Unfortunately, the answer to this question is probably nothing can be done to prevent financial institutions from taking to much risk. Increased regulations would do nothing to prevent future bank failures. These companies have auditors, haha. Companies pay auditors to give an opinion. Auditors have a strong monetary incentive to give favorable opinions. I have never been in the accounting or corporate finance world but my understanding is that an audit would not prevent anything like happened to SVB. I highly doubt auditors give a crap about whether or not a company has taken too much interest rate risk. I think auditors are merely attesting to whether or not the financial statements adhere to sound accounting principals.
There probably needs a bigger and more important role for Standard & Poors & Moodys. They get more into the fundamentals of companies but even here there are conflicts. Companies pay for ratings. Downgrades are not that helpful if it is done after most of the bad news is out. I really do not know what the answer is but removing the conflicts would be a start.
Comments (46)
Banking regulation is like whack-a-mole. In the 1930s banking crisis, they added FDIC insurance to prevent bank runs. In response to the 2008 global financial crisis, they vastly increased capital requirements as banks failed under the weight of bad assets and insufficient capital to back up those assets (among many other reforms). And there have been countless cases like this over the years where regulations morphed in response to specific inadequacies.
In this instance, the question is, how do you prevent a run on banks? You could increase FDIC insurance to, say, $500 million for business (commercial) accounts without needing to meaningfully increase consumer account insurance limits. This way, commercial-heavy banks would pay via steep insurance assessments. $500 million is an outrageous figure, but let's be real--after the 2008/9 bailouts and the SVB/Signature bailouts, we now know that the federal government will essentially back banks regardless of the written rules. The implicit has become the explicit. At this juncture, we know, more or less, that all depositors are backed by the full faith and credit of the federal government, so why not just make some explicit outrageous insurance guaranty and charge for it?
Some other ideas: you could allow banks to back large depositors by pledging securities. They are required to do that with public funds, but they could be allowed (possibly required?) to do so with large deposits. You could allow a form of private deposit insurance, which I don't think is allowed to exist at this point in time. Then, of course, you'd have to regulate the insurers. You could increase liquidity requirements, but if a black swan event happens, there is no reasonable regulation that will provide for sufficient liquidity across the industry. The state of Massachusetts has a private insurance fund funded by member banks which insures all deposits above the FDIC limit. The other banks could form something like this.
Right, so stop passing more and more ridiculous regulations on banks and start including the executive team in the existing regs. SVB collapsed because their corporate oversight was so shitty that they put the bank in an absolutely horrific position to deal with rising interest rates, a phenomenon which should have been obvious to any rational observer at least a year ago.
We will never find a reasonable solution until there is accountability on Wall Street, because the federal government is almost obligated to step in to prevent banking crises to protect average people. As long as we are privatizing gains and socializing losses, this issue will continue to recur. Making banking executives responsible for their decisions through compensation clawbacks is an easy first step in discouraging some of the excessive risk-taking that financial institutions routinely engage in.
Genuine question: what is your distinction between it being state vs federal, or even involving blue sky laws? Just asking since we have state banking agencies and not just the federal ones. Obviously with blue sky there is that too. Regardless, this shit is whack yo.
I've been thinking a lot about this issue recently. There is tremendous pressure on rating agencies to give clients the ratings they want. It's really ugly. Say you're on the ratings team of Bank X. Bank X doesn't get the rating they want, they drop you. If you are in the annual review process of a bank and you put them on negative watch or downgrade them, you stand to lose their business. If your team loses 10 banks to competitors or to just dropping their rating, your team is going to have to layoff at least 1 person.
I think the only solution to this is to have a slate of approved rating agencies (by, say, the state) that specialize in certain areas (banking, BDCs, asset management firms, ABS, etc.) and for the customer to have the rating agency selected randomly and then changed every x number of years, as with auditors. The pressure to give the the company the rating they want or lose your job is real and it 100% weighs on the rating.
Yeah, I would take it one step further. May be you can make the ratings anonymous but I am not aware that there a long list of agencies. I hesitate to make the following statement on WSO but perhaps the agencies become part of the government. Government workers would not have an incentive to give inflated ratings.
I can't speak for all industries, but the banking industry is really, really complicated and requires smart analysts to be really well trained. I think if the rating agencies became "gov't" you'd end up with really poor credit rating quality. I don't think the credit ratings today are poor quality, but they are very much pressured by direct threats to one's livelihood. Also, the federal government is very bad at hiring people--getting a first job with the feds can take 6-12 months and hiring can be insanely arbitrary. Maybe the solution is to outsource credit ratings to non-corrupt governments, such as Norway. Maybe they could competently cover ratings on behalf of American companies.
Tbh, after working for a rating agency for a couple years before shifting to banking, the culture has shifted
Downgrading a company against their wishes was a badge of honor. Someone on my team got called up by a company literally screaming profanities and they fired us as a rating agency. Our director told them 'good job, this is a feather in your hat'
Rating agencies post 2008 are very conservative with their ratings because of the fallout. Going into the pandemic, I'd put together a model and have a senior say 'slash revenue growth from -40% to -90%, we'll rate it based on that'
Currently rating agencies are way too far on the conservative end to the point that in my opinion it's diminishing the quality of their ratings
the only solution is communism
https://www.youtube.com/watch?v=TVEatEO-CTE
actually it's distributism
Quant (ˈkwänt) n: An expert, someone who knows more and more about less and less until they know everything about nothing.
To be honest the most reasonable thing would be to raise the FDIC limit to $5M for companies and require anything held over that to be held in a sweep account. For larger corporations the $5M limit can be raised if the account holders pay for an additional insurance premium. The issue this would create is how do you ensure fair opportunity for sweep account products given that this could create significant imbalance in the pricing of these products.
IMO:I think that CDARS may be a prime target for regulatory action if expanded regulations are discussed.
The system currently allows up to $50Mm in deposits to be covered in a cash sweep product spread among member banks.
We may see eligibility and enrollment for CDARS adjusted.
An underdiscussed angle here is the technology angle. It's maybe not a coincidence that this happened to the bank at the heart of the tech industry, who depositors were power users of the latest technology and dialed in to social media.
The maturity mismatch problem has been an Achilles' heel for fractional reserve banking throughout its history. But it's been constrained (albeit imperfectly) in the past by technological limits. News of bank runs didn't spread instantaneously, and banks had at least some ability to slow-walk withdrawals that had to be made at the teller window in person.
Now the banks' depositors are all walking around with smartphones, and the banks have helpfully made apps that let them instantly withdraw their money from the comfort of their couches at home. The depositors can also obsessively scroll through social media on those phones. The result is that panics can spread like wildfire and massive amounts of money can vanish extremely rapidly. This wasn't really possible even as recently as 2008, a year when smartphone-based social media and banking barely existed.
It could be that the insane drops in things like Terra are not actually limited to crypto: in the era of smartphones, the same could happen to any financial institution that doesn't lock up its users' funds.
I'm curious about another related question: what can be done with this world's inherent upward/upside bias towards everything when "the world" means any cohort ?
Do you really believe this was an auditor issue? What do you want them to do? I'm assuming that interest rate risk is part of the risks section of the filing. Also the unrealized losses on the HTM book was footnoted. Based on all actuarial models, there wasn't some outsized risk. This was a classic bank run
I do not think think it is an auditor issue and even said made this statement in the topic.
You're right! Totally glossed over that. Sorry
The real solution is we need a LT interest rate that makes sense enough to promote saving and decrease irrational risk-taking. Don't give out free money promoting stupid use of capital. ZIRP interest rate policy promoted irrational capital allocation, irrationally propped up valuations, and caused people to take on excess risk. I'm sorry but no bank should EVER have 56% of it's loan book to P/E/VC lines of credit. SVB deposits shouldn't have grown as fast as they did. The market also gave SIVB a big premium multiple for this growth, completely overlooking the risk of having a deposit base concentrated in the highest risk businesses in our economy. As SIVB's VC customers received shit tons of irrational capital inflows in the frothy markets of the prior few years, SIVB's deposits grew faster than they should.
This correction we are seeing is very healthy and much needed for LT functioning of our economy, capital needs to be flowing in prudent and rational ways. I'm sorry EV SPACs that were really just sexy websites showing futuristic car prototypes should never have been multi-billion dollar companies parking cash at SIVB.
This is not an auditor issue, this is not a regulatory issue, SIVB, Silvergate, and Signature were absolutely stupid businesses that should not have gotten as big as they did as fast as they did, the market should not have completely overlooked the high risk of these businesses by giving them high valuation multiples giving them permission to grow like they did. The reality is we actually encouraged these business to grow when they really shouldn't have. A bank based on high risk venture customers is an absolutely irrational concentration of risk. Worse yet, SIVB did not account for the higher risk of it's deposit base/balance sheet at all so it deserved to fail. This bank would be fine if it was managed more conservatively than most banks to compensate for it's higher risk mix, but that was the complete opposite of reality.
Weren't the lines of credit subscription lines though? I.e. backed by capital commitments? It's not like the loans went bad
No but as the VC companies which make up much of the deposit base burned cash, they pulled deposits out which caused SIVB to consider raising capital in the first place causing further pulling of deposits then the run and failure because of SIVB's stupidity in managing duration.
SIVB was managed like shit but the market also incented it by giving it a huge multiple for a bank. Irrational. If you know the majority of your deposit is higher risk than average, you should manage your leverage/risk as such. If you were watching, it was pretty easy to see this was a piece of shit and that this could happen.
Due to regulations that arose from the financial crises, most banks are fairly well-capitalized and the issue with SVB wasn't a credit issue. I imagine there will be future regulations on garnering deposits (a financial liability for a bank) without a prescribed loan to deposit ratio, duration requirements on securities portfolios, or simply a requirement to keep excess financial assets in cash.
I'll give you my unpopular opinion that TBH banks are already regulated enough. Big banks (i.e. not SVB) are literally required to keep enough liquid assets to cover 100% of an stressed outflow (i.e. bank-run) period. SVB, as a smaller bank, was not required to do this. The question here is if you really want to regulate small banks in the same way you regulate JP Morgan? Jamie Dimon is probably getting a hard-on thinking this could happen as it would effectively kill all of his competition but most reasonable people will probably agree that smaller banks should be given a bit more freedom.
SVB was a start-up bank, in two ways, and it makes total sense that it would fail in this kind of environment. They, like all start-ups, bet on the free money party never ending and now that it did end, they are all collapsing. To be honest sometimes things just need to be allowed to fail because the only alternative is to outlaw business ideas like this and this would be directly taking freedom away from everyone else. If you have a bad idea you should be allowed to invest in it, build it, and then unwind it as it crashes down. In hindsight what SVB was doing (tying all of its assets into long-term bonds yielding 1.56% when everyone and their mom knew JPow was gonna make interest rates moon) was clearly stupid, but if it was SO stupid as to be outlawed then I'm sure all of us smart finance bois would have been calling this out years ago. We didn't, because it probably had a small probability of not going to shit, but now it did and we all want to feel like big brain risk managers when we are not. The economy sorted itself out, it is kinda what it is designed to do.
Banks are regulated well enough. The people making decisions at those banks aren't.
Make executive compensation contingent upon future financial performance instead of past results and you'll solve 99% of the issues in finance. Allow executives to keep their base salary, but make their discretionary comp (cash and equity) liable to make up future losses and you'll never see an issue like this again. Or, it will happen for more rarely.
We've made this insane decisions to "regulate" companies but we do nothing to disincentivize stupid risk taking for the people who work there.
I would honestly support any sort of regulation around the lines of forcing bank executives to pay back all of their bonuses, in full and with interest (time value of money), in the case that their bank collapses due to mismanagement. This should definitely apply to all the C-suite and maybe non-C-suite SVP level people but at least the entire C-suite for sure.
According an article on Seeking Alpha, which is quoting their 10K, the average duration of their bond portfolio was 5.7 years at the end of 2022 up from 4.0 at the end of 2021. It seems as though, they were actively increasing duration as the Federal Reserve was tightening and raising certain rates. I am not a bond portfolio manager but I do know that increasing duration as the Fed is tightening is a terrible idea.
They just thought the Fed was too pussy to go through with the hikes
All this diversity hiring nonsense must stop. When employees are competent and focused on their job instead of some bs, rough waters can be navigated successfully.
Your comment is BS. The banking issues have nothing to do with diversity hiring.
What! Don't be ridiculous. Obviously SVB collapsed because the damn libruls and Demonrats are demanding that schools put litter boxes in the bathroom for all the students that identify as cats!
The sheer nerve of suggesting that maybe rolling back regulations on financial institutions might have some bearing is offensive to any true patriot
Yeah, give more power to the ratings agencies, nothing bad ever happened from that...
idk but the fact that the depositors got an illegal bailout is extremely frustrating. life isn't fair except for when you are the rich guys then you can retroactively change the rules to save yourselves.
I've been going back and forth on this issue since Friday and I can't come to a conclusion about what is right. I see both sides to the argument. Ultimately, this bailout has, at least temporarily, prevented a wide-ranging banking sector collapse in the United States; on the other hand, the moral hazard can't be denied--bailing out depositors will probably mean this will repeat itself at some later date.
Not that this is news, but based on market activity and comments by one of their big investors, Credit Suisse may be on the way out. Based on superficial data, I looked at, they seem to have problems prior to this financial crisis.
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