by regulators.
So what happened?
In a nutshell, the bank had a huge inflow of deposits during the tech bubble of 2020-2021, invested that money in government bonds (standard practice) and subsequently experienced huge losses on those securities. This effectively led to liquidity concerns and a run on deposits - the rest is fresh history.
Now Silicon Valley Bank is owned by the taxpayer, as the government strives to keep depositors whole.
This has sent the markets into a tailspin as PTSD from the 2008 Global Financial Crisis resurfaces. The complexity and interdependence of financial markets almost assures that there will be knock-on effects. Shell-shocked investors that lived through the GFC are asking “who’s next”?
With all this generalized market anxiety, the two-year US Treasury is rallying unusually hard. Yields are down about 44bps in two days, matching moves seen around major historical financial crises. Is this unwarranted? Tough to say.
What comes after the Silicon Valley Bank collapse?
Over the next couple weeks the news flow will undoubtedly move on to something different. And Silicon Valley Bank will be a faint memory.
We must, however, remember that financial crises don’t go from 0 to 100 overnight. They build slowly, problems compounding over time.
Jay Powell has repeatedly told us that the effects of restrictive monetary policy have yet to be felt.
There were almost two years between the peak Fed Funds Rate in August 2006 and the Lehman Brothers collapse in September 2008. Lags indeed.
Of course, to say the lag was two years isn’t entirely accurate. Between August 2006 and September 2008 were many bumps in the night that hit the newswires for a day and then disappeared.
2006-2008 Global Financial Crisis timeline:
2006: Warnings about housing downturn
August 2006: Yield curve inverts
April 2007: New Century bankruptcy
June 2007: Bear Stearns bails out two hedge funds, which are eventually liquidated in 2007
August 2007: American Home Mortgage bankruptcy
August 9, 2007: BNP Paribas blocked withdrawals from three of its hedge funds with a total of $2.2 billion in assets under management, due to "a complete evaporation of liquidity"
September 14, 2007: Northern Rock, a medium-sized and highly leveraged British bank, received support from the Bank of England.
September 2007: NetBank bankruptcy
December 2007: Delta Financial Corp bankruptcy
January 11, 2008: Bank of America agreed to buy Countrywide Financial for $4 billion in stock
March 5, 2008: The Carlyle Group received margin calls on its mortgage bond fund
July 11, 2008: IndyMac failed
September 7, 2008: The Federal takeover of Fannie Mae and Freddie Mac was implemented
On September 15, 2008, Lehman Brothers collapsed and then the shit really hit the fan.
Most mark the Lehman bankruptcy as the major milestone in the Global Financial Crisis, but the lead-up to this point took two years. The slow drip of liquidations barely registered and even with hindsight few recall the preceding timeline.
Full Global Financial Crisis timeline
While the interconnections were complex, the framework for financial collapse was simple: higher rates put the squeeze on speculative excesses. The problem is, when the squeeze is on nobody really knows how those excesses unwind.
Did Silicon Valley Bank do anything wrong? Or is it a victim of unintended consequences. I’m oversimplifying but it’s demise can be traced back to a pandemic nobody saw coming.
Dust off your time machine, go back to 2018 and try to convince a Silicon Valley Bank executive that the following was about to happen:
global pandemic → economic shut down → cheap money → speculative excess → tech bubble → lots of deposits → invest in low yielding bonds → inflation rises → sharp increases in rates → bond portfolio market value plummets → liquidity concerns and SVP collapse
I admit that I suffer from Global Financial Crisis PTSD. It was THE most stressful time of my life. My foresight paid off during that time and I avoided losses, but it left me overly-vigilant.
Over the years, with a lot of introspection, I’ve balanced my view and have become a better investor. I’ve used my vigilance to my advantage, but am constantly battling my tendency to be too risk averse.
So take everything I write with a grain of salt. But I think you’ll agree that everything does not seem fine.