What happens when “woke management” runs a bank under ESG Concepts? Failure.
- The failure of Silicon Valley Bank (SVB) is not a failure of the banking system. It is a failure of management to ensure sources of liquidity when customers increased the amount of non-FDIC-insured deposits and increased its reliance on bonds to fund its operations.
- Management was more concerned with its “wokeness” than prudent banking. SVB did not even have a Chief Risk Compliance Officer on staff. The regional Fed chair was oblivious to the risks to solvency.
- The Biden Administration made a completely unforced error by extending FDIC protection for deposits over $250,000. This decision creates a future moral hazard, favoring its most politically connected customers, at a cost to be borne by the rest of us. Non-U.S.-based customers could also get coverage, according to Treasury Secretary Janet Yellen.
- The Federal Reserve now has even more work ahead to ensure banking system liquidity. Rate policy will be even more unclear until the liquidity albatross is subdued. This is very likely to make a choppy economic outlook even choppier.
What’s in Your Pension? This should be the “$401k question” in a world of ESG-centric investing and woke management.
“ESG Investing” represents an approach targeting companies for investment based on their scores in the areas of Environmental, Social, and Governance. It has become a mantra for social justice warriors to champion favored managements, superseding traditional fiduciary responsibility for prudent return on capital invested. This is a topic we look forward to discussing in greater depth in future columns.
FACTS IN A NUTSHELL
SVB Financial Group was a Santa Clara, CA based banking and financial services provider focused on specialty industry clients and entrepreneurs, notably in wine making, venture capital (VC) technology, life sciences, and other niches. It was a unique bank that funded the “back yard” venture capital firms, their portfolio companies, and other interests of a very wealthy and politically connected customer base. By certain measures, it was the 16thlargest bank in the nation. It is now the second largest bank failure in US history. SVB’s peak stock market valuation was over $44 Billion near the end of 2021 with a February 3, 2023, valuation that still approached $18 Billion.
Management’s insider selling track record is well documented, with board members selling millions upon millions of dollars of stock in 2022 and 2023. The lack of banking experience among board members is also well chronicled, along with clips of its focus to be recognized for its DEI (Diversity, Equity, and Inclusion) and ESG efforts. SVB’s board was packed with long-term Democrat donors with a penchant for social activism.
WHAT A TRUE SHAREHOLDER, FIDUCIARY-ORIENTED CULTURE WOULD NOT HAVE MISSED
SVB’s 2023 outlook was downgraded to “Avoid” on February 3rdby Value Line as its client industries are more sensitive to economic volatility than by those serviced by more traditional banks. Debt also rose from $350M pre-pandemic to $5.4B at the end of 2022 as management acquired additional assets but remained unable to reduce the bank’s overall volatility. SVB did not have a Chief Risk Compliance officer on staff. Moreover, the San Francisco Fed President Mary Daly was cited by the New York Postas the “poster child for wokeness replacing competence and merit across the banking sector.”
Management was also unable to adapt to the impact of the rapid-fire 2022 interest rate hikes on its customer/asset mix. When Fed Funds rates were fixed for years at exceptionally low levels, depositors would be more apt to keep the funds in ultra-low rate checking accounts that were protected by the FDIC up to $250k and unlikely to be moved elsewhere. With Fed Funds rates increased to 4%, customers were more likely to want the market interest rates of CDs, treasuries, and mortgage-backed securities and decline the FDIC protection.
The bank also purchased these assets at higher yields for its own balance sheet rather than relying on the lower paying “overnight” Fed Funds to fund its operations. These assets are longer in duration than checking accounts. This limits, often significantly, the bank’s access to “overnight” cash resources when the need for liquidity was becoming critical. Moreover, the continued increase in interest rates created losses for the more recently purchased bonds and higher yielding securities that were no longer the highest yielding.
SVB management seemed to ignore what made it – and it alone – the riskiest bank in the nation.
Most importantly, it had the highest percentage of uninsured deposits (at 97%) of any bank in the nation. This risk made SVB depositors most vulnerable to a bank failure. Moreover, it incentivizes clients to take their money out (start a bank run) at the earliest whiff of trouble.
The bank run started when venture capital funds told their portfolio companies to move their assets, particularly amounts over the FDIC limits, to safer banks.
But thanks to technology, today’s bank runs spread far more rapidly than they did in the Great Depression era. Social media spread depositors’ fear throughout the community like wildfire, and nobody today needs to physically appear at a bank to withdraw money. Everything happens in instants.
The bank had to raise cash by dumping at a loss those treasuries, mortgage-backed securities, and other bonds that it recently had purchased. These assets are often the least actively traded. No time was left to raise meaningful equity or longer duration debt capital.
WHERE THE GOVERNMENT WENT ASTRAY
The traditional response is to allow the FDIC process to take care of itself, the way it was structured to do in response to the depression-era bank runs. The FDIC is funded by all banks based on the dollar amount of deposits under coverage and the FDIC’s assessment of a bank’s risk profile. The process is to allow customers overnight access to their insured funds with a claim for amounts not specifically covered. The failed bank’s assets are unwound with proceeds first to the customers, then the bondholders, then shareholders last. No thumbs are allowed on the scale for the loudest or most political voices.
Rather than let this time tested process play out, the FDIC and Treasury Departments rushed to intervene.
It didn’t help that New York’s Signature Bank was shut down a day later. It is now the 3rdlargest bank failure in US history. It also had over 90% of its deposits uninsured by the FDIC. Moreover, its client base was top-heavy with customers in the most niche oriented and least understood financial asset throughout the world... the dreaded cryptocurrency.
This intervention was a seance between the FDIC and Treasury Departments. They jointly guaranteed all deposits at both SVB and Signature Banks. They leveraged the balance sheets of the healthiest banks to absorb the poor practices of a troubled few.
Then the Federal Reserve took it another step further… It developed a liquidity program to permit regional banks, credit unions, and similar financial institutions to borrow against the least liquid assets in their portfolios for short term funding rather than sell them.
This response brings the perspective of moral hazard to the equation.We cannot allow our governments to protect the most well-off citizenry from their own sloppiness or even bad luck, let alone be rewarded by consciously taking on risk that require us to bear the downside burdens for them.
This response by the Fed didn't create the initial moral hazard. That occurred long ago. This is the product of moral hazard. With perhaps more to follow.
Now the slippery slope continues. Treasury Secretary Janet Yellen told the Senate Finance Committee this week: “Uninsured investors will be made whole in that bank, and I suppose that could include foreign depositors, but I don’t believe there is any legal basis to discriminate among uninsured depositors.”
We are looking at our local hometown banks (and we the depositors!) funding the politically connected worldwide – not just in the liberal blue enclaves. The working people and retirees of Michigan deserve far better protection from the FDIC, the Treasury Department, and the Federal Reserve.
WHAT COULD BE NEXT
What is the ultimate cost? Our currency is the natural balancing mechanism. Bad behavior of treasury departments and central banks should be penalized with capital flight, higher sovereign borrowing costs, and a devaluation of the currency.
The Federal Reserve was on target to finally catch up to the inflation its policies hatched. A 4% yield on the 10-year treasury bond seems to be a sweet spot for our Goldilocks, rates we can somewhat afford to pay but also allows enough inflation that we can pay the interest on our $31 trillion debt load with inflated dollars.
Uncertainty in the Fed’s interest rate policy will immediately impact the mortgage market. Housing is connected at the hip to the mortgage market and will be similarly unsettled.
The secret sauce tactic to win the inflation battle is to take the Fed Funds rate ABOVE the rate of inflation (as proven by Paul Volcker and Ronald Reagan). The Fed's preferred measure of core inflation most recently checked in at 4.7%. The rate for Fed Funds is effectively at 4.58%. One more rate increase or two would likely have finished this job.
As usual, it's the likely overreaction of government that will bring on the real pain in years to come. The semi-financially-literate corporate media will want us to think that every “smaller” bank is a candidate for implosion with a series of bailouts and cheap money creation as the only solutions. The reality is the banking system is well capitalized and can absorb these “one-off" shocks, particularly if no additional structural risks are piled on by the political elites. FYI — The Bank of the United States 1931 failure was the largest in history at the time. SVB has merely 4% of the impact to the current economy as this 1931 failure.
The rest of the world does not have the economic power to absorb more interest rate hikes. They want the US financial system to absorb their banking risks. We will pay for it with reduced economic growth and/or a weakened US dollar. Truly a manufactured outcome.
Expect the globalist central bankers to coordinate as they have done since 2009 to “fix” the global financial crisis.
This is why it is critical that Congress assert its authority over the Federal Reserve and take back our country's monetary policy.
Look forward to deeper dives for all the most vital things related the Federal Reserve and central banks in future commentary.