Fortunately, the SVB was only slightly insolvent

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Good morning It’s going to be an interesting market day today. Have the US authorities done enough to allay concerns about bank runs? It looks like it to us, but the situation remains tense. Emotion, not reason, can rule the day. Send us your concerns, conspiracy theories and trading strategies: and

Silicon Valley Bank (and the US banking system)

Until last night, there were high hopes that another bank would step in and buy Silicon Valley Bank to take a problem out of the hands of the FDIC and protect unsecured depositors. But it seems a deal couldn’t be struck. At 6:15 p.m. New York time, the Treasury Department, the Federal Reserve and the FDIC announced that they would take matters into their own hands, not only for the SVB but also for Signature Bank, another lender that recently had suffered outflows of deposits. Both banks would be dissolved and all their depositors, insured and uninsured, would be cured. The Meat of the Announcement:

[All] depositor [in SVB] will have access to all their funds from Monday March 13th. No losses related to the dissolution of Silicon Valley Bank will be borne by the taxpayer.

We are also announcing a similar systemic risk exemption for Signature Bank, New York, New York, which was closed today by its state founding agency. All depositors of this institution will be healed. ..

Shareholders and certain holders of unsecured debt will not be protected. Management was also dismissed. Any losses incurred by the Deposit Insurance Fund to support uninsured depositors are recovered through a special assessment of the banks

This has been widely interpreted to mean that the authorities are paying uninsured depositors out of the $128 billion deposit insurance fund anything that the SVB’s assets cannot cover. However, the statement read a bit ambiguous to us, and we’re still not sure to what extent this is a bailout. Details will be announced in the coming hours and days. In the case of SVB, however, the fact that the bank was not very badly defaulted is likely to account for a large part of the answer.

Granted, in banking, a small bankruptcy is like a small pregnancy, but bear with us. Keep in mind that SVB’s problem, unlike most failed banks, was not that bad credit left a hole in the asset side of the balance sheet. Instead, it was a pure duration mismatch between deposit liabilities and high quality bonds. Ken Usdin’s team at Jefferies offers an analysis that if SVB’s securities portfolio were sold at a 20 percent discount, its loans were paid at a 2 percent discount, and its creditors and insured depositors were still $86 billion in cash would be left:

Jefferies estimates there are $91 billion in uninsured deposits left with SVB after last week’s run. If true, the bank is only missing about $5 billion. Perhaps that gap will be filled by leaving some or all of the other creditors of the banks, who are owed some $22 billion, out in the cold?

The Federal Reserve also said it would make liquidity available to other banks facing withdrawals. A “bank-term financing program” will offer banks loans of up to one year, take government-backed bonds as collateral, and price those bonds at face value rather than market value.

Will the two actions be enough to end this week’s looming bank runs? In a rational world they would be. While the rest of the banking system suffers from the same ailment as SVB, the systemic ailment simply isn’t that severe.

The sickness, as a reminder, is that banks have been flooded with deposits in recent years and invested much of them in long-term government-backed bonds. Now that interest rates have risen, you have significant unrealized losses on these bonds. If they were forced to sell those securities (e.g., through a bank run), those losses would be realized.

Banking system doomsters on Twitter gave this chart a workout by JPMorgan’s Michael Cembalest over the weekend. It shows what would happen to the capital ratios of various major banks if all unrealized losses were crystallized on their portfolios:

Yes, realizing the losses would take a heavy toll on some banks’ equity, the Doomsters pointed out. Note, however, that all banks would still have a solid equity cushion in this case. Even the SVB (as of late last year) would have been solvent and had the highest securities ratio of any US bank. All other banks in the chart would have been fine in the securities portfolio liquidation scenario. And there’s no reason to believe that even in extreme circumstances, any of them would have to sell all of their holdings. For one, if they needed cash, they could repossess the securities instead of selling them.

That’s not to say it’s great that the banks have all these securities that they bought when interest rates were low. It stinks to them and will weigh on profits for years. But it’s not an existential question.

On balance, most banks are still benefiting from higher interest rates as their loan portfolios are re-rated. Bank of America is a prime example of this. The bank has lost half a trillion dollars (!) in government-backed mortgage securities in 10 years or more, a yield of 2.1 percent. In and of itself that is very bad! The yield is well below market value, and unless interest rates return to the lows of a few years ago, any sale of these items before maturity (which is a long way from now) will result in a large loss. But zoom out: The bank also has $1 trillion in loans that pay more interest as interest rates rise. It also has another half trillion dollars in cash and reserves to cover withdrawals or invest at higher rates. The higher interest rates that dropped the SVB are helping Bank of America.

There are regional banks that aren’t nearly as well positioned – their names have been thrown around this weekend – but, as we’ve argued, no bank has been as vulnerable as SVB, with its combination of interest-sensitive commercial deposits and an asset portfolio dominated by long ties. It would be a shame if, despite the actions taken by regulators on Sunday, panic still reigns in the banking system this week. It wouldn’t make much sense.

The job report

Friday’s February job report would have been confusing even if a bank hadn’t gone bust on the same day. The jumble of data included 311,000 new jobs that blew consensus, offset by slowing wage growth and a rise in unemployment but driven by better labor force participation.

But because a bank collapsed that day, it’s hard to read market reaction to the report. By and large, investors fled to safety: yields fell across the curve as stocks fell. Futures markets priced in rate cuts (again) in December. However, market observers were divided on whether the reaction was short-lived panic or a reasonable revision in interest rate expectations. Barclays’ Christian Keller contradicts the SVB’s absence and job numbers:

If Powell’s comments set the stage during the week [for a 50 basis point hike this month], Friday’s nonfarm payrolls should have sealed the deal. . .[leaving]the 3-month average [payroll] Gain at 351k – far too hot job market for Fed consolation. Correct, Average Hourly Earnings (AHE) growth slowed to 0.2% m/m (vs. 0.3% m/m expected) [but the] The metric is notoriously loud as it has no control over composition (i.e. rising employment in low-wage service industries… Therefore, based on jobs data alone, we would have assumed our forecast of a 50 basis point increase for the upcoming March meeting with larger Conviction.

However, news from the financial sector towards the end of the week complicates this assessment. . . As the news broke, US bonds rallied on safe-haven demand, and fed funds futures are pricing a 50 basis point probability of a hike below 50% after rising well over 50%, according to Powell.

On the other hand, JPMorgan’s Phoebe White argued on Friday that “improving labor supply and moderating wage inflation should ease some of the pressure on the Fed.” The SVB-related safety boost, White writes, came despite “low risk of market contagion or broader fire selling,” suggesting markets will soon return to monetary policy, especially if CPI data falls this Tuesday.

How to analyze that? Here’s how we put the facts together.

Contrary to Keller, we would argue that the slowing trend in wage growth is an important disinflationary signal and is more relevant to inflation than strong employment growth per se. It also aligns with reports from companies this quarter that hiring is getting easier. Yes, payroll data can be noisy month-to-month, but the guts of the most recent data don’t suggest horrible biases. As Inflation Insights’ Omair Sharif notes, eight out of 13 sectors tracked have seen slowing wage growth over the past three months, suggesting the February figure is a signal, not noise. The general trend is very clear:

Line chart of annualized wage growth indices, % shows no wage spiral here

is white probably Right that the SVB safety flight is overkill – especially now that the government has stepped in. But even without a bank run, SVB chaos could have long-term implications for Fed policy and markets.

Consider Powell’s public statement last week restating a faster pace of rate hikes. This tool – the pace of increases versus the peak rate – is most affected by near-term economic data, including jobs data and whatever this week’s CPI shows. SVB probably won’t affect this one way or the other. But over time, this could affect the Fed’s longer-term dovish policy as it puts tightening on a timer. The SVB’s double-decker bet on forever low interest rates was idiosyncratic stupidity. But tighter policies will soon uncover other stupidities, the nature of which we can only guess. They will hurt the economy, as the consequences of SVB already are. And the more things break, the less durable it will be for a long time. (Ethan Wu)

A good read

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