It is game over for central bank inflation hawks; there have been two bank runs in the US in as many days, and policymakers have been working overtime, weekend to prevent a systemic financial meltdown.
So let’s get to the bones of why Silicon Valley Bank, the 16th largest commercial US bank in Santa Clara, California, collapsed and how this could lead to global financial contagion unless monetary policymakers pivot from unprecedented monetary tightening; the pin that pricked the bubble of everything wiping off more than 30 trillion US dollars of wealth from asset portfolios in 2022.
Relationship between Fed tightening, collapsing bond market, and bank runs
“So more rate hikes could mean a wave of distressed banks, bank runs, bank bail-ins, and a financially engineered depression,” written in a piece entitled Distressed Banks February 13.
Here is the chronology of events; On February 2 Fed Chair Powell announced a 25 basis points increase, bringing the Key interest rate to a range of 4.5% to 4.75%.
February’s Fed 25 basis point rate hike triggered two bank runs
March 9 Silvergate Capital collapses
March 10, Silicon Valley Bank SVB collapses
March 13, breaking news Signature bank is collapsing as Darren Winters just pointed out..
The Fed has already raised rates six times in eighteen months and thus far has failed to slow inflation.
These aggressive rate hikes have pushed the average variable rate mortgage in the US to 7%, which means households are spending, on average, 40% more on monthly mortgage payments compared with one year ago. Moreover, the higher cost of servicing business loans means many low-profit margin businesses can no longer break even, collapsing the supply chain, causing inflation, and leading to a food crisis.
So the call made on February 13 was a mind’s eye into the future.
What is causing bank runs, collapsing liquidity, and bank failures?
Collapsing market liquidity flashed red in November when the reverse Repo hit a historic $351BN In the Biggest Weekly Jump In History.
The Repo market is where banks go for short-term finance to finance day-to-day funding operations.
So if banks rely heavily on the Repo market, that indicates banking stress, a looming liquidity crisis, and potential bank runs.
The crux of SVB collapse is a liquidity crisis caused by the crash of the 2022 bond market, which wiped trillions of dollars off their bond portfolio.
During the 2020 lockdowns, investors deposited billions of dollars into the bank, and because Fed fund rates were near zero, SVB invested in bonds of varying risk from Mortgage-backed Securities Bonds to US Treasuries.
Relationship between Fed tightening, bond price, yields, and rational investors
So when the Fed tightens, hikes rates, or sells assets, such as bonds, that reduces demand for bonds, sending bond prices lower and their corresponding yields higher.
But the banks do not pass on higher central bank hikes to their depositors. So SVB had invested in bonds when the yields were low, and their depositors started seeing aggressive Fed rate hikes, were mindful of their spiraling cost monthly mortgage payments and business loans, and were seeking a better return for their savings.
Short-term maturity treasuries, say 6 months to 2 years, with yields above interest on cash deposits is better than money in the bank. During a recession, loan delinquencies collapse banks, but the US treasury is bankrolled by the Fed, which can print the US dollars, the world reserve currency at will.
So SVB depositors acted rationally, seeking a maximum return for their capital with minimal risk, and pulled their money out of their SVB deposit account, offering miserable interest of under 3%, and bought the 6-month treasury with yields of 5%.
It is a no-brainer why keeping money at SVB where there is a risk of bank failure and return on capital is worse than investing with treasury direct.
So this is why SVB had a bank run.
SVB’s liquidity problem is due to the bank being forced to sell its distressed bond portfolio at a deep discount to meet depositor cash withdrawals.
SVB didn’t have the luxury of letting its 2-year treasury bond mature to meet depositor cash withdrawals.
Selling assets at a deep discount, in some cases, 40 to 60 percent of book value, led to the bank’s liquidity crisis.
SVB is no isolated case, and could lead to contagion and other bank runs
Central bank rate hikes have now triggered a systemic crisis in the bond market. US Treasuries are pledged by commercial banks to underwrite loans and are the collateral of the entire western banking system.
If the Fed continues its hawkish posture, the entire Fed western aligned system collapses within weeks.
Who benefits from bank runs, and bank failures?
Darren Winters notes, he was watching his trading screen as the crisis unfolded, banks were all blood red, except for a blip of green, JP Morgan.
We are witnessing the consolidation of power and wealth in the hands of a few. JP Morgan is already feasting on the SVB carcass, picking off quality assets on the cheap, and the toxic meat is left for Fed bailouts. The inflation fight is over. Fed will print to save the banks. People will shoulder an even more diluted currency as their standards of living fall, whereas the current generation will envy their parents.
Yes, the Fed will choose the path of least resistance.
Get ready for decades of high inflation and more public spending. Invest in yourself developing unique and valuable skills that will enable you to pass on higher prices. Investment in assets that perform better in a period of inflation could outperform.