Headlines, headlines, fear, and more fear. It can all become a little overwhelming indeed.
You may remember this column covering ‘shock financial headlines that lose you a fortune’.
Endless sensationally positive headlines in 1999 were followed by a 48 per cent fall in global markets over the next three years, in fact the FTSE100 was still lower than that high point nearly 21 years later.
Armageddon headlines in 2003, just as the Iraq war was starting, were followed by a 119% rise over the next four years. In 2007, excessively positive headlines were followed by a two-year fall of 46%. I could go on, but you get the drift. Over the same period to now, the MSCI World Index had risen 250%, but not without its panic and shifts. That’s how markets work. Each movement can have quick money bouncing in and out causing dramatic shifts in certain institutions as they guess where the next problem could come from.
Are banks in trouble and are we in the beginning of a global banking crisis, or is this a toothache? The latter, but read on.
Let’s talk about the limping and beleaguered Silicon Valley Bank (SVB). We have a problem that was created with record low interest rates for a very long time, followed by a Fed reluctant to raise rates, then raising them dramatically without stopping to see what the impact would be. Central banks often do that, raising rates until something starts creaking, then back off. Things creaked.
Let’s remember the USA isn’t Europe. They have a two-tier banking system and SVB is just a regional bank. It was a specialist lender to venture capital-backed tech startups, which in turn are much higher up the risk curve. (More on that in a second).
Regional lenders’ regulation is laxer. The chief executive at Silicon Valley Bank was a board member at the local Federal Reserve and called for more relaxed rules in terms of stress testing. At the same time, he invested deposits in riskier assets to gain a better return on his equity. Remember he is bonussed based upon that. There were longer-dated Treasury bonds in there alongside mortgage-backed securities. You now understand part one of the problem – root cause is he was incentivised to take risk.
Back to the tech startups. If you are a startup company, you are on a new ‘venture’ and so don’t have any cashflows to prove your solvency/success. Startups are given money by their venture capitalist backers but borrowing can be difficult. SVB said that in return for depositing this money, it would lend to them. (I’m sure you can see the pack of cards building here in both risk, as well as concentration risk in one sector, and an unknown risky sector too).
Let’s also remember they were without a risk manager for about four months.
How did it get into difficulty? The Fed started driving up interest rates, hammering the value of where SVB had ‘invested’ the money. There is a little quirk in US banking regulation which allows for a bank to report on its asset values in a strange way. If it buys Treasury bonds at, say a price of 100, and interest rates rise and the value falls to say 90, 80 or 70 for example, the regulation says, don’t worry you don’t need to report that drop, just report it at the price you paid. Provided you don’t have to sell.
Strap yourself in. So, remember, companies don’t have the same deposit guarantees as us. £300m is a lot to guarantee, so any rumour ‘shiver’ means that companies (who need their cash to pay staff/bills) will exit stage right.
A rumour spread that SVB mightn’t be in as good as a shape as it should. So, in the age of social media, where Elon Musk can talk to his 133m followers in one button, and they retweet. It’s a big snowball. The rumour triggers a response from Californians (where the problem is). People don’t know what happened under the bonnet (above), so react with "What does everyone know that I don’t?”
In one further button press, companies transferred their capital to another safe institution. The chief executive starts ringing around for a rights issue to raise more capital. Everyone asks why he wants more money, freaks out and pop, the remaining deposits are withdrawn. Fast. You now have a run on a bank.
This wasn’t a UK/European fully capitalised bank, so chill. Episode two with Credit Suisse and Deutsche next week.
- If you have a question on investments or would like advice, please ring 01872 222422 or email info@wwfp.net .
- Peter McGahan is the chief executive officer of independent financial adviser Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
