Not all banks are created equal. Some bank failures, like those in 2008, have the power to paralyze the entire global economy, and others, like the ones we’re seeing now, are simply painful illustrations of what happens when avarice is exposed.
“This was NOT a systemic event,” the famed short-seller Jim Chanos, the founder of Chanos & Company, told me. “This was a duration-mismatch problem. It only affects a few really dumb, greedy institutions.” Dumb because they were run by bankers who failed to do the business of banking or manage risk. Greedy because the bankers behaved that way in order to make as much money as they could as fast as they could.
The pandemic era was a boom time for the market, and these are the kinds of mistakes that come to light as boom times end. When the Federal Reserve hiked interest rates to 4.75% from 0% over the course of a year — a blink of an eye in the world of monetary policy — the rules of money changed. The speed of the shift means markets are still processing it, sharply repricing every aspect of our financial lives. Some assets — cryptocurrencies, startups, investment funds, and even banks — will not survive this violent transition. But other investors, the kind of Wall Street sharks who thrive on uncertainty, stand to make a killing.
“The basic problems financial markets have today, particularly in the US, is that they continue to be priced for everything to go right,” Chanos said. “The Silicon Valley Bank run may have been a two-day preview of what can happen when that belief is shaken.”
The offside rule
At the core of the recent banking problems, mostly notably at Silicon Valley Bank, is an issue known as a duration mismatch or an asset-and-liability mismatch. But among Wall Streeters it’s known as “getting caught offside.” In the popular imagination, banks are fortresses with big money vaults that rarely open or close. In reality, banks are way stations for money as it passes between borrowers and lenders. Customers who deposit money allow the bank to turn around and lend it to borrowers trying to buy a home or invest in their business. In return for allowing their money to be circulated, depositors get compensated with interest. The offside issue arises when a bunch of customers want to pull their funds but the bank has all their cash loaned out or invested. In that case, you end up with a gaping hole where there once was money.
Money was going into banks lightning fast during the pandemic, one executive with over a decade of experience in small to medium-sized banks told me. Customers flush with stimulus cash and businesses with soaring valuations meant bank deposits soared. Bankers across the country had to make quick decisions about how to put that money to work. Some banks, like Silicon Valley Bank, put virtually all their money in high-yielding but still relatively safe bonds: Treasury bonds that mature in 10 years. This bet maximized returns and helped SVB become one of the fastest-growing banks around, but it did nothing to balance risk if the economic environment ever shifted. Reports suggest an internal committee flagged this concentration of interest-rate risk but executives decided to ignore the warnings because properly hedging that risk would have hurt profits. When the Federal Reserve started hiking rates to calm inflation, the bankers who’d invested as if the good times would never end got walloped. As rates go up, the prices of bonds decline, so the value of the bonds SVB was holding fell dramatically.
This is the part where the business of banking also becomes a matter of social psychology. In theory, a decline in a bank’s holdings doesn’t have to spell disaster; it could just hang on to the bonds and wait for the price to recover or hold them until the government pays out their full value. Unfortunately for SVB, its own customers in the tech world started pulling their money out and tweeting about it for all to see. SVB didn’t have enough cash to pay out these suddenly freaked-out customers — who obviously had no interest in waiting a decade for SVB’s investments to mature. This mismatch between the illiquid, long-dated bonds and the panicking customers’ demand for immediate cash brought SVB to its knees and shook confidence in the entire banking sector.
“In a go-go time, people reach too far,” the bank executive said, “and people reached too far.” Not every bank behaved like this. Some banks invested in assets that stood to do well in an environment of rising interest rates, hedging their risk to make sure they’d be on steady ground if economic conditions changed.
“If you thought rates were going to stay at zero forever then you’re a fool, and there are a lot of fools in this business,” the bank executive said while also reiterating that “banking broadly is fine.” But the foolish banks that didn’t move their money in the right direction at the right time are getting caught offside. And in banking that’s a penalty that can force you to clear the field and start the entire game over again.
One person’s bust is another person’s buy
The cataclysmic shift in interest rates and risk is creating pure chaos — but while this chaos will wipe out some people, it can be an opportunity for others. For those on Wall Street with the stomach and the ability, it’s time to filter through the wreckage and put on some trades.
When I asked one investment chief for a large family office whether there was money to be made on betting against smaller banks, they replied, “Ding ding ding!” They added: “The obvious trades have happened, but we still have a while to go. Best time for stock pickers imaginable in bank land right now.” In other words, it’s time to do the work of analyzing these balance sheets to figure out which banks are offside. And the family-office head suggested there’s still action to be had looking into “the smaller regionals that don’t garner attention” like Horizon Bancorp. They described First Republic Bank, whose stock price has dived because of its similarities to SVB, as “at best a total zombie, definitely worthless.” On the other hand, they said that “none of the household-name banks in the US are in material trouble” and that “UBS got a home-run deal” when it took over Credit Suisse — making these bigger banks a good investment. You can just feel the money wheels turning.
While some of the sharper investors on Wall Street see this mess as an opportunity, chaos cannot suit everyone. The less prepared on Wall Street — like the billionaire investor Bill Ackman — have been, as the MSNBC host and former investment banker Stephanie Ruhle put it, “yelling fire in a movie theater.” The Federal Deposit Insurance Corporation guarantees everyone’s bank account up to $250,000 — more than 90% of SVB depositors, who were mostly businesses and rich VCs, had more than that in their accounts and were therefore unprotected if the bank went under. This simple rule seemed to come as a surprise to many in the tech community, whose wailing and gnashing of teeth could be heard across the country, from Sand Hill Road to Central Park South.
Ackman and his acolytes are using their platforms to tell everyone that unless the government guarantees every dollar deposited in a bank, this crisis could bring down the whole banking system. Making that guarantee would insulate not just depositors, of course, but also the shareholders in other medium-sized banks who fear they’ll be subject to the same Old Testament justice as their peers at SVB. It would also ensure that money continues flowing to the businesses these banks support — whether they’re in tech or, say, commercial real estate — and that losses in those ventures could be marked at a later date when the market is a kinder place. But the longtime bank executive argued that guaranteeing all deposits isn’t necessary. Insead, they suggested, the FDIC could raise the cap and peg it to inflation so that it keeps up with the times.*
Beyond the technical merits of the argument, Ackman and the “guarantee it all” crew’s caterwauling is problematic because, like fire, bank runs feed on oxygen. “The longer people talk about this, the more risk there is,” the bank executive told me. The more people hear that the system is on the verge of collapse, the more likely it is to become a self-fulfilling prophecy as more people get scared and yank their money from the bank unnecessarily. This is the polite way of saying the bank-collapse fearmongers are making things worse. The family-office head gave a more blunt assessment: “In my chat room with a few other finance people we have spent a good deal of time recently ripping and mocking Bill Ackman.”
There will be blood
The liquidity problems may not be big enough to take down our whole financial system, but they will continue, and more banks may go bust. Last week the Federal Reserve reiterated its commitment to fighting inflation and continued to hike interest rates. It’s a sign that its chairman, Jerome Powell, believes that the Fed’s goal of price stability supersedes the stress of a few (or maybe a few dozen) financial institutions. That’s capitalism for you.
“It’s been quite an interesting seven weeks,” Powell said at his latest press conference to nervous laughter. He added: “It’s not a surprise that there are institutions that have unhedged long positions in long-duration securities that have lost value as longer-term rates have gone up due to our rate increases.”
Translation: If you’re a bank and you’re offside, Powell isn’t going to change the rules of money to ensure you can keep playing the game. The new rules — higher interest rates — will remain for the foreseeable future.
But the future is a moving target. At the beginning of this year it seemed as if the Fed would have to hike dramatically because the economy was so strong and the stock market was rallying. Then the Silicon Valley Bank run happened, and some called for the Fed to cut rates to help the banks. Now all we can do is wait. When banks have problems, they lend more slowly. When lending slows, the economy slows. And when the economy slows, inflation cools — at least in theory. It could be that problems in the banking system mean fewer rate hikes, less work for the Fed, and an economic correction. Even in the best of circumstances, that will involve pain for investors and for the economy. Wall Street’s winners will be the people who expected that, and the losers will be the ones who pretended like this day would never come.
Linette Lopez is a senior correspondent at Insider.
Correction: An earlier version of this piece incorrectly cited the FDIC deposit insurance amount in 1934 as $250,000. It was $2,500.
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