Tag: Banking Deregulation

Final Thoughts On The SVB Situation

The Daily Escape:

Spring wildflowers, Four Peaks Wilderness, AZ – March 2023 photo by Chris Flores

(This will be the final column for this week as Wrongo and Ms. Right are heading to CA for the Napa Valley wedding of granddaughter Nicole. Columns will resume on 3/23)

Several readers commented on how Silicon Valley Bank’s (SVB) major problem went beyond Wrongo’s discussion of asset management. They’re all former bankers and former colleagues of Wrongo, and they rightly brought up liability management as a key contributor to SVB’s problem.

For banks, the deposits that people make are the bank’s liabilities. The essence of banking is borrowing short term (deposits, overnight borrowings and medium term borrowings) in order to lend that money out for a longer term (mortgages, long term loans or, investments in bonds and long dated US treasuries). The difference between what they pay on their liabilities and what they earn on their loans and investments (the spread) is how banks make their profits.

SVB had little risk that their loans wouldn’t be eventually paid back (credit risk), but they did have substantial interest rate risk if rates went up. That included the risk that the face value of the bonds they invested in would decline in value in higher interest rate scenarios.

This is a well-known challenge for all banks. They try to maintain enough of their assets in easily sold investments so if there’s an unforeseen need to pay out cash to depositors, they can meet that need. The bigger the expected (or unexpected) cash need, the more assets the bank must hold that are easily converted to cash.

It wasn’t a surprise to the banking industry that the Federal Reserve (Fed) was raising rates; Chair Powell clearly said they were going to do that until inflation was under control. Basic liability management principles should have told SVB to move to hedge the risks in a rising rate environment by investing more in very short term (near cash) assets. But SVB didn’t. Maybe they thought they knew better.

SVB isn’t alone. The Fed raised interest rates quickly and sharply during 2022, so the face value of bonds fell. According to the FDIC, US banks were sitting on $620 billion in unrealized losses (assets that had decreased in market value but were still on their books at purchase price) at the end of 2022.

Of that amount, Bank of America alone had unrealized losses of around $114 billion, or 18% of the total.

A major risk that the banks didn’t correctly anticipate was the effect of huge cash injections into the economy during the pandemic, along with a prolonged period of historically low interest rates that predated the pandemic. That had ripple effects on all banks. According to Marc Rubinstein:

“Between the end of 2019 and the first quarter of 2022, deposits at US banks rose by $5.4 trillion. With loan demand weak, only around 15% of that volume was channeled towards loans; the rest was invested in securities portfolios or kept as cash.”

Then came the Fed’s rapid rise in interest rates. From FDIC Chairman Martin Gruenberg:

“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies….Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs,”

Banks do not continually adjust the value of their bond portfolio to market. So their unrealized losses can be difficult for an outsider to see. It also means banks find that selling parts of the portfolio will bring in less cash than they may need, because the securities are worth less in the market than they originally paid for them. That happened to SVB.

From Michael Batnick at Irrelevant Investor:

“Without the pandemic, rates are not at zero for two years. Without the pandemic, $638 billion does not go into venture capital. Without the pandemic, rates don’t go from 0% to 4.5% in a year. And without the pandemic, we wouldn’t be talking about a run on the bank.”

So there’s plenty of blame to go around. The SVB management surely failed: More Treasury bills and fewer bonds would have helped, that’s for sure. They had to know that their customer base, which was concentrated in start-ups, were hemorrhaging cash. They knew that they had unrealized losses in their bond portfolio. Shouldn’t they have shortened their asset mix?

Should we blame the regulators or SVB’s auditors? KPMG gave them a clean bill of health just a few weeks before they went belly up. You would think KPMG should have seen what was coming. And the Fed just announced that they are leading a review of “the supervision and regulation of Silicon Valley Bank in light of its failure.”

For SVB, the government drastically changed its policy about insured deposits. Had SVB been “The Bank of Depositors With No Political Clout”, you can bet that the $250,000 insured deposit limit would have been enforced. And depositors with larger deposits would have had to wait for their money.

But, the exception was made, and now, it will certainly happen again. Ben Carlson says it best:

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Another Bank Bailout!

The Daily Escape:

Pronghorn in Las Cienegas National Conservation Area, AZ  – March 2023 photo by Alan Nyiri Photography

More about the Silicon Valley Bank (SVB). A joint announcement by Treasury Secretary Yellen, Fed Chair Powell, and FDIC Chairman Gruenberg said:

“After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13…”

This appears to be the mechanics of the bailout:

  1. The Fed gives money to the FDIC as needed.
    2. The FDIC makes all deposits available on Monday. Not just those that are FDIC-insured.
    3. The FDIC then sells the assets of the banks, which will take time.
    4. The difference between the cost of bailouts and the net proceeds from the asset sales is the actual amount the FDIC will have lost.
    5. The FDIC will charge all other banks a “special assessment” to cover the losses.
    6. The FDIC will then pay the Fed back with the special assessment funds it collects.

Much about this makes Wrongo’s blood boil. We have a well-defined regulatory system for the US banking industry. But, as with our lax regulation of train traffic that resulted in the Norfolk Southern accident in East Palestine, these pesky banking regulations were considered a major impediment to Mr. Market.

Regional banks argued that they shouldn’t be held to the same standards as the biggest banks because if they failed, they wouldn’t pose systemic risks to the banking industry or the nation.

So in 2018, Dodd-Frank was amended by the Trump administration to raise the asset threshold at which a bank would be considered “too big to fail” from $50 million to $250 billion. The 2010 original law required that banks considered systemically important keep more capital on hand, undergo stress tests and produce a “living will” that would provide for their orderly dissolution.

But now five years later, the FDIC says that SVB and Signature Bank in NY really do pose a systemic risk to the banking system! The regulators are saying that the threat of a systemic risk gives them the authority to hold all SVB depositors harmless, even if their deposits exceed the current FDIC maximum of $250,000.

Few if any average Americans have $250,000 in a single bank account. Who has bank accounts above $250,000? Corporations.

The FDIC insurance on deposits is meant to assure retail customers, not companies that hold very large balances. Why? Because companies have the ability to perform their own risk analysis. This risk analysis should force them to ask questions about the business practices of the bank, to make sure the bank will properly manage their assets.

The US is going to protect the deposits of corporations in this bailout despite the fact that there’s a product called “Insured Cash Sweep” that cuts your large deposits into pieces that are FDIC insured (i.e. $250k each). In the event of a bank run, those deposits would not be over the limit, so they would be safe.

But, for reasons unknown, the Silicon Valley Venture Capital masters of the financial universe didn’t deign to use it.

American capitalism remains a system that privatizes profits until shit happens. And then? We socialize the losses, meaning it’s up to the federal government and taxpayers to handle the problem. When Biden says the banking system will pay fees via a special assessment, that means the cost will ultimately be paid by depositors and borrowers through higher fees and interest costs.

This is why people have so little faith in our government.

The very serious people in finance and politics were worried that the 2023 version of the US banking system might be close to another 2008-style collapse. So the Treasury, Fed and FDIC had to step in.

The basic problem relates to what’s called “asset management” in the banking biz. The goal of asset management is to maximize the return of the bank’s investment portfolio while maintaining an acceptable level of both liquidity and risk.

For banks, that means keeping a certain amount of cash available to meet the needs of depositors and investing the rest in loans or bonds. SVB invested in long-term bonds in order to realize better returns on their investment portfolio, because short-term interest rates were very low. They, like others, felt it was necessary to maintain a portfolio of higher yielding assets to offset the low market rates generally available to them.

But when mass withdrawals from depositors started to happen, they had to sell bonds at a loss, ultimately leading to default and FDIC takeover. Wasn’t it the job of the SVB executives to foresee this? And adjust their asset management accordingly?

This seems to mean that the $250,000 FDIC limit has effectively gone away. If true, there’s systemic risk that taxpayers will have to bail out bank deposits with uninsured deposits at any bank. Most of those depositors will be corporations. So, new rules must be written. And until then, we’re in trouble.

The big picture is that very few people of means in America ever pay a price for bad management.

And none go to jail.

Average Americans who get caught cheating on their taxes might go to jail if you were represented by an overworked public defender. But if you had the means to hire a high-priced lawyer, most likely, you will get community service, or probation.

It’s never been a fair system. Back in the 2008 Great Financial Crisis, then-Treasury Secretary Timothy Geithner worked to save his banker cronies; they didn’t lose money. They didn’t go to jail. The economy was saved, but no one who profited from blowing it up paid a price.

The bottom line: If I’m bad at my job, I’ll get fired. If these bankers are bad, they may get rescued by the government.

And one way or another, we’ll be paying for it.

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Financial Industry Buys Politicians

The Daily Escape:

Tulip time, Skagit Valley, WA – 2019 photo by Karen Randall

Yesterday, we talked about how the Democrats might ultimately need Wall Street money for the 2020 presidential election. Now, we learn from Americans for Financial Reform (AFR), a consumer interest group, that Wall Street spent at least $1.9 billion on political campaigns and lobbying during the 2018 mid-term elections:

“The figure, which includes contributions to campaign committees and leadership PACs ($922 million) and lobbying expenditures ($957 million), reflects a massive rush of pro-industry nominees and legislation over the last two years, at a time when the biggest banks made $100 billion in profits for the first time.”

That was the largest-ever amount for a non-presidential year, outstripping the total of $1.4 billion, in the 2013-14 election cycle, by 36%.

The 63-page report, “Wall Street Money in Washington”, uses a special data set compiled by the Center for Responsive Politics on behalf of AFR in order to provide a more precise look at financial services industry spending. The data excludes spending by health insurers, who work to influence a different group of issues than do US banks.

The data also doesn’t include “dark money” that goes mostly unreported, so the actual sums of Wall Street spending are likely to be much higher.

The report breaks its findings down by Campaign Contribution and Lobbying:

Campaign Contributions:  Individuals and entities in the financial sector reported making $921.8 million in contributions to federal candidates for office during the 2017-18 election cycle.

Of the $519.6 million in party-coded contributions by individuals and PACs associated with finance, 53% went to Republicans and 47% went to Democrats. About $402.2 million in additional cash flowed from financial sector contributors to candidates through outside groups.

Lobbying: The financial industry reported spending a total of $956.8 million on lobbying in calendar years 2017 and 2018. This spending only got the financial sector to third place. The “Health” sector was second, spending $1.12 billion, and “Miscellaneous Business” which comprises companies and trade associations, was first, spending $1. 02 billion. “Miscellaneous Business” includes the US Chamber of Commerce, which spent $189.4 million.

And which politicians got the money?

In the House, Republicans did very well, with Former Speaker Paul Ryan (R-WI) leading the way. Rep. Kevin McCarthy (R-CA), now the House minority leader, and Rep. Patrick McHenry (R-NC), now the ranking member on the House Financial Services Committee, both benefited from Wall Street largesse.

The freshman class in the House, including first-term Democrats, had substantially less reliance on money from Wall Street than those Democratic incumbents who won re-election. Another report that AFR co-authored on small-dollar contributions found that 17% of money contributed to the Democratic freshman came from small donors, compared to 9.4% for incumbent members.

In the Senate, the data underscores how money moved to members who supported the industry’s legislative goals. Overall, spending favored Republicans. But the industry gave significant amounts to Democratic Senators who helped get S. 2155 passed, which was a significant rollback of the Dodd-Frank regulations.

Wall Street gave heavily to the Democratic senators who supported the bill and were up for reelection in 2018, mostly from states that Trump won in 2016. One Dem who won in 2018, was Jon Tester (D-MT); others, including Joe Donnelly (D-IN), Heidi Heitkamp (D-ND) and Claire McCaskill (D-MO) did not win.

Sen. Kyrsten Sinema (D-AZ) won after she supported the legislation as a House member.

But, not all top Senate Democratic recipients of Wall Street money did the industry’s bidding. Sen. Sherrod Brown (D-OH) opposed S. 2155.  He was the only Democrat in Ohio to win statewide office in 2018.

Who spent the most? The top five donor companies and trade associations in the financial sector were:

  • National Association of Realtors — $144,716,676
  • Bloomberg LP — $96,481,469
  • American Bankers Association — $25,769,494
  • Paloma Partners — $25,575,800
  • Citadel LLC — $20,596,381

You can see a list of the top 20 donors here. It is easy to see that turning down Wall Street funding could put a big dent in the Democratic nominee’s spending plans for 2020.

It also seems clear from yesterday’s reporting that Wall Street Democrats might bolt to Trump if the 2020 nominee is Sanders or Warren. A decision to reject Wall Street funding could hand Trump a very large gift.

The money spent by the financial services industry won’t be any lower in 2020 than in 2018. We’ll just have to wait and see if the 2020 Democratic presidential nominee rejects their support.

OTOH, this money helps Wall Street rig the system in its favor, largely by buying the support of politicians who will help insulate them from accountability.

Does any Democrat have the guts to reform capitalism?

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GOP Plans To Gut Dodd-Frank

Do you trust the banks and brokerage houses to govern themselves? Do you think that reducing banking regulations will help the economy, or your personal financial situation? Before you answer:

  • Remember that the economic meltdown of 2008 was caused by overreach by the financial industry.
  • Remember that it took the next eight years to climb out of the Great Recession and return to pre-2008 employment levels.

Dave Dayen in the Fiscal Times points out that there will be a vote this week in the Congress that will say a lot about how willing the Democrats in Congress will be to fight the deregulation avalanche that’s about to come crashing down on We the People. From Dayen: (brackets and emphasis by the Wrongologist)

As early as Wednesday, the House will take up H.R. 6392, the Systemic Risk Designation Improvement Act. This bill would lift mandatory Dodd-Frank regulatory supervision for all banks with more than $50 billion in assets, meaning those financial giants would no longer be subject to blanket requirements regarding capital and leverage, public disclosures and the production of “living wills” to map out how to unwind [the bank] during a crisis.

The intent of the new regulation authored by Blaine Leutkemeyer (R-MO), isn’t about helping the biggest banks, but the relatively smaller regional players, firms like PNC Bank, Capital One and SunTrust. An estimated 28 institutions would be affected. The eight “global systemically important banks” would remain subject to the standards: Citigroup, JPMorgan Chase, Bank of America, Goldman Sachs, Wells Fargo, Bank of New York Mellon, Morgan Stanley and State Street Bank.

But the so-called regional banks are not small operations. These 28 regionals have combined assets of about $4.5 trillion. It is useful to remember that in the 2008 crisis, regional banks like Washington Mutual and Wachovia also came crashing down.

The American Banker says that the Financial Stability Oversight Council (FSOC), the new super-regulator charged with monitoring systemic risk, will be gutted by the Trump administration: (brackets and emphasis by the Wrongologist)

Because the FSOC is headed by the Treasury secretary…[a cabinet post selected]…by the White House, a Trump administration is unlikely to continue any of the council’s…priorities, including the designation of nonbanks or continued regulation of those firms already designated.

It is obvious that if this bill passes and is signed by President Trump, financial regulation will be relaxed, not by repeal, but through atrophy. Republicans want to replace any mandatory rules for regulation with discretionary ones. That way they can claim that they’re merely improving the system by putting the decisions in the hands of the experts instead of members of Congress.

A next step will be to hire regulators dedicated to turning a blind eye to what the financial industry does. The chair of FSOC is the Treasury Secretary. Trump’s candidates for Treasury Secretary include Steven Mnuchin, Trump’s national finance chair and the most likely choice for Treasury, who sits on the board of directors of CIT, a financial services company with more than $50 billion in assets. The Treasury Secretary will ensure that the rest of the FSOC board is made up of regulators and presidential appointees who share Trump’s laissez-faire philosophy.

President Obama will veto this bill if it passes the Senate before January 20th. But the Republicans plan to roll it out this week, instead of waiting for Trump to enter the Oval Office. They want to gauge just how much backbone Democrats have after their thumping in the election. More from Dayen:

This is really a moment of truth for those Democrats. If Republicans put up a big bipartisan vote in the House for this, the Senate will be more inclined to try to pass it down the road. And it will serve as a test case for Democratic resolve more generally.

Wall Street-friendly Dems have already endorsed tailoring Dodd-Frank rules to eliminate smaller regionals from the rules. This bill is a big change, and the question is whether Democrats play ball with Trump’s deregulation agenda, or will they recognize the harm it will cause?

This is an early test for those Dems whose seats are at-risk in 2018 and 2020.

Financial deregulation has rarely been a partisan political matter. Democrats and Republicans have typically worked together to roll back rules and loosen up the Wall Street casino.

HR 6392 could represent a return to those times, or it could be the moment when Democrats join together and say “no”, forcing Republicans to support the banking industry agenda on their own.

Party line resistance by Democrats could be in their longer-term best interest.

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