The Banking Crisis: More Kicking the Can

There were a ton of hot takes on the banking crisis over the last few days. I didn’t feel like contributing to the cacaphony on Twitter because I was busy working with USV portfolio companies and also in Mexico City with Susan celebrating her birthday.

Before addressing some of the takes, let me succinctly state what happened. SVB had taken a large percentage of their assets and invested them in low-interest-rate long-duration bonds. As interest rates rose, the value of those bonds fell. Already back in November that was enough of a loss to wipe out all of SVB’s equity. But you would only know that if you looked carefully at their SEC filings, because SVB kept reporting those bonds on “hold-to-maturity” basis (meaning at their full face value). That would have been fine if SVB kept having deposit inflows, but already in November they reported $3 billion in cash outflows in the prior quarter. And of course cash was flowing out because companies were able to put it in places where it yielded more (as well as startups just burning cash). Once the cash outflow accelerated, SVB had to start selling the bonds, at which point they had to realize the losses. This forced SVB to have to raise equity which they failed to do. When it became clear that a private raise wasn’t happening their public equity sold off rapidly making a raise impossible and thus causing the bank to fail. This is a classic example of the old adage: “How do you go bankrupt? Slowly at first and then all at once.”

With that as background now on to the hot takes

1. The SVB bank run was caused by VCs and could have been avoided if only VCs had stayed calm

That’s like saying the sinking of the Titanic was caused by the iceberg and could have been avoided by everyone just bailing water using their coffee cups. The cause was senior management at SVB grossly mismananging the bank’s assets (captain going full speed in waters that could contain icebergs). Once there was a certain momentum of withdrawals (the hull was breached), the only rational thing to do was to attempt to get to safety. Any one company or VC suggesting to keep funds there could have been completely steamrolled. Yes in some sense it is of course true that if everyone had stayed calm then this wouldn’t have happened but this is a classic case of the prisoner’s dilemma and one with a great many players. Saying after the fact that “look everyone came out fine, so why panic?” is 20-20 hindsight – as I will remark below there were a lot of people arguing against making depositors whole.

2. The SVB bank run is the Fed’s responsibility due to their fast raising of rates

This is another form of blaming the iceberg. The asset duration mismatch problem is foundational to banking and anyone running a bank should know it. Having a large percentage of assets in long-duration low-interest-rate fixed income instruments without hedging is madness, as it is premised on interest rates staying low for a long time and continuing to accumulate deposits. Now suppose you have made this mistake. What should you do if rates start to go up? Start selling your long duration bonds at the first sign of rate increases and raise equity immediately if needed. Instead of realizing losses early and accepting a lower equity value in a raise, SVB kept a fiction going for many months that ultimately lost everything.

3. Regulators are not to blame

One reason for industries to be regulated, is to make them safer. Aviation is a great example of this. The safety doesn’t just benefit people flying, it also benefits companies because the industry can be much bigger when it is safe. The same goes for banking. You have to have a charter to be a bank and there are multiple bank regulators. Their primary job should be to ensure that depositors don’t need to pour over bank financials to understand where it is safe to bank. If regulators had done their job here they would have intervened at SVB weeks if not months ago and forced an equity raise or sale of the bank before a panic could occur.

4. This crisis was an opportunity to stick it to tech

A lot people online and some in government saw this as an opportunity to punish tech companies as part of the overall tech backlash that’s been going on for some time. This brought together some progressives with some right wing folks who both – for different ideological reasons – want to see tech punished. There was a “just let them burn” attitude, especially on Twitter. This was, however, never a real option because SVB is not the only bank with a bad balance sheet. Lots of regional and smaller banks are in similar situations. So the contagion risk was extremely high. The widespread sell-off in those bank stocks even after the announced backstopping of SVB underlines just how likely a broad meltdown would have been. It is extremely unfortunate that our banking system continues to be so fragile (more on that later) but that meant using this to punish tech only was never a realistic option.

5. Depositors should have taken a haircut

I have some sympathy for this argument. After all didn’t people know that their deposits above $250K were not insured? Yes that’s true in the abstract but when everyone is led to believe that banking is safe because it is regulated (see #3 above), then it would still come as a massive surprise to find out that deposits are not in fact safe. As always what matters is the difference between expectation and realization. If SVB depositors would take a haircut, then why would anyone leave their funds at a bank where they suspect they would be subject to a 5% haircut? There would have been a massive rush away from smaller banks to the behemoths like JP Morgan Chase.

6. The problem is now solved

The only thing that is solved is that we have likely avoided a wide set of bankruns. But it has been accomplished at the cost of applying a massive patch to the system by basically insuring all deposits. This leaves us with a terrible system: fully insured fractional reserve banking. I have been an advocate for full reserve banking as an alternative. This would let us use basic income as the money creation mechanism. In short the idea is that money would still enter the economy but it would do so through giving money to people directly instead of putting banks in charge of figuring out where money goes. The problem of course is that bank investors and bank management don’t like this idea because they benefit so much from the existing system. So there will be fierce lobbying opposition to making such a fundamental change. I will write more posts about this in the future but one way to get the ball rolling is to issue new bank charters aggressively now for full reserve banks (sometimes called “narrow banks”). Many existing fintechs and some new ones could pick these charters up and provide interesting competition for the existing behemoths.

All of this is to say that this whole crisis is yet another example of how broken and held together by duct tape our existing systems are. That’s why we are lurching from crisis to crisis. And yet we are not willing to try to fundamentally re-envision how things might work differently. Instead we are just kicking the can.