Three things from this week’s pod with AEI’s Economic Policy Director Michael Strain:
Yes, the Biden administration bailed out Silicon Valley Bank’s depositors, well beyond the FDIC insured $250,000 limit. It did *not* bail out the executives, who have been fired, or the shareholders, who have lost all their money.
SVB is a story about incompetence, not wokeness. Bad management led to collapse. Their DEI policies may have been ridiculous, but that’s not what led to the bank’s collapse.
Long story short, this is another straw in the wind. A recession is coming. Strain bets 2023.
Anytime you see a fancy bank with fancy tech clients and fancy tech shareholders and it goes belly up, the right question to ask is… why would the federal government step in with a bailout for this bank in particular? The Biden administration argues that there’s nothing special about SVB; they’re just worried about contagion. Generally, when one bank fails, others follow.
With an economy that’s already fragile, a wholesale loss of confidence in banking could turn bad news into disaster. Of course, the apt riposte is, why is this my disaster? And why should the taxpayer be assuming the risk of paying out depositors beyond the $250,000 insurance limit in all banks?
The short, and somewhat simplistic answer is that we are all paying for the Covid spending spree of recent years. Covid ➡️ Spending ➡️ More spending ➡️ Inflation ➡️ Rising interest rates ➡️ Plummeting bond rates ➡️ Collapse for careless banks like SVB which lent for the short term but invested as if the long term was completely solid. Bills always come due, especially if you bet that the good times you know will always go on.
The larger problem is that the trouble that led the ridiculously incompetent California buffoons of SVB is still in place. The Fed is still raising rates. Inflation is still high. Unemployment is still low. But guess what? Eventually, those high rates will hit spending and then…. recession. Who’s to blame? Pretty much everyone. So expect more bad news, sooner or later. Per Mike Strain, probably sooner… this year.
HIGHLIGHTS
Mike, what the hell happened with SBV?
MS: Well, so when interest rates are low for a very long time, which of course they were since the 2008 financial crisis, really up until about a year ago, there's a lot of money, as you say, in the system. Money is free. Money is actually cheaper than free on an inflation adjusted basis, and there were certainly periods of years where that was true. And if you're putting your money in bonds, you're not really getting much of a return. And so that incentivizes investors to put their money in stocks. And we've seen really large increases in stock prices. And it also encourages investors to put their money into riskier assets like startups, like Silicon Valley type tech companies. And that is what we have seen in general in the last five or 10 years. And Silicon Valley Bank was a beneficiary of that, and a lot of people wanted the bank with them.
And they were unusual in a few ways. They were unusual in that they had a very narrow customer base. A lot of these startups, a lot of these tech startups, a lot of venture capital related to tech startups, in general, a lot of commercial deposits, most banks have commercial deposits and then have individual deposits. SVB had a lot of commercial deposits. And so that left their customer base quite exposed to interest rate increases because what made a lot of their customers successful was a low interest rate environment.
Then in addition, they were just really, really, really badly managed. The share of the money that the bank held that they put into assets was very high. The share of the money they had in treasury bonds was very high. They did not diversify against the risk that interest rates would go up, and that was a substantial management failure.
So, is this a bailout?
MS: The shareholders of Silicon Valley Bank have lost everything. They will not be bailed out. The holders of unsecured debt are, I think, completely wiped out, or at least they're taking really serious losses. To my understanding, the executives have all been fired. So this is not a bailout of the people who made the bad decisions, of the management of the bank. And it's not a bailout of the shareholders. The shareholders have been completely wiped out.
Instead, what happened, two things happened. The first thing is that the FDIC, the Treasury and the Fed have agreed to implement policies that will make all the depositors whole. So the shareholders will not be made whole. The shareholders are wiped out. The execs will not be made whole. The execs are wiped out. But if you had money in the bank as a depositor, then you will be made whole.
But the Biden people are saying this isn’t any kind of a bailout…
MS: The Biden administration, I think is misrepresenting the situation. The taxpayers will be on the hook for this. I think that there are real questions about how much the taxpayers will be on the hook. The FDIC limit is a quarter of a million dollars. If you had a million dollars in there and you're a rich hedge fund guy or you're a Silicon Valley based tech business, you're going to be made whole under this program. The funding for that as an accounting matter is going to come from the FDIC. And so the funding is going to come from a fee that is assessed of banks. So all banks contribute to the FDIC's insurance fund. Then when a bank fails, the FDIC can use the money in that fund to protect deposits of up to a quarter of a million dollars. In this case, deposits above that will be protected as well.
So in an accounting sense, the money's going to come from that fund, but who ultimately pays that? I think some of that is paid in the form of lower profits by banks, and some of that is paid by people who have money in banks, by the three of us and by millions of Americans. And so that is the taxpayer certainly contributing financially to bail out people with really large balances in Silicon Valley Bank.
Ron DeSantis says it’s because the bank was insanely woke… Thoughts?
MS: Well, I think that's ridiculous and I… Well, and I'm trying to think of something else to say other than that. I think their stance on those issues had absolutely nothing to do with what happened. I mean, look, to underscore again, this was a very, very, very badly run bank. It was a bad bank, it was a badly managed bank.
Isn’t this failure in part the product of insane spending during Covid?
MS: In response to the pandemic, Congress wrote a lot of checks to the American people, and in part because people had got so much money from the government, and in part because there were real restrictions on their ability or willingness to spend money, they didn't want to go out to dinner for a lot of that period of time. They didn't want to get on an airplane and go on a vacation for a lot of that period of time. We saw trillions of dollars of savings pile up that otherwise wouldn't have been there. And that has fueled extremely strong consumer spending and that has really elevated the level of consumer demand for goods and services in the economy. And more specifically, it has pushed the demand for goods and services beyond the supply side of the economy's ability to meet that demand.
And when you have demand go up a lot faster than supply can go up, prices rise, and that's what we've been living with. And so, one of the most important questions about the economy is for how long can consumer spending continue to run at this pace? For how many months are we able to have consumers spending so much money? For how many months is consumer demand going to remain really, really hot? And I think that for a while, consumers were spending out of their savings. They were running down their savings. That's certainly still happening. But you're also right, Marc, that consumers are shifting to spending a lot of money on credit. And my view is that at some point, consumers are going to really slow down their spending
Are we headed for a recession?
MS: So recessions I think are deeply mysterious. I mean, the business cycle itself is very mysterious. Why is it that for some periods you see businesses hiring and hiring and hiring, and then for other periods you see businesses laying people off? Why is it for some periods consumers spend a lot of money and then other periods consumers don't want to spend any money. And my basic view on this is that recessions are ultimately about a loss of confidence. And I think the way that it plays out in this specific instance is businesses see the number of people coming into their shop. It's going down. Businesses see that their sales for this week were lower than they were the same week a month ago, and businesses have been on edge for at least a year. When is the music going to stop? When is this thing going to turn around?
…once businesses start to lose confidence that people are going to keep spending money at their store, once businesses start to gain confidence that even if they lay some workers off, it won't be impossible to backfill those positions should demand to pick up again, then you're going to see layoffs happen and you're going to see the unemployment rate go up and you're going to see price inflation cool down.
So the Fed is going to drive us into a recession?
MS: The Fed's goal is not to start a recession, but the Fed's goal is to push the economy pretty close to a recession. The Fed doesn't want the economy to go in reverse, but the Fed does want the economy to tread water for a little while in order to bring price inflation back down to a more sustainable rate.
What's my best guess as to the timing? I expected that the downturn would begin in the fourth quarter of 2022, and I was wrong about that. I now think that the downturn will begin in the third or fourth quarter of 2023. This is not going to be the kind of recession that we had following the financial crisis, which was our last real recession. We went into recession during the pandemic, but that was such an unusual event. So the last recession we had where there wasn't a pandemic was the financial crisis. I don't think the recession will look like that. This'll be the kind of recession where people like me go on excellent podcasts like this or television shows or wherever, and we say, I think we're in recession right now and here's why. And then another smart person will say, well, I think you're wrong, and here's why I don't think we're in recession. And thenat some point six months later, we'll know who was right.
I think this'll be the kind of recession where the unemployment rate goes up by two, two and a half percentage points, but not the kind of recession where we have nine or 10% unemployment. I think we're talking about a five or 6%, maybe 7% unemployment rate recession, not a 10% unemployment rate recession. So I think it'll be a pretty mild recession and it won't feel like the world was ending in the way that the recession following the financial crisis felt.
Full transcript here.
SHOWNOTES
The Real Reason Silicon Valley Bank Collapsed (National Review, March 12 2023)
How Silicon Valley Turned on Silicon Valley Bank (Wall Street Journal, March 12 2023)
Washington surveys the damage (Politico, March 13 2023)
Wall Street Braces for the Next Silicon Valley Bank (Wall Street Journal, March 12 2023)
Wall Street Analysts Didn’t Foresee the Silicon Valley Bank Collapse (Wall Street Journal, March 10 2023)
Ron DeSantis blames Silicon Valley Bank’s collapse on DEI (Florida Politics, March 12 2023)
Biggest Banks Are Likely Safe From SVB Fallout, Blankfein Says (Bloomberg, March 13 2023)
SVB Clients Get a Painful Lesson: Bank Failures Are Common (Bloomberg, March 13 2023)
JPMorgan, PNC among suitors for SVB holding company (Axios, March 13 2023)
Joint Statement by the Department of the Treasury, Federal Reserve, and FDIC (Treasury, March 12 2023)
Federal bailout for Silicon Valley Bank off the table, Yellen says (Politico, March 12 2023)
SVB Doesn’t Deserve a Taxpayer Bailout (Wall Street Journal, March 12 2023)
Biden admin’s response to Silicon Valley Bank collapse is the ‘greatest form of corporate cronyism’: Tim Scott (Fox, March 12 2023)
Silicon Valley Bank Depositor Bailout Makes Mockery of ‘Too Big to Fail’ (National Review, March 12 2023)
Strain twitter thread:
· Is the Fed's new facility (BTFP) to provide additional liquidity the right response to SVB/Signature? I am still pondering.
· But it is worth noting that the Fed is in part responsible for this situation by waiting so long to begin raising rates that it had to hike so rapidly over a short period of time.
· The Fed's analytical errors led to a tightening cycle that was much faster than it needed to be. And that played a role in what happened this weekend.
· Nikki Haley tweet:
o Taxpayers should absolutely not bail out Silicon Valley Bank. Private investors can purchase the bank and its assets. It is not the responsibility of the American taxpayer to step in. The era of big government and corporate bailouts must end.
· Vivek Ramaswamy tweet:
o It’s a bailout, pure & simple. For years, SVB and its cronies lobbied for looser risk limits by arguing that its failure wouldn’t create “systemic risk” and wouldn’t need special intervention by the U.S. government. Yet now the same cronies claim SVB was “systemically important.”
· House Financial Services Chair Patrick McHenry statement via Politico
o This was the first Twitter fueled bank run
· CIO of asset manager Unlimited Bob Elliott via WSJ
o The big question is whether the FDIC and Fed make the uninsured depositors whole – or at least close to whole. If the resolution of SVB Financial isn’t handled well, there’s a systematic risk that uninsured depositors will flee small banks.
· Kevin McCarthy on Fox via Politico
o I have talked with the administration from [Fed Chair] Jay Powell and Janet Yellen. They do have the tools to handle the current situation. They do know the seriousness of this, and they are working to try to come forward with some announcement before the markets open
What about the woke policies? The woke stock holders? The woke companies.
I says this was all planned and the bunch of scammers laughed themselves all the way to the bank.
First, executives, all received bonuses .
Second, employees received bonuses hours before they were shutdown.
Third, Biden is bailing out certain people.
Forth, the bailout has not stopped the bleeding. It’s has now hit the UK.
This is a planned takedown of our economy. No way do I believe this all just a bunch bumbling idiots, that could not comprehend how long and short works.
Agree that wokeness alone was not the blame for SVB's failure, but it doesn't take a lot of research to find executives everywhere who are distracted by ESG's wokeness and improving "stakeholder value" over "shareowners." That same mindset contributed to mismanagement, neglect, and failure as the bank failed to hedge against inflation risk, driven by increasing the money supply 40% over the past three years. Do not dismiss "wokeness" as a contributing factor, perhaps even a major one.