It's 30 years since Warren Buffett first warned ‘It's only when the tide goes out that you learn who's been swimming naked.’ He was talking about how hurricane reinsurers were happy to accept money for underwriting catastrophic risks they thought would never happen. Until they did.
So, it’s no wonder that following the recent failure of not one, not two but three quirky US banks, investors currently fear they have inadvertently wandered onto a nudist beach. Are these three banks simply the first three dominoes to topple? Maybe. And, if so, is it the start of a major financial crisis, like the burst property bubble and credit crunch of 2008? That seems much less likely. Nevertheless, everyone has been taken aback by the sheer speed at which it happened.
The first two banks closed because of their sizeable exposure to crypto currencies. No surprise there. Those closures may have been symptomatic of the financial strains induced by the rapid increase in interest rates, but they did not constitute a systemic threat.
However, it was collapse of California’s Silicon Valley Bank (SVB), the second-largest banking failure in US history, that caught people’s attention. This was the first bank run of the Twitter age with repercussions exacerbated by the tangentially related run on and forced rescue of Credit Suisse, Switzerland’s second largest bank. Rather than a bank for crypto, SVB was a bank for startups. In the days following its collapse, the shares of mainstream banks and dull insurance companies around the world fell by 5-10 per cent or more. Why? Because fear of contagion is contagious.
Some US regional banks fell by 50 per cent as a nervous market ditched shares in anything that looked like it might be the next vulnerable bank to explode, ie, anyone whose customers and assets looked similar to SVB. Were seasoned investors panicking? Yes, they were panicking. So were American depositors. Big banks like Citigroup and JPMorgan Chase were swamped with requests from people seeking to move their money away from small regional banks.
The US central bank was quick to set up a blood drip (credit lines) to all banks to ensure they remained adequately capitalised if deposit withdrawals were to further speed up. After a few nervous days, this halted the outflows of deposits, much of which ended up in money market funds. Unlike banks, money market funds do not have $250,000 depositor insurance because they can’t go bust in the same way as banks can. But they do offer interest rates of around 4 per cent - much more than the measly 0.4 per cent paid by many regional banks.
In reality, the collapse of SVB was more like an old-fashioned Keystone Kops run on a bank triggered by a bunch of venture capital finance director lemmings all frantically swapping texts about whether to move their money elsewhere. Depositors wanted all their money back and SVB didn’t have enough assets to repay them. That’s because unlike proper banks, which are highly regulated and frequently stress tested, SVB had not insulated its lending from the asset-depleting effect of the Fed’s rising interest rate policy. Not entirely coincidentally, SVB had no chief risk officer from April to December 2022.
