Apparently SVB had assets of ~$220 billion in 2022 [2].
[1] https://www.congress.gov/bill/115th-congress/senate-bill/215...
[2] https://fortune.com/2023/03/11/silicon-valley-bank-svb-ceo-g...
[1] https://www.ecfr.gov/current/title-12/chapter-II/subchapter-...
And if they have to value it appropriately every quarter, the issue likely would have been seen earlier and maybe they could have changed their positions as the rates were rising instead of being in a hole and trying to do it all at once.
At least I think that’s how the regulations might have worked here.
Edit: this FT opine summarize the sillyness: https://www.ft.com/content/c95e7708-b903-405d-a017-963844eb3... (paywall bypass: http://archive.today/2023.03.11-083455/https://www.ft.com/co...)
> Calculating the amount of a highly liquid asset. In calculating the amount of a highly liquid asset included in the liquidity buffer, the bank holding company must discount the fair market value of the asset to reflect any credit risk and market price volatility of the asset.
>A bank holding company subject to this subpart must maintain a liquidity buffer that is sufficient to meet the projected net stressed cash-flow need over the 30-day planning horizon of a liquidity stress test conducted in accordance with paragraph (a) of this section under each scenario set forth in paragraph (a)(3)(i) through (iii) of this section.
Would it have prevented a bank run by a bunch of spooked VCs? We’ll never know, but one would imagine it would have put them in a better financial position.
Yes. If SVB weren’t mark-to-market insolvent, they could have borrowed at the Fed’s discount window to settle liabilities.
The general thrust of Dodd-Frank was to push banks away from high-risk investments. The Volcker Rule that’s at the heart of Dodd-Frank is most explicit about this, it expressly forbids certain types of investment for being too high-risk. Treasury bonds are considered to be some of the lowest-risk investments possible, with correspondingly low returns (in fact, in researching this I discovered, horrifyingly, that it’s not uncommon for Treasury bonds to be described as literally risk-free). The Volcker Rule has a specific exemption to explicitly allow trading in U.S. Government securities, in recognition of their perceived low risk.
SVB held a lot of Treasury bonds, percentage-wise more than most other banks. This is because they had a lot of startups depositing a lot of venture capital funding, they needed somewhere to invest it, and Treasury bonds were one of the few investment options that were in regulatory compliance and available in large amounts.
When the Federal Reserve started rapidly increasing interest rates, this tanked the value of Treasury bonds. And “tanked” is no exaggeration; there are grim charts from the beginning of this year like https://www.usbancorpassetmanagement.com/index/our-insights/... and back in November 2022 we had the Chairman of the FDIC warning that these unrealized losses could very quickly become actual losses for a bank that needed to increase liquidity.
Which is precisely what happened to SVB, down to the letter.
The argument that “Dodd-Frank exemption is good actually” goes like so: if the regulations were applied more stringently to SVB, they would have bought even more safe-bet Treasury bonds (and offered lower interest rates to depositors), and thus they would have been even more blown out by Federal Reserve increasing rates.
In practical terms, the reason SVB held MBSes was the same reason they held Treasury bonds (low risk because of Government guarantee), Treasury bonds and MBSes react to Federal Reserve rate increases in much the same way, and the ways that MBSes and Treasury bonds differ are largely walled off by the Government guarantee and thus immaterial to SVB (if the housing market does some wild stuff then MBSes might pay out differently to Treasury bonds, but this didn’t happen here).
Yeah, way to victim blame.
Only an irrational person would “take one for the team” and leave their assets in an obviously failing bank.
I mean, if only so-and-so had kept their mouth shut nobody would have noticed that some cryptodudes and dudettes had blown a few measly billion of their customers’ funds.
This is extremely perceptive! I do feel that way, and you know what? I didn’t fully realize that I did until you pointed it out. Yeah, two major activities of the Federal Reserve are “saying what it will do with interest rates in the next few years” and “changing interest rates”, it’s really bizarre that they can’t get these two to even remotely line up. I know they have to respond to fluctuating macroeconomic situations, but is that really enough to almost completely disconnect “their predictions of their actions” from “their actions”? It feels like a bit like a fig leaf, it kinda doesn’t pass a smell check.
> Yeah, two major activities of the Federal Reserve are “saying what it will do with interest rates in the next few years” and “changing interest rates”, it’s really bizarre that they can’t get these two to even remotely line up.
True, but it wasn't just the Federal Reserve. I live in Australia. It was exactly the same story here: https://www.afr.com/markets/equity-markets/why-the-rba-and-e...
What I didn't realise is the Reserve Banks also operate in "hard mode" when it comes to economic predictions, just as the VC's did in this bank run:
https://www.abc.net.au/news/2023-03-12/imf-how-we-missed-the...
So you can put this down to SVB operated on the best available advice, butt the best available advice was wrong. Well that, and their customer base was a bunch of lemmings.
It isn’t that treasury bonds are inherently “risky”. The risk is that when you hold longer duration bonds at low interest rates like SVB did, even modest rate increases will have a large effect on value.
Combine that with the bonehead investment in MBS which allegedly only yielded 1.5% at 10 year duration and you have massive losses.
I assume though, that like any black swan there were many things that went wrong together. Lately at work, I have been telling people that one in a million happens eight times per day at just 100 requests per second! Shit is going wrong in small ways all the time. So you design for that — but eventually in a big system enough of those minor failures will line up to cause something you notice. You probably remember that huge facebook outage in 2021? Lots of things went wrong and then they were locked out of their own conference rooms. The financial system is different parts at a different scale but the same theory of failure applies.
Not smoking guns, more like a bad bet here, and a stupid decision there, and one dumbass VC influencer gets jumpy and runs his dumbass mouth in slack and bobs your uncle bye bye SVB.
More fundamentally though, the stress test is testing capital, not liquidity. What actually did in SVB was a bank run during a liquidity crisis. Due to interest rate rises, their liquidity got so bad they had to sell long-term assets at a loss, and when they announced they were raising capital to cover that loss, they triggered a bank run: the ultimate and most cruel test of liquidity there is. The stress test they lobbied their way out of would have indicated poor-but-manageable health, it’s not useless, and they should have been required to do it. But the stress test does not involve simulating a bank run, it would not have predicted this collapse.
I don’t think the stress test is meant to model a collapse. As has been mentioned elsewhere, no bank survives outflows of 40-50% of deposits. I understand Baker’s comment to imply that stress tests are not simply “are you over this minimum bar” but also designed to probe for any weakness in lots of different scenarios so the weaknesses are discovered and can be addressed. I imagine it like the regulator is the parent telling the kid to eat their veggies — they might not force them into your mouth but they’re acting as a third party check on your worst impulses. If that’s the case, the stress test should have prompted a discussion about this risk about nine months ago. That this fell apart so fast implies that risk management failed, that those discussions never happened, and so there will presumably be motion to fix that weakness for next time. So you’re right that the run would still have killed them, but better long term risk management would have prevented the blood in the water that spooked the VCs that caused the run.
PS: I feel like that one meme from it’s always sunny — everything is connected to everything. Have to look past the first-order effects.
For what it’s worth, the most plausible scenario I can see where SVB doesn’t collapse is something like “Their lobbying isn’t successful, they are required to undergo rigorous Dodd-Frank testing, because of this they are forced to get a risk officer, the risk officer armed with the kinda-worrying stress test results convinces SVB management to at least ratify a liquidity strategy even if they don’t really want to act on it, when they go to sell bonds and raise capital they present it as part of this liquidity strategy, the VCs see the strategy and aren’t as spooked, so the wave of withdrawals fizzles out instead of becoming a bank run - but inside SVB it gets way closer to a full-blown run than anyone outside realizes, and this scares management into executing on the liquidity strategy”. That’s an absurdly long chain of events and it’s very easy to step off that path at any point (or just get unlucky) so I still think it’s unlikely, but if I had to give an account of how SVB hypothetically survived, this is what I’d give.
1. Financial analysts were not devoting much time to analyzing the risks from rapid rate increases, as rapid rate increases were deemed very unlikely (in part because the Federal Reserve itself had offered guidance that it was unlikely!). Furthermore, the time that was spent on analysis of this low-probability event was spread very thin (interest rate increases affect pretty much everything), and the perception of “zero risk” in T bonds would have bumped them to the end of the list for analysis, meaning even less analysis time for this outcome. Just now on Twitter I’ve seen two financial analyses praised for their prescience in this event - one from the FDIC, one from Byrne Hobart. Both of them only picked this up after the rate increases came into effect.
2. Even if there was full awareness of this risk, and plenty of forewarning that the rapid rate increase was definitely coming, the regulations as written would still permit these investments. The bank itself would probably have made smarter decisions and wouldn’t have collapsed, but that would be orthogonal to the regulations under discussion in the OP. (In my initial comment I even sketched out the argument that the regulations would have been mildly opposed to the smarter decisions.)
If you want my motivation for discussing it all day: I’m curious, it’s an interesting and fast-moving puzzle that a lot of smart people are discussing. If you want my qualifications for offering so many specific assertions: I’ve read the primary sources and it just doesn’t seem like it would fix or prevent this the way other people assume it would. If in my enthusiasm I’ve oversold myself as an expert, I apologize unreservedly.
If SVB had owner those they would not have had liquidity problems which lead to insolvency.
It was a risky move but one that could have panned out if the deposits had remained.
It seems SVB didn't account for the fact that there was a strong correlation between the source of their money (tech propped up by low rates) and their investment risk (bonds/loans propped up by low rates).
I'm honestly unsure if we can ascribe this to to incompetence or greed.
You're borrowing at a lower yield to lend at the higher yield, and the risk is that you have to liquidate before the long one is mature.
Traders do this all the time, because every day you carry this position you're making the difference in yields.
The risk is always the same: the value of the things that give you the yield may change by enough to wipe out the interest difference.
There were plenty of places to park cash. Just none whose yield SVB liked.
That is not why they are less sensitive to interest rates. They are less sensitive to interest rates because the value of a bond (assuming no coupon) is (whatever you get paid at maturity)^((1+rate)^(-time to maturity)). The sensitivity to rates increases exponentially with the time!
If you buy 30-year bonds, hold them to maturity then roll them over, and don’t mark to market, you are just taking the graph of your returns and heavily smoothing it. And the smoothing obscures a fascinating thing about bonds: they’re sensitive to rates both ways. When rates go up, existing bonds lose present value immediately, but they start to gain present value at the new higher rate forever, or at least until the next rate change or until you sell them or let them mature without rolling them over.
If you want to do an honest HTM forecast of SVB’s position, you need to project everything out to the same future time, say 10 years. So you’re looking at SVB’s portfolio, with a reasonable expectation (with error bars or confidence intervals) of returns over 10 years, in 2033 dollars. In this model, the value of SVB’s 10-year bonds didn’t change, but the value of its liabilities exploded: it needs to pay a lot more interest on its interest-bearing deposits, and customers (I assume) are a lot more likely to demand interest when rates are high.
Wow, that's wrong wrong wrong.
Dodd-Frank would have forced SVB to do and report tests including the vanilla interest rate curve sensitivity values.
Look for "10-year Treasury yield" in this document (it's about everywhere as a parameter):
https://www.federalreserve.gov/publications/files/2019-march...
Which would have alerted the authority that SVB management was heavily playing a dangerous game.
Bought Treasury bills. They’re more liquid and have less interest rate risk. They yield less, however, which is why SVB bought the riskier stuff.
The 2021 Report https://www.federalreserve.gov/publications/files/2021-dfast... took the baseline scenario to 1.9% in 2024 for 10yr Treasury returns, while the adverse scenario went to 1.5%. Likewise for the previous year: in 2020, baseline took it to 2.7% in 2023 while the adverse scenario went to 2.2%. The 2022 Test variables are quoted at https://www.federalreserve.gov/publications/2022-Stress-Test... saying year 2025 would see 2-1/2 and 1-1/2, for baseline and adverse respectively. For comparison, the actual rate now is close to 4%. So, honestly, I’m not sure if DFAST would have caught it, since this is a full percentage point and a half above the highest values they used in the last three tests. 2019 had 3.6% in baseline for 2022, so maybe it would have, though.
But ignore that, let’s assume DFAST would have clearly highlighted this. If it did, it would be cautioning “you have the potential for significant unrealized losses, make sure you maintain a good position so you can carry those securities to maturity” - which SVB was doing right up until its dwindling liquidity was in reach of a big bank run. The stress test is simply not designed to detect all potential periods where a sudden bank run of significant scale might kill a bank - fundamentally, it’s a capital stress test, not a liquidity stress test.
At best I think we can say DFAST, in some years but not in others, could plausibly have given a moderate to strong indication that more of SVB’s assets would be tied up than usual. From that, you could certainly take a hint and look at liquidity.
But then you have to have enough paranoia to model “The Fed lights a rocket under the interest rate just like they said they wouldn’t” and “our depositors, who all walk around with their burn rates practically tattooed on their foreheads, decide to do a bank run” at the same time to see this coming. And then you have to tell other people this is coming, and grit your teeth listening to them quote the Fed’s forecast that interest rates will stay low. Ultimately they would calculate the cost of your proposal and ask you why they ought to give up that much potential profit to hedge against the chance of these two unlikely events happening together - “that’s like seeing a pair of black swans mating”, they would say to you.
Again, I want to stress I’m not saying Dodd-Frank caused this, I’m not saying Dodd-Frank exemptions for SVB were a good thing, etc. I’m saying that this collapse was mostly out of scope of Dodd-Frank, the parts that were in scope were affected in both directions, and all of this in service of the original point: the article bringing up their exemption lobbying is just airing dirty laundry, not elucidating the cause of the downfall.
SVB did lobby so it could play the game it wanted, it looks like it was a basic game from what I can read in the media.
In Europe the current test is page 5, 2023 10 year interest rate at 4.5% in the stress test, and you see that it's a moving target (nice historical graph):
https://www.eba.europa.eu/sites/default/documents/files/docu...
Incentives matter ... While regulation will not prevent failure, it helps. We already know what happens after deregulation of risk management in banking.
Disclaimer: worked for a decade in finance, including on software used for those report computations...
Correct me if I'm wrong, they are practically risk-free if held to maturity no? It's only when you need them to be a liquid asset that you can sell for money in a pinch that it's not so risk free as the amount you can get for them depends on the market.
But if you buy $1B in bonds at 1% and inflations runs 4-5% over the bond term, you’re running a -3-4% real return.
Keeping cash in a vault is of course highly impractical, and also doesn't produce any money for you or the bank. If that's what you want, I think you could find it but it would be at a security company (security as in guards), not a bank.
The electronic equivalent would be depositing the money with the federal reserve. (What they do with the physical bills I don't know! But most deposits would be coming in electronically these days anyways.) However, up until the passage of the Emergency Economic Stabilization Act of 2008, the fed didn't even pay interest on reserves. [1] Now they do, but until 2022 this rate was only 0.15%. [2]
The first problem with this would have been it didn't provide enough money to run the bank. SVB's non-interest expenses were over $2 billion annually for the last 3 years, so with $200 billion of deposits you need at least to earn 1%, just to keep the lights on. Also your deposits will go up and down but you'll still have to pay your rent, so better be more than 1%. (This is how they ended up invested in longer duration treasuries, to earn more money by taking on greater interest rate risk.)
But the more fundamental problem with just keeing the money at the fed is that I don't think they would let you. It is not, traditionally, the social-economic purpose of a bank to just collect deposits and do nothing with them. Instead, the bank is supposed to take in deposits and then provide loans to the community (credit cards, business loans, mortgages, etc.). Probably this purpose has gotten a little fuzzy over time, since banks are not holding on to the loans, but it is the basic idea.
There is a company calling itself "The Narrow Bank" that actually wants to do exactly this, deposit all client money at the fed. [3] Tellingly, the fed has not granted them approval yet to do so. Maybe they will! But notice that this proposed bank is bare bones: no physical branches, no tellers, no ATMs, no FDIC insurance, just a place to deposit vast amounts of money from institutional clients and earn money from the interest rate spread from the fed vs what you pay out. I do not think such a bank would be very popular with many "regular" people or businesses, who have needs beyond just stashing money under an electronic mattress.
[1] https://www.stlouisfed.org/open-vault/2018/april/why-fed-pay...
[2] https://fred.stlouisfed.org/series/IORB
[3] https://www.tnbusa.com/2022/04/tnb-seeks-to-become-states-ne...
If I'm buying low yield bonds for 100B, even if interest rates go much higher, shouldn't I still be able to sell the bonds for 100B?
There's still an obligation by the government to give me 100B back at the end of the loan.
Also in retrospect they were likely insolvent or at best barely capitalized at the end of last year. Probably should have been pushed into receivership or forced to recapitalize then.
The fact that these were marked as "hold to maturity" for accounting purposes, means this insolvency was concealed until SVB faced a a liquidity crunch.
The issue was never that these bonds can't be sold (are illiquid), but that their real value was much lower than how they were valued under the applicable accounting rules.
I don't think this is actually true. Could you provide the source for that? I understood that the bond assets can not be converted to enough liquidity to cover withdrawal demands, but it's not the same thing. If you own a house worth $1M, and I ask you to give me $1M tomorrow, you couldn't do it - but that doesn't mean your house is worth less. It means it's an illiquid asset that can't be easily converted to cash. Even if you agreed to sell it for $100, you probably couldn't pull it off in one day. Maybe you could take a loan against the house - but even that is hard to do by tomorrow.
> but that their real value was much lower
What's "real value"? Is it the value of the income stream when held to maturity? Then I never encountered any mention that these bonds were bad (in fact, some of them were Treasuries which are as good as any bond can be) - could you provide a source for this claim? If you mean "fire sale" value then yes, of course the "fire sale" value was low - but that's not because the bonds were bad, you can not value an asset by it's "fire sale" value.
The same bonds can be held in two different ways MTM (Mark to Market) and HTM (Hold to Maturity), the underlying bond is equally liquid (in that they would be sold to the same pool of buyers) but the way they are tracked in accounting differs.
It's like if you bought a house for $1M but then the housing market crashed and prices dropped by 20%. Regardless of whether you value the house as still worth 1M or $800k on your balance sheet, that doesn't change the liquidity of the house.
> What's "real value"? Is it the value of the income stream when held to maturity?
The market price of the bond.
> Then I never encountered any mention that these bonds were bad (in fact, some of them were Treasuries which are as good as any bond can be) - could you provide a source for this claim? If you mean "fire sale" value then yes, of course the "fire sale" value was low - but that's not because the bonds were bad, you can not value an asset by it's "fire sale" value.
There are two types of risk for these bonds. One is the risk of the bond issue defaulting on the bond. You are correct that this risk is extremely low for Treasury bonds (thought not for the MBS bonds that SVB also owned a lot of).
The other risk is due to interest rate changes. The reason the bonds are worth less on the market now is because interest rates have gone up. You can buy a 5 year bond with a higher interest rate than the 10 year bonds that SVB owns. Thus, if you are selling those bonds, you have to offer them at a discount so that buyers will see a comparable return to new bonds sold with higher interest rates.
The lower price has nothing to do with the number of bonds SVB needed to sell vs the size of the market for those bonds, but rather that the market values those bonds as lower given the current interest rates, regardless of how many of those bonds SVB needed to sell.
It's not regulations that are the problem. They were obviously using this bank as a free margin account using customers money to leverage their debts. They did it because they have a lot of money to win when betting with other people's money and only 100% to lose.
10x margin and the government making your counterparty whole if you fail?
Of course this degenerate bank used it in the most VC way.
Don't make a single client of them whole. Those banking there probably had connections to the people making tons of money when the bets went their way. Those who recommended banking there need to lose their credibility.
The risk they took was not a mistake. It was a feature. It was intended.
Having to pay a lot of attention to your bank to wonder what’s going on behind the scenes is work and requires expertise. There’s no reason to have everyone do it, we can create agencies full of experts to do it for us.
Only thing that can stop this misalignment of incentives is to revoke the regulatory privileges of banks. Let everyone bank directly at the Fed. There's no reason these banks should get the privilege of holding other people's money. They dont hold the risk so they shouldn't hold the privilege.
This sentence sounds profound but it’s meaningless.
Of course you can regulate incentives, by definition a regulation is something that changes the incentive structure.
For example the fact that I have more money if I don’t pay my taxes is one incentive. If that was the only incentive at work there’s a good chance I wouldn’t pay anything. But there’s also an incentive that if I pay I avoid heavy fines and possible imprisonment. So I do.
I have a financial incentive to steal shit, and a regulatory incentive to not steal shit. And so on.
But when you're up against corporations, the only thing they can lose is money. And the incentive structure is such that losing 100% with some probability is still profitable. That's why this happens. No regulation can bring the loss further down. Therefore you can't regulate it away.
Regulation is only a possible solution to a problem when it has a high enough probably for a penalty, and high enough penalty (100% is always the maximum!), to tilt back the expectation value from different choices.
You can't solve this with regulation. Regulation can't, by definition, solve misaligned behavior which already happens under when the risk is 100% loss on getting discovered.
Regulation doesn’t just apply to the corporate entity it applies to the actual humans involved.
You can have regulations that require those humans to provide regular documents to the government with severe penalties for falsifying them, you can require licensing and training and all sorts of things.
Of course criminal prosecution is a type of regulation. It’s also a standard counterpart to run of the mill corporate regulations that creates incentives for people to follow regulations. People have kids and families and most certainly respond to incentives.
You can threaten those humans with loss of everything they own and their own personal feeedom.
Try running an airline without any licensing and see if shutting down the airline is the maximum consequence . Good luck with that.
Regulations have teeth. The government of course can do more than just wipe out a company.
"Finally, the Board has determined not to impose enhanced prudential standards on nonbank financial companies supervised by the Board through this final ($50B stress test) rule."
Note the word "non-bank". And pre-dates any 2018 actions.
https://www.govinfo.gov/content/pkg/FR-2014-03-27/html/2014-...