Global Financial Crisis 2.0? Part 4

Chapter 4: Should the government have intervened in Silicon Valley Bank? 

Fair question. Uncle Sam’s intervention in Silicon Valley Bank certainly wasn’t popular with the average American.

And I can see why. For one thing, SVB was understandably seen as a Venture Capital bank. Venture Capital isn’t exactly the darling of the banking world; it’s a high-risk, high-reward space in which bets are sometimes placed on stupid, laughable stuff.  Snapchat filters that make people look like cats, for example.

Plus, the whole thing seemed a lot like a bailout — or at the very least a backstop — that we both know YOU would never get from the Fed if it was your business about to collapse.

So I can totally understand the backlash. I wouldn’t blame anyone who felt like Big Government swooped in to protect idiots from the consequences they so rightly deserved.

But the government didn’t have a lot of good options vis a vis SVB.

It ultimately picked the cleanest dirty shirt among them.

See, left unchecked, a run on SVB would have spilled over to other banks and likely spiraled out of control. And though it might not seem obvious, American homebuyers would have been at the tail end of this spiral.

Let me explain.

The first thing to know: the run on SVB led the government to put the bank into "receivership"

In the context of SVB, this basically means two things:

1. That the bank’s deposits would be backstopped by another institution (the FDIC, in this case).
2. That the bank's depositors would be first in line to be made whole (before other SVB creditors).

So, how might they make depositors whole without taxpayers footing the bill?

Well, figuring that out is part of the receivership process.

The most obvious way would be to firesale some portion of its remaining ~$100 Billion security portfolio, of which $50 Billion were mortgage-backed securities.

A quick refresher on mortgage-backed securities:

An MBS is essentially a bond secured by a bundle of home loans. Much like a traditional bond, an MBS is tradable asset with a coupon rate (akin to an annual interest rate) that delivers periodic payments to the investors who hold them.

The difference though, between an MBS and a more traditional bond, is WHO is paying the coupon.

In the case of a bond, it’s the government, corporation or other entity that issued it.

In the case of an MBS, the payor is the pool of homeowners whose mortgages are within it.

Thus, if an MBS fire sale were part of the SVB receivership plan…

…here's the vicious cycle that would have likely ensued:

SVB sells its MBSs at a loss to cover withdrawals and pay creditors.

Then, hearing about the SVB situation, depositors at the next smallest regional bank scramble to withdraw funds (as happened with Signature Bank on March 10th. Signature customers panicked after SVB failed because a lot of their deposits were uninsured and Signature had significant exposure to the crypto sector).

Now that bank goes into receivership and sells its MBSs at a distressed price.

From there it could spiral through the whole banking system and beyond.

Because what happens in that scenario? The market gets deluged with distressed MBSs.

The supply of MBSs shoots up, demand goes down, and prices fall.

Balance sheets everywhere would be upended. Banks and lenders across the board would likely find themselves in a negative net equity position…

…unless of course their MBSs were very well hedged with other assets that would appreciate as the MBSs tanked (precious metals might be one such asset). But most institutions are not that hedged.

And the FED simply CANNOT let the market get flooded by MBSs

For a number of reasons…not the least of which is THEIR balance sheet!

The Fed’s balance sheet currently contains $2.6 Trillion+ of MBSs, much of which it bought as part of its Quantitative Easing policy in 2020 and 2021 (when mortgage rates and thus the coupon rates were super low).

All of which would lead to even worse housing affordability than we have now

Think about it: 70%+ of homebuyers need financing to afford a home.

If they had to qualify at higher interest rates and even stricter Debt-to-Income ratios, a home purchase would become further out of reach.

If fewer people can afford to borrow, economic expansion becomes a real challenge. After all, housing makes up 15%-18% of GDP, so any hit to that segment of GDP would likely sink us into a recession in very short order.

That’s why the government absolutely HAD to intervene so quickly after the run on SVB

It wasn’t about propping up the VC world. And it was only somewhat about making SVB depositors whole.

More than anything, it was about shielding the American housing market from a potentially catastrophic blow, at a time when it’s already up against the ropes.

I’m not saying I like it. Far from it…

It’s yet another instance of the government pulling its levers to manipulate the housing market. Artificiality created the problem, and now they’re using artificiality to “solve” it.

From a forecasting standpoint, it makes this stuff a lot tougher to predict when there’s always some magic wand a HUMAN in power can wave to delay NATURAL consequences. 

And while I don’t wish ill on the American homeowner……if the government HADN’T intervened, we probably would have seen opportunity in real estate sooner than we will now 

That said, NOT intervening might have led to a real bloodbath. One that might have been a fair bit worse than a propped-up housing market. Hard to say for sure, but it seems probable.

In any case, the Fed’s action brought the immediate crisis under control, and U.S. homeowners lived to fight another day.