"Liquidity" vs "solvency" in bank runs (and some notes on Silicon Valley Bank)

[-]Brendan Long3y60

I'm curious to learn more about the hold-to-duration thing. It seems like this rule will always lead to situations like this (although usually at smaller scales, hopefully). I can understand if banks don't know what their assets are worth, but t-bonds have a known price.

[-]rossry3y20

This isn't a complete answer, but Monday's Matt Levine has a discussion of this in historical context.

More to the point, SVB did disclose their unrealized HTM losses in an appendix of their annual report:

Most relevant, check out page 125 of the 2022 Form 10-K of SVB Financial Group Inc. (Silicon Valley Bank’s former holding company). On page 95, you get the balance sheet showing $16.3 billion of stockholders’ equity. On page 125, in the notes, you get $15.2 billion of unrealized losses on the HTM securities portfolio.

One presumes that traders covering banks spent last weekend (or else this week) re-reading 10-Ks, and the whole world will care a lot more about this term in bank reports, basically forever. Even if it stays legal to report solvency based on HTM marks (which it may not), I think it unlikely that the market will let banks get away with it very much, going forward.

[-]ChristianKl3y2-1

The way the market does not let banks get away with it is by starting a bank run on the bank. If the standard is that banks get bailed out any way that might not happen.

[-]Brendan Long3y*21

That's not really how it works. The way the market doesn't let banks get away with this is owners of the bank losing money (equity), and getting wiped out in a bank run is just a special case of that. Equity holders of banks don't get bailed out by the FDIC so they're not really getting away with anything.

That said, the (separate) Fed bailout for not-officially-failed banks is likely preventing banks that don't experience runs from correcting properly.

[-]rossry3y10

Agree that equity incentives are the relevant forces in market self-regulation here.

That said, the (separate) Fed bailout for not-officially-failed banks...

I am reasonably confused about the BTFP commentary that I've read suggesting it's equivalent to a bailout. My reading of the terms is that it's basically the Fed offering to lend you $100 at (1yr) SOFR+10bp collateralized by (let's say) $75 face value of Treasurys, with general recourse.

If they were lending $100 at SOFR+10bp against $100 face value of Ts, that wouldn't even be a subsidy -- SOFR is supposed to be defined as the going rate for term lending secured by Ts.

And I feel reasonably confident that if a bank went to the Fed with an asset book that was $75mln face value of qualifying securities and said "I would like to use $57mln face = $76mln par of these to borrow $76mln in the BTFP", the Fed would say "yes, here's your money", and then also that bank would get seized by the FDIC that Friday afternoon. So the "bailout" in the par-value detail only matters to banks who wanted to borrow more than 100% of the face value of their qualifying assets, and the only way you pump money out of the government is if you do actually go bankrupt (in which case the Fed has accidentally done a 0% interest T-secured loan to your bankruptcy estate, not the usual definition of "bailout").

[-]Brendan Long3y*20

My understanding is that the government subsidy is the rate: no one else will give you a loan so close to the risk-free rate when the whole purpose of the loan is that you're a bad credit risk.

Another way of looking at it is that if there was no subsidy, this would be unneccessary because banks could get this loan from someone else.

[-]rossry3y10

the government subsidy is the rate: no one edse will give you a loan so close to the risk-free rate when the whole purpose of the loan is that you're a bad credit risk.

For unsecured credit, absolutely. But the BTFP specifically is secured by rounds-to-Treasurys, and the rate it gives is the market-indexed rate for T-secured lending. Your credit really shouldn't come into the economic rate for your secured borrowing.

To the extent that a bank gets cheaper financing from BTFP, it seems to me much more like "other banks would charge you 1% over their economic costs, but the Fed will undercut them and charge only 10bp", which seems more like a (barely profitable) public option, rather than a bailout.

(When the government runs the postal service at a profit but undercuts the theoretical price of private mail, is that helpfully described as a "bailout" to mail-senders?)

[-]Brendan Long3y20

The government is agreeing to pretend that this is more-secured than it actually is, since they're treating treasuries that everyone knows are worth $85 (or whatever) are actually worth $100. If these treasuries were actually worth $100, the banks could just sell them for that price instead of needing loans. Also I suspect the cost of a loan from someone else would be much more than 1% higher since the banks needing these loans are very bad credit risks (you'd only take this loan if you're insolvent and hoping no one will notice). The government is taking on a fairly large credit risk in exchange for basically nothing here.

[-]Ramiro P.3y1-1

and the whole world will care a lot more about this term in bank reports, basically forever.

I'm usually astonished w how seldom investors and supervisors read the fine print in annual reports. I don't think "this time will be different". Unless GPT-like automated report-readers step in (or maybe precisely because humans will leave this boring details to machines), we'll see it happen again.

Btw, I just noticed that $9.3bi of these $15.2 are MBS - yeah, the same type of security associated w the great crisis of 2007-2008. And the HTM total more than U$90 bi, $72bi of which are MBS and CMBS - so dwarfing their investments in bonds, and their $17.6bi in AFS.

From the post above:

...something called Agency MBS (which you can just read as "government debt with extra steps")

I'm no expert in US markets, but I don't think that's true. For instance, if you try to get a repo w them, you'll probably need a larger hair-cut than w gov bonds.

if people had learned to read bank reports, I'd expect to read more comments on this, instead of the last three pieces I read that basically just said SVB had too much gov bonds.

EDIT: after googling "svb mbs htm," I found tons of surces commenting on this. So, my bad. And most of all, thanks for this post & for this comment, rossry. I believe you saved me at least 1h of googling - to have a better grasp of the situation.

[-]ChristianKl3y30

I'm usually astonished w how seldom investors and supervisors read the fine print in annual reports.

If that would be true, you should be able to make good money by reading the fine print of annual reports, buying some options, and then publishing the information.

Why aren't we seeing that in your view?

[-]Ramiro P.3y00

Because I work for a regulator and am not allowed to do that? Also, many investors won't have enough incentives to read beyond what other investors are reading... except if, as you mentioned, u work w shortselling And shortsellers did make money in this case. So in this sense, the system works... but when it happens to a bank, that's not so cool

[-]ChristianKl3y10

Why don't they have incentives? Isn't reading beyond what other investors are reading exactly the way to make profits if you don't just put your money into a diversified index fund?

[-]rossry3y21

I'm usually astonished w how seldom investors and supervisors read the fine print in annual reports.

I am occasionally astonished by this as well. My claim is not that the whole annual report will be read more closely for the rest of time; my specific claim is that the specific footnote about unrealized HTM losses will be read closely for the rest of time.

[-]rossry3y10

I'm no expert in US markets, but I don't think that's true. For instance, if you try to get a repo w them, you'll probably need a larger hair-cut than w gov bonds.

I suspect it is true that they're haircut less generously, but I do not believe that any part of SVB's trouble looked like "well, if only we could haircut our Agency MBS like our Treasurys, we'd be fine..."

The relevant fact about them for the SVB story is that their credit is insured (by the government, except with extra steps), so ultimately they're like a slightly-weirder interest-rate play, which was exactly the firearm which SVB needed to shoot its own foot. The weirdnesses don't add much to the story.

if people had learned to read bank reports, I'd expect to read more comments on this, instead of the last three pieces I read that basically just said SVB had too much gov bonds.

[E: People just say "SVB had too much gov bonds"] is evidence consistent with [H1: people haven't read the reports closely enough to know the actual holdings] and [H2: people have decided that Agency MBS is adequately described in the category "gov bonds"]. The update that I make, on seeing the evidence that Agency MBS dimension not much discussed, doesn't re-weight my ratio belief between H1 and H2, and I continue mostly believing H2 for the reasons I believed it before.

[-]Ramiro P.3y20

It turns that the truth is more bizarre. From Matt Levine's Money Stuff:

But today at the Wall Street Journal Hannah Miao, Gregory Zuckerman and Ben Eisen have the actual, horrifying explanation, which is that the Fed’s computers go to bed at 4 p.m. and you can’t wake them up until the next morning

The point I stressed before on government bonds was right: SVB could have borrowed against them. But it seems like I was wrong: it could have borrowed against Agency MBS, too.

[-]rossry3y10

Btw, I just noticed that $9.3bi of these $15.2 are MBS - yeah, the same type of security associated w the great crisis of 2007-2008. And the HTM total more than U$90 bi, $72bi of which are MBS and CMBS - so dwarfing their investments in bonds, and their $17.6bi in AFS.

This is technically true but much, much less interesting than it sounds.

The "subprime CDO-squared mortgage-backed securities" associated with the 2008 crisis were:

based on mortgages of "subprime" credit rating (which is, like most terms invented by credit bankers, a gross euphemism)...
...which were(, because of the above,) not backed by the pseudo-governmental agencies that insure mortgages
"securitized" in a way that splits the existing risk between three different classes of investors, with the bank selling the riskiest two to someone else
had their middle tranches subsequently repackaged into second-order financial derivatives...
...some of which were safe to an arbitrary number of 9s if and only if you believed that defaults on the backing mortgages were independent random events...
...and which were regulated as if that condition were true...
...with the consequence that banks were allowed to take almost literally infinite leverage on them (and in relevant cases, did).

The "agency mortgage-backed securities" on SVB's balance sheet were:

based on "conforming" mortgages insured by the pseudo-governmental "agencies"...
...the credit of which is not material to the bank, because of the insurance.
"securitized" in a way that splits the existing risk between three different classes of investors, with the bank selling the riskiest (and maybe also the second-riskiest) to someone else
definitely not repackaged using the same trick
require a ~10% capital buffer for every dollar of assets, truly regardless of riskiness (yes, even Federal Reserve deposits need this), just in case there's some other trick that makes them bad credit

The problem in 2008 is that these theoretically-perfect-credit, infinite-leverage-allowed instruments were in fact bad credits because the independence assumption was violated. The failure couldn't have happened within the regular system if the banks were restricted to directly owning mortgages.

The problem in 2023 has nothing to do with creditworthiness, has everything to do with the effect of interest rates on asset prices, and could have happened exactly the same way if the bank had directly owned insured mortgages.

The only facts about Agency MBS that are relevant to the SVB story are:

their credit is insured by the US government...
...so they're basically just an interest-rate play...
...so SVB bought long-term exposures to earn interest...
...which were put underwater by rising rates, just like every other long-term debt
just like direct mortgage exposures, they have slightly super linear losses in the case of rising interest rates (which, I admit, makes them more effective at causing the problem than I present in the simple model here).

[-]Ramiro P.3y-40

in a nutshell (I don't have the time to write a treatise on this, every word I write is 20w i could have read instead): I'm pretty confident (status: ~ .6) that if SVB had 90bi in gov bonds HTM instead of MBS and the like, it wouldn't have failed. You can say it would have had losses (especially in 2022), it would likely have been bought, but not failed. I know of no bank that has suffered a run because they had too much gov long term bonds (from the corresponding government, and unless the gov defaulted, ofc) in the last century (if you have an example, please enlighten me); not only there's a very liquid market for them, but, in the last century (perhaps since Badgehot) central banks will let banks convert them into money easily - because tax payers will suffer no losses. On the other hand, MBS (and other similar derivatives) may be linked to credit risks (even Agency MBS) and it's quite unsure how your liquidity line will work, and the market is not so liquid; and that's why they offer higher yields - which is why they dominated SVB's HTM. Thanks for the memory refreshing lecture on the crisis of 2008. But I still remember almost everything

[-]Daniel V3y42

Matt Levine at Bloomberg also has good comments on this - basically it was a boring bank run/collapse. With it being primarily a duration issue (rather than an impaired assets issue) and a large amount of deposits, I also suspect we'll see an acquisition.

Check the date on this too.

[-]rossry3y96

https://www.bloomberg.com/opinion/articles/2023-03-10/startup-bank-had-a-startup-bank-run is the Levine article for anyone else interested in it.

Despite being a near-religious Levine reader, I somehow missed Friday's post and wrote this post without it. (In my defense, he said on Thursday that he'd be off Friday, then came back to talk about SVB.)

Anyway, Matt has a good phrasing of the unusual weirdness in SVB's assets, for a bank:

Or, to put it in different crude terms, in traditional banking, you make your money in part by taking credit risk: You get to know your customers, you try to get good at knowing which of them will be able to pay back loans, and then you make loans to those good customers. In the Bank of Startups, in 2021, you couldn’t really make money by taking credit risk: Your customers just didn’t need enough credit to give you the credit risk that you needed to make money on all those deposits. So you had to make your money by taking interest-rate risk: Instead of making loans to risky corporate borrowers, you bought long-term bonds backed by the US government.

[-]Dagon3y5-1

I second the recommendation of reading Matt Levine. https://www.bloomberg.com/opinion/authors/ARbTQlRLRjE/matthew-s-levine . Bloomburg subscription required to see back-issues, but you can subscribe to future ones for free.

One point that's not often (enough) made is that liquidity crises and insolvency are more similar than they are different. They're distinguished by duration and certainty. If the value loss is KNOWN to be temporary, because the long-term securities are truly safe, and "temporary" is on the order of a few months to maybe a year (again, with guarantees of payout), then it's liquidity. If it's longer-term than that, or there's a real chance that it'll NEVER pay out in full, it's solvency.

[-]Chris_Leong3y20

I'm curious about what the value of acquiring the customers would be. That said, it'd probably be less than you might think because of how clear it is that the customers aren't well-balanced at all. I almost wonder if the acquisition would be more valuable if the bank was split so that it would be easier to balance them out.

[-]rossry3y30

Interesting. One could imagine this working by:

Acquirer A acquires assets, non-deposit liabilities, and issues a new promissory note to Acquirer B to cover the current amount of deposits.
Acquirer B receives the promissory note from A and acquires the depositor liabilities (and the customer accounts to service).
Any new deposits are just liabilities of B, and B will match them with new assets.
Somehow, eventually, the promissory note gets paid down as the old assets mature or are sold by A, and B uses those payments to fill up a new asset book against the deposits.

Seems like it could work on paper?

That being said, the FDIC's sole criterion for selecting a resolution plan is the option that minimizes payout from the FDIC insurance fund. Assuming they can get it done with one buyer by tonight with $0 from the insurance fund, they won't look at any cleverer options.

[-]rossry3y10

On this point, you'll likely be interested in the discussion in Wednesday's Matt Levine. Excerpt:

The third thing you get, the franchise and relationships, looked great a year ago when the tech industry was booming. It looked pretty good a week ago, when the tech industry was slumping but still prominent and profitable. But I think that the story of SVB’s failure has turned out to be that SVB was the banker to tech startups, and tech startups turned out to be incredibly dangerous customers for a bank. 2 So any other bank will have to be careful about acquiring SVB’s customers, no matter how loyal they are promising to be now. You might ascribe a negative value to those relationships: “If I become the bank of venture capitalists, they will push me to do stuff that is not in my best interests, and I will be seduced or pressured and say yes, so the expected value of these relationships is negative.”

[-]Chris_Leong3y31

That's part of why I was suggesting that it might be more valuable to only acquire of fraction of their customers.

[-]Thomas Sepulchre3y10

I'm a bit confused by the structure of the T-notes in your examples.

A typical X% bond works like this:

You buy it for $100
You receive $X of coupon every year (T-notes pay a coupon every 6 months)
You receive $100 back in a fixed number of years (for example 5 years)

It doesn't really change any of the points you highlight in this post: the price of a bond can fluctate, especially if a bank needs to sell a lot of them ; an increase in interest rates will cause the old bonds to decrease in value (you paid $100 for a $1 annual coupon and $100 back, but now the interest rate is 5%, so for $100 you can get $5 every year and $100 in 5 years ; this has to mean that your old bond isn't worth $100 anymore).

So, I'm curious, why did you choose an alternative bond structure?

[-]rossry3y20

I did my math in zero-coupon bonds (pay $100 at maturity, yield is defined by discount to par) because it's simpler and doesn't change the analysis. Same reason that I rounded 5%/ann for five years to 75¢/$1.

[-]Daniel V3y20

As you said, it doesn't really change the point, but I'm here to say it's not an alternative bond structure, just that the bond happens to be trading at a discount already at the initial conditions. It will trade at a steeper discount as interest rates rise. It would be even less intuitive, but you could also do this analysis with bonds that are trading at a premium (trading at a smaller premium, or even hitting par or switching to a discount, as interest rates rise).

LESSWRONG
LW

LESSWRONG
LW

108

"Liquidity" vs "solvency" in bank runs (and some notes on Silicon Valley Bank)

108

108

A "liquidity" crisis

Equity capital: A liquidity solution

A "solvency" crisis

Silicon Valley Bank

Liquidity: Okay until it's not okay

(In)solvency: Why, and where else?