How much did ESG and DEI factor into the SVB collapse? At minimum they were distracted from focusing on the core business of a bank and risk management. Here are the receipts: https://yuribezmenov.substack.com/p/svb-linkedin-receipts
Not a factor at all. The story of SVB's failure, like most bank failures is about specific people and incentives. Note the SVB had run with out a head of Risk Management for over a year running up to the failure. I should note, Yuri, that I sold risk management systems to banks to assess interest rate and other risks so I'm not speculating, these deets were in the financial press.
The reason for the risk manager leaving was not made public but I can tell you that any risk manager would see the build up of these floating, interest rate sensitive liabilities. It's not a esoteric.
And those risks would have become obvious over a two year runup to the busy, according to what it looked like to me. My hypothesis is this. Risk manager recommended hedging the interest risk with swaps or perhaps some other financial engineering techniques I'm not up to speed on to hedge out that exposure. At that point, it would have been very expensive to purchase those hedges. It would have had an immediate impact on profits and bonuses for management. for sure.
Regulatory reporting is a different matter. This interest rate exposure might not have been seen as a solvency level risk. It depends how it was measured. I didn't take the time to read up on all that but the disclosure of risk is an art in and of itself. It could be that the risk model used understated the risk, which lulled both management and the regulator into a false sense of security. The risk manager may have been positioned as overreacting or too conservative - who knows.
But in the end it was an unhedged risk that was fairly straightforward. Management knew what they faced and the interest rate market moved against them. Zero DEI. 100% management greed. Keep in mind SVB wired all management their bonuses within days of going bust...these guys are almost always the culprits, gals too these days. Everyone is in on the hustle.
Thanks for this ...Financial crises always come back.... An evergreen issue ....it's just fascinating in a weird sort of way that only an economist would appreciate!
Seems to me that rather than ban them, the fed give them a license to operate under a strict "no bailout" policy and see if they end up producing popular products for customers. My guess is that the fear is not that they are dangerous to consumers but they would be too successful and would result in a lot of current wide-banked customers moving their money to a narrow bank and thus causing a systemic bank run on all the wide banks
The problem has always been and will always be Government regulation of banking in general and the Federal Reserve in particular. More non-economists/social scientists need to read Murray Rothbard, especially his monograph: “What Has Government Done to Our Money?”
The only things standing in the way of your recommendations are the Bank Policy Institute, US banking cabal influencers and their well lubricated members of Congress, a Bipartisan supermajority.
John: "They need only the will to overcome the powerful interests that benefit from the current system." If economics is about incentives stimulating self-interest, then bank officials will assume excessive risk believing they will benefit no matter the bank failure. If the risk assumed is rewarded with risk adjusted returns, they get bonused. If it blows up the losses are covered by the taxpayer whether with taxes or inflation (diminished buying power). It seems the moral hazard problems can be ameliorated by with contracts that specify penalties for their bad decisions. Stockholders should ( normative) be willing to penalize bad decisions.
"Such firms are REQUIRED to...participate actively in U.S. Treasury securities auctions."
Cochrane solution (non-free market):
"Deposits MUST be funneled narrowly to reserves or short-term Treasurys."
Given that the Dodd Frank regulations failed, what makes you think that one more regulation (government telling banks how to handle deposits) is going to do any better?
As soon as you tell banks they must buy Treasuries, that destroys any notion of government bond sales being a free market process.
More government control, so those who are already in power will stay in power and benefit from others being slaves of the government (through getting more and more debt). If Fed can continuously print money without any accountability, seriously, “End The Fed”
Wouldn’t a narrow bank put too many eggs in the fed basket? If one bank does it sure, but if the only thing paying interest on most checking accounts is the fed, doesn’t that increase risk of bad fed policy going more drastically wrong? Don’t get me wrong, I think it should be legal and that the fed probably prevents it to prevent ordinary depositors from having access to their special rates, but you wouldn’t argue that one big fed bank would decrease systemic risk so why the same claim about narrow banks? I would love to hear more from John on this angle. In my mind the key feature of narrow banks as conceived is liquid assets—not an account at the fed—but the concentration in accounts at the fed would increase risk.
Matt Levine is a columnist for Bloomberg.Com. He was an investment banker and a mergers & acquisitions lawyer before he went into financial journalism. I highly recommend his column/newsletter Money Stuff for his excellent explanations of the latest developments in finance. You can find it on the web: https://www.bloomberg.com/opinion/authors/ARbTQlRLRjE/matthew-s-levine
Bloomberg subscriptions are expensive, but they will send you Levine's column as a daily email newsletter gratis. You can sign up for it on this page: https://www.bloomberg.com/account/newsletters
On May 1, Levine wrote a column: "Banks Are Still Where the Money Isn’t" which includes his thoughts on narrow banking. here is a taste:
"One thing I wonder about is: If you were designing a financial system from scratch, in 2024, would you come up with banking? That central traditional trick of banks — that they fund themselves with safe short-term demand deposits, and use depositors’ money to invest in risky longer-term loans, with all of the run risk and regulatory supervision and It’s a Wonderful Life-ness that that involves — would you recreate that if you were starting over?
"Part of me feels like, if you started a new civilization and put smart but ahistorical tech people in charge of designing a financial system, it would never occur to them to recreate traditional banking. It is so messy and opaque and imprecise, using a shifting pile of demand deposits to fund long-term loans. Plenty of people — insurance companies, retirement savers — want to earn a return on their money and don’t need it anytime soon; their money can be locked up in long-term loans. The money that people keep in the bank just to pay rent and buy sandwiches doesn’t need to be pooled and invested in risky loans; it should just sit in the vault.
"This idea — that bank deposits should just sit in the vault (or, realistically, in electronic money at the Federal Reserve), while risky loans should be funded by long-term investors who intend to take those risks — is sometimes called “narrow banking.” It has a long intellectual pedigree, it came back into vogue after the 2008 financial crisis, and it got attention again after last spring’s US regional banking crisis. All those crises! The traditional business of banking is necessarily crisis-prone; using risky long-term loans to back risk-free short-term demand deposits involves a fundamental mismatch, and every so often that flares up into a crisis.
"And so, since 2008, but more visibly since last spring, banking really has become narrower. Private credit is the lending side of “narrow banking”: Private credit firms raise dedicated funds, with locked-up money, from investors who intend to invest in long-term loans to earn a return. And private credit is the hottest area of finance, making buyout loans and investment-grade corporate loans and funding consumer loans. And private credit is booming not just as a competitor to banks, but as a funding source for banks: Banks have the relationships and technology to make loans, but not the money, so they partner with private credit to fund the loans."
I want to add some historical notes. Levine mentions "It's a Wonderful Life", the old Christmas chestnut starring Jimmy Stewart. Great Movie, but not an essay on banking law. Stewart's bank is not a commercial bank. It is a "Building and Loan (British terminology, in the U.S. it is a savings and loan).
At the time of the movie, 1945, and until the 1980s those institutions (S&Ls) were not allowed to accept demand deposits which could be used for checking accounts. That was the business of commercial banks. S&L deposits were evidenced by passbooks and were withdrawable on demand, but, and this is a big but, the institution could require advanced notice -- 7 days IIRC, but it might have been longer. In theory they were run proof because of that right.
The other big difference between S&Ls and commercial banks was that S&Ls could pay interest on their accounts, but commercial banks were not allowed to pay interest on demand (i.e. checkable) deposits. They were allowed to accept time deposits at interest.
Commercial banks did not issue residential mortgages. That was the S&L's domain. Their basic investment vehicle was the revolving credit under which the bank loaned money for working capital needs--financing inventory, work in progress, and accounts receivable. Term loans to acquire fixed investments often came from insurance companies.
This set of institutional arrangements which had been created by the New Deal financial reforms of the 1930s collapsed when inflation and soaring interest rates took off in the 1970s. Money market mutual funds were invented to evade the interest payment restrictions on banks. S&Ls collapsed because interest rates on their funding vehicles soared while their portfolios of 30 year fixed rate loans sank in value because of the rates and the stretching out of maturities.
The 1990s attempts at institutional stability hit a rock in 2008, and the Sarbanes Oxley fix to those has clearly failed.
As long as I mentioned It's a Wonderfiul Life, a plot point that has always bugged me as a commercial lawyer is the loss of the $8,000 deposit by Uncle Billy. The money winds up in Potter's hands. Since he is an officer of his bank he is obligated to put the cash in safekeeping and to credit the S&L's account. By not doing so he is guilty of theft, fraud, and restraint of trade. The movie should have ended by having the police perp walk Potter.
How much did ESG and DEI factor into the SVB collapse? At minimum they were distracted from focusing on the core business of a bank and risk management. Here are the receipts: https://yuribezmenov.substack.com/p/svb-linkedin-receipts
Not a factor at all. The story of SVB's failure, like most bank failures is about specific people and incentives. Note the SVB had run with out a head of Risk Management for over a year running up to the failure. I should note, Yuri, that I sold risk management systems to banks to assess interest rate and other risks so I'm not speculating, these deets were in the financial press.
The reason for the risk manager leaving was not made public but I can tell you that any risk manager would see the build up of these floating, interest rate sensitive liabilities. It's not a esoteric.
And those risks would have become obvious over a two year runup to the busy, according to what it looked like to me. My hypothesis is this. Risk manager recommended hedging the interest risk with swaps or perhaps some other financial engineering techniques I'm not up to speed on to hedge out that exposure. At that point, it would have been very expensive to purchase those hedges. It would have had an immediate impact on profits and bonuses for management. for sure.
Regulatory reporting is a different matter. This interest rate exposure might not have been seen as a solvency level risk. It depends how it was measured. I didn't take the time to read up on all that but the disclosure of risk is an art in and of itself. It could be that the risk model used understated the risk, which lulled both management and the regulator into a false sense of security. The risk manager may have been positioned as overreacting or too conservative - who knows.
But in the end it was an unhedged risk that was fairly straightforward. Management knew what they faced and the interest rate market moved against them. Zero DEI. 100% management greed. Keep in mind SVB wired all management their bonuses within days of going bust...these guys are almost always the culprits, gals too these days. Everyone is in on the hustle.
Thanks for this ...Financial crises always come back.... An evergreen issue ....it's just fascinating in a weird sort of way that only an economist would appreciate!
It's not just the Fed, other people seem to think Narrow Banks are bad. I don't personally see why but they do e.g. https://bondeconomics.substack.com/p/narrow-banking-a-bad-solution-to
Seems to me that rather than ban them, the fed give them a license to operate under a strict "no bailout" policy and see if they end up producing popular products for customers. My guess is that the fear is not that they are dangerous to consumers but they would be too successful and would result in a lot of current wide-banked customers moving their money to a narrow bank and thus causing a systemic bank run on all the wide banks
The problem has always been and will always be Government regulation of banking in general and the Federal Reserve in particular. More non-economists/social scientists need to read Murray Rothbard, especially his monograph: “What Has Government Done to Our Money?”
Please explain further why " Inflation shows us that the government is near its limit to borrow or print money to fund bailouts".
And what will be the consequences when the government indeed EXCEEDS its limit to borrow or print money to fund bailouts - as it will.
I'm quite sure, however, that if the "progressive" congress passes just one more law, that all of this can be solved.
The only things standing in the way of your recommendations are the Bank Policy Institute, US banking cabal influencers and their well lubricated members of Congress, a Bipartisan supermajority.
https://www.wsj.com/finance/regulation/washingtons-pivot-on-bank-rules-could-free-up-tens-of-billions-109713c0?st=7gyh65c5kmnzjc6&reflink=article_copyURL_share
https://bpi.com/bpi-submits-supplemental-comments-on-basel-iii-endgame-proposal/
https://bpi.com/basel-accord/
One of the obstacles to this idea is that the government desperately needs to "borrow long". :-)
John: "They need only the will to overcome the powerful interests that benefit from the current system." If economics is about incentives stimulating self-interest, then bank officials will assume excessive risk believing they will benefit no matter the bank failure. If the risk assumed is rewarded with risk adjusted returns, they get bonused. If it blows up the losses are covered by the taxpayer whether with taxes or inflation (diminished buying power). It seems the moral hazard problems can be ameliorated by with contracts that specify penalties for their bad decisions. Stockholders should ( normative) be willing to penalize bad decisions.
My solution (free market)
End this:
https://en.wikipedia.org/wiki/Primary_dealer…
"Such firms are REQUIRED to...participate actively in U.S. Treasury securities auctions."
Cochrane solution (non-free market):
"Deposits MUST be funneled narrowly to reserves or short-term Treasurys."
Given that the Dodd Frank regulations failed, what makes you think that one more regulation (government telling banks how to handle deposits) is going to do any better?
As soon as you tell banks they must buy Treasuries, that destroys any notion of government bond sales being a free market process.
More government control, so those who are already in power will stay in power and benefit from others being slaves of the government (through getting more and more debt). If Fed can continuously print money without any accountability, seriously, “End The Fed”
Wouldn’t a narrow bank put too many eggs in the fed basket? If one bank does it sure, but if the only thing paying interest on most checking accounts is the fed, doesn’t that increase risk of bad fed policy going more drastically wrong? Don’t get me wrong, I think it should be legal and that the fed probably prevents it to prevent ordinary depositors from having access to their special rates, but you wouldn’t argue that one big fed bank would decrease systemic risk so why the same claim about narrow banks? I would love to hear more from John on this angle. In my mind the key feature of narrow banks as conceived is liquid assets—not an account at the fed—but the concentration in accounts at the fed would increase risk.
Matt Levine is a columnist for Bloomberg.Com. He was an investment banker and a mergers & acquisitions lawyer before he went into financial journalism. I highly recommend his column/newsletter Money Stuff for his excellent explanations of the latest developments in finance. You can find it on the web: https://www.bloomberg.com/opinion/authors/ARbTQlRLRjE/matthew-s-levine
Bloomberg subscriptions are expensive, but they will send you Levine's column as a daily email newsletter gratis. You can sign up for it on this page: https://www.bloomberg.com/account/newsletters
On May 1, Levine wrote a column: "Banks Are Still Where the Money Isn’t" which includes his thoughts on narrow banking. here is a taste:
"One thing I wonder about is: If you were designing a financial system from scratch, in 2024, would you come up with banking? That central traditional trick of banks — that they fund themselves with safe short-term demand deposits, and use depositors’ money to invest in risky longer-term loans, with all of the run risk and regulatory supervision and It’s a Wonderful Life-ness that that involves — would you recreate that if you were starting over?
"Part of me feels like, if you started a new civilization and put smart but ahistorical tech people in charge of designing a financial system, it would never occur to them to recreate traditional banking. It is so messy and opaque and imprecise, using a shifting pile of demand deposits to fund long-term loans. Plenty of people — insurance companies, retirement savers — want to earn a return on their money and don’t need it anytime soon; their money can be locked up in long-term loans. The money that people keep in the bank just to pay rent and buy sandwiches doesn’t need to be pooled and invested in risky loans; it should just sit in the vault.
"This idea — that bank deposits should just sit in the vault (or, realistically, in electronic money at the Federal Reserve), while risky loans should be funded by long-term investors who intend to take those risks — is sometimes called “narrow banking.” It has a long intellectual pedigree, it came back into vogue after the 2008 financial crisis, and it got attention again after last spring’s US regional banking crisis. All those crises! The traditional business of banking is necessarily crisis-prone; using risky long-term loans to back risk-free short-term demand deposits involves a fundamental mismatch, and every so often that flares up into a crisis.
"And so, since 2008, but more visibly since last spring, banking really has become narrower. Private credit is the lending side of “narrow banking”: Private credit firms raise dedicated funds, with locked-up money, from investors who intend to invest in long-term loans to earn a return. And private credit is the hottest area of finance, making buyout loans and investment-grade corporate loans and funding consumer loans. And private credit is booming not just as a competitor to banks, but as a funding source for banks: Banks have the relationships and technology to make loans, but not the money, so they partner with private credit to fund the loans."
I want to add some historical notes. Levine mentions "It's a Wonderful Life", the old Christmas chestnut starring Jimmy Stewart. Great Movie, but not an essay on banking law. Stewart's bank is not a commercial bank. It is a "Building and Loan (British terminology, in the U.S. it is a savings and loan).
At the time of the movie, 1945, and until the 1980s those institutions (S&Ls) were not allowed to accept demand deposits which could be used for checking accounts. That was the business of commercial banks. S&L deposits were evidenced by passbooks and were withdrawable on demand, but, and this is a big but, the institution could require advanced notice -- 7 days IIRC, but it might have been longer. In theory they were run proof because of that right.
The other big difference between S&Ls and commercial banks was that S&Ls could pay interest on their accounts, but commercial banks were not allowed to pay interest on demand (i.e. checkable) deposits. They were allowed to accept time deposits at interest.
Commercial banks did not issue residential mortgages. That was the S&L's domain. Their basic investment vehicle was the revolving credit under which the bank loaned money for working capital needs--financing inventory, work in progress, and accounts receivable. Term loans to acquire fixed investments often came from insurance companies.
This set of institutional arrangements which had been created by the New Deal financial reforms of the 1930s collapsed when inflation and soaring interest rates took off in the 1970s. Money market mutual funds were invented to evade the interest payment restrictions on banks. S&Ls collapsed because interest rates on their funding vehicles soared while their portfolios of 30 year fixed rate loans sank in value because of the rates and the stretching out of maturities.
The 1990s attempts at institutional stability hit a rock in 2008, and the Sarbanes Oxley fix to those has clearly failed.
As long as I mentioned It's a Wonderfiul Life, a plot point that has always bugged me as a commercial lawyer is the loss of the $8,000 deposit by Uncle Billy. The money winds up in Potter's hands. Since he is an officer of his bank he is obligated to put the cash in safekeeping and to credit the S&L's account. By not doing so he is guilty of theft, fraud, and restraint of trade. The movie should have ended by having the police perp walk Potter.