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Originally Posted by Texas Contrarian
My take on this is that the biggest reason for SVB's sudden blowup was an almost complete lack of the sort of risk management practiced by almost all banks.
Post-GFC, regulators have required banks to hold high quality liquid assets (HQLA) in sufficient quantity as to have the ability to meet a stressed outflow of deposits and to meet a required liquidity coverage ratio. These assets can be Treasury notes, MBSs, or even high-quality corporate bonds.
But here's the interesting thing, and from what I have seen so far, I'm not sure it's been well covered in the financial press.
HQLA can be booked under either Available for Sale (AFS) or Held to Maturity (HTM) accounting regimes.
AFS unrealized losses don't appear in the bank's P&L, but do show up in the capital accounts.
But booking the assets in an HTM regime prevents them from showing up at all! Convenient for those who want to delay the day of reckoning, isn't it?
This appears to be exactly what SVB did, at least to a large extent.
Further, it appears that SVB didn't hedge its asset portfolio against interest rate risk at all! Banks generally do this with interest rate swaps and any of several other types of derivative assets, thus reducing the risk of facing crises with tanking bond portfolio market values.
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Thanks for your insights. I share your dismay at the way SVB has blown up despite all the new rules and stress tests ushered in by the Dodd Frank Act in the aftermath of the 2008/09 Great Recession.
A few thoughts, prefaced by the caveat that I haven't been following developments in the banking industry as closely as I did a decade or so ago:
Remember when Hank Paulson was in charge at Treasury? He was gung-ho about forcing banks to mark their portfolios to market daily. Of course, be came from Goldman Sachs and was used to the financial discipline imposed by MTM rules.
Back then, the problem involved subprime mortgages, MBS and CDOs. That stuff was sitting on everyone's balance sheets. Many of those securities were unique, even esoteric. When trading dried up, there were no readily available market prices to mark to. In many cases, the market overshot. When trades did occur, they were at deeply discounted prices - even for highly rated bonds that continued to perform fully (i.e. to pay all required interest on time to the holder).
As I recall, the banks kept announcing huge quarterly paper losses, rattling the financial markets and deepening the crisis. It wasn't until Tim Geithner took over at Treasury that some of those mark-to-market rules were suspended in Q2 2009 - which was also when our financial markets finally bottomed out (not coincidentally IMO).
Maybe someone can look up the details of what MTM rules were actually suspended back in 2009, and how those rules have evolved since then.
There has long been a difference in the required treatment of AFS (available for sale) versus HTM (held to maturity) securities, and for good reasons. One thing missing from this discussion is - to what degree were assets and liabilities at SVB mismatched? If a bank offers 2% interest on a 5-year CD, then turns around and invests it in a 5-year bond yielding 4% - that's match funding by maturity, to lock in a 2% net interest income stream for 5 years. You wouldn't want that bond to be marked to market at all.
One big difference between 2009 and now is that the securities involved today are more liquid and of higher quality. US Treasury markets are the most liquid in the world. No problem finding an instantaneous price quotation if you want to mark to market. The unrealized losses are mostly the result of the Fed-engineered upsurge in market interest rates and have little or nothing to do with credit concerns or downgrades. But yeah, Tiny is right - wtf were they doing pushing so much into longer maturities, instead of staying in stable, liquid short-term treasuries?
And yeah, TC is right to ask why the fuck weren't they making smarter use of interest-rate swaps and derivatives? If you are funding a long-term asset with a short-term liability that keeps repricing at a higher & higher rate, then you should swap it into a fixed-rate liability with the same maturity as the asset being funded! The swap market is relatively cheap and easy to use for purposes like that.
I need to read up more on this. Not sure how relevant my observations are but I thought I would share them anyway.
