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What Does SVB Fallout Mean for the Markets?

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It seems that the major crisis from SVB has been averted for now, but there are so many lingering questions that it will likely be an issue for the markets for a while. And then there is the potential that SVB exposed underlying issues in the financial markets that could imply problems further down the road.

For a bit of context, the collapse of SVB – the largest bank to go under since Lehman Brothers – happened around the anniversary of the failure of Bear Stearns back in 2007. That came as the markets were about to slide into the sub-prime crisis a few months later. In hindsight, Bear Stearns showed that there were major issues in the financial markets. But the company’s buyout by JPMorgan at the time was seen as providing relief to the markets, which continued their trajectory until the underlying issues that were first seen in Bear Stearns became manifest in the whole market.

What happened?

There is a lot of speculation on the details of what led to SVB’s collapse, with some pointing to bad hedging and moral hazard. Others say it’s because the bank was too focused on one sector. Others still point to regulatory issues. A full account of what happened specifically in the bank is likely to take a long time.

But the general problem was that SVB, like every other US bank, bought treasuries to hold in reserve for their clients’ deposits. This is a requirement by regulators. When the interest rates on bonds were pushed higher by the Fed, the face value of the bond fell substantially, leading to unrealized losses for the bank. As long as the bank didn’t have to use the funds, it could keep those losses on the books until the interest rate returned or the bonds reached maturity.

The crisis

SVB isn’t the only bank with unrealized losses; the banking system in the US carries about $620B in lost value from lower interest treasuries. In SVB’s case, a lot of people with deposits withdrew their money, forcing the bank to sell these assets and incur losses. The US Treasury Department disclosed that there were other financial institutions in a similar position as SVB.

What the Fed did on Sunday was announce a new program that would give banks unlimited credit to pay out their depositors using these bonds that have fallen in value. That would mean banks would not be forced to realize the losses from their treasury holdings, and effectively prevent another situation like SVB happening in the current circumstances.

Are there still risks?

SVB wasn’t the only bank to fail; Silvergate was already winding down its banking arm, and Signature Bank was seized by the FDIC. First Republic Bank is trading down over 60% as of this writing over concerns that it might be the next bank to be taken over by the FDIC, as it holds a lot of unrealized gains.

The main lingering issue now is cash flow. It’s not certain how depositors will get their money back from SVB. The Fed and the US Treasury have guaranteed that the money will be returned to depositors, but that there will be no bailout. The owners of SBV will lose their assets. But, in guaranteeing depositors will get their money, it’s not sure when that money will become available, with some speculation that the FDIC is looking to return 50% now and the balance in up to six months later. This is a problem for a lot of tech companies who need that cash to pay day-to-day operations, and can’t wait months to get their money. This has led to speculation that many firms might pull money out of other banks in order to ensure they have sufficient liquidity, which could put other banks at risk of failing.

The future of monetary policy

Following the collapse of the three banks last week, the consensus among traders has shifted so that virtually all are expecting a 25bps hike at the next meeting. A very tiny minority are even expecting a pause in hikes. The theory is that the Fed wants to keep intervention and monetary policy separate, so will go through with the 25bps, and then pause afterwards.

What is certain is that the market does not expect a 50bps hike, and is starting to price in rates staying flat for the rest of the year after the March meeting. If inflation doesn’t keep trending down, however, that could imply the dollar weakens even more.

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