Regulators Say SVB Was a Regulatory Failure. So Why Don’t They Resign?

The collapse of Silicon Valley Bank (SVB) on March 10, 2023, can be understood on three levels.

At the simplest level, the bank held over $100 billion in U.S. Treasury securities at a time when interest rates were rising. The Federal Reserve began its campaign of interest rate hikes in March 2022, but it warned markets in advance that the rate hikes were coming. That was 14 months and 5 full percentage points of rate hikes ago.

Bond Math 101 says that when rates go up, bond values go down. It’s that simple. With over $100 billion in notes and bonds (mostly at long maturities, which means a given rate hike produces larger losses than for shorter maturities), SVB was clearly in for major mark-to-market losses.

The second level involves bank management. When rates are going up, and bond prices are going down, there are several established strategies. One is to gradually sell the longer maturities and replace them with less volatile shorter maturities. That involves some losses, but it prevents much larger losses down the road.

Another strategy is to hedge the bond position by selling interest-rate futures contracts. That way, losses on the bonds are offset by gains on the futures. There are some transaction costs on the futures, but they are modest relative to the protection offered. It’s like paying a $1,000 insurance premium to protect the value of a $5 million house. It’s worth it.

Bank management didn’t do any of these things. Instead, they were greedy and preferring not to realize losses or buy insurance. They relied on the fact that the bond losses were “paper losses” only because the bonds were booked in a “held to maturity” (HTM) account, which does not require losses to be recognized.

That works as long as you don’t have to sell the bonds. The minute you do sell to raise cash to pay panicked depositors, the house of cards collapses.

The third level involves regulators. Where were they? The potential for losses by SVB was in the billions of dollars. Management had buried its head in the sand.

Why did regulators do nothing? This article describes an internal review conducted by the Federal Reserve to assess the Fed’s failures.

That’s fine, but why has no one resigned or been fired?

The two lead regulators were Michael Barr, the Fed’s vice chair for supervision, and Mary Daly, the president of the Federal Reserve Bank of San Francisco. They were in the chain of command and had the ability to force SVB to take hedging measures to reduce their exposure. They did nothing except send a few letters, which were never followed up.

Barr and Daly should resign or be fired. Unless that happens, there’s no accountability for failure at the Fed. That means you should expect these bank failures to continue and morph into a full-blown banking crisis. Get ready.

Corporate leaders and institutional fiduciaries looking to incorporate state of the art predictive analytics to their risk mitigation and strategic analysis should click the link to learn more about Raven Predictive Analytics®