I wrote two opeds on the future of the Fed for the Washington Post. Full text of the first one, focusing on monetary policy, in my previous post here. The second focusing on financial regulation is joint with Amit Seru.
Can't the Silicon Valley Bank fiasco be distilled down to a combination stupidity and hubris - SVB management thought they could predict interest rates and stretched the maturities on their assets that were funded with short-term deposits. Kind of like Orange County back in, what, 1993? 1994? That guy thought he knew what rates would do as well. Both were wrong.
If I recall, SVB had their Chief Risk Officer position unfilled for something like 12-18 months before the implosion - that may have had somethng to do with it as well. And, of course, the regulators did not flag the asset/liability imbalance.
Well, maybe SVB management was just following FOMC forecasts of permanent low interests rates and inflation despite MMT and fiscal insanity?
But really what the CEO was doing was trying to line his own pocket. Their multiple and stock price was expanding based upon deposit growth, so they just waved in as many deposits as possible and went out as far along the curve as necessary to get some carry and not kill ROA. Equity analysts rewarded this behavior. They sold SVB as a VC play instead of a giant leveraged carry trade that was picking up nickels in front of the steamroller.
Republic, at least, had sort of a real model (their own mortgages), maybe not a great one.
Incredible how many firms got into the extreme carry trade business (à la GFC). When Schwab’ sold off on the SVB news I bought the stock…then I looked at their balance sheet and saw they were a carry trade (pushing their brokerage cash balances out long) rather than a brokerage business…and sold.
Shows how pernicious ZIRP and QE can be. When the Fed is paying people to take stupid risks maybe they shouldn’t be surprised when they do!
If they had hedged, they’d have no carry- or not much. Better to have not taken the deposits at all - but that was a strategy aimed at stock price and CEO pay. Not just stupidity but also greed (same as it ever was)
Can anyone explain why the idea of Limited Purpose Banking is not the case? Seems clear enough to me that financial crises are mostly the result of fractional reserve banking, over which the Fed rides herd.
The failure of Fed oversight during the excessive ZIRP/QE/fiscal splash out post-Covid coupled with Yellen’s intervention made a mockery of the post GFC reforms.
A big idea was that banks should issue more long-term corporate debt to make runs less likely and secondly to ensure liquid assets were kept against deposits.
By ignoring the credit waterfall and stuffing senior corporate bond holders in favor of what should have been pari passu uninsured deposits, Yellen and Powell completely undermined the use of stable long-term funding and for years destroyed the bank bond market. Insanity.
Of course, SVB was exempt from big bank rules on liquid asset coverage vs deposits, but are regulators blind?
Can a bank nearly double its balance sheet using short term deposits and put it all into 15 year govt-backed mortgages yielding less than 2 percent without attracting regulatory attention (and without a chief risk officer being employed at the bank)?
Perhaps only if the CEO of the bank is a Biden bundler?
The stress test and CCAR has always been structured to fight the last battle- basically a recession, credit crisis and a collapse in interest rates. Maybe now after the inflation and interest rate surge of ‘22 they finally added an updated scenario? Probably just in time for the traditional recession and interest rate collapse 😊
Anyway, sure, a banking system more reliant on long-term debt and equity capital or even uninsured depos trading like closed end funds (you can sell the asset to another investor but it doesn’t take any cash out of the bank- the next investor gives you your cash) would be better. We’d have a less leveraged, less run-prone banking system- à la Mervin King’s ideas (who Warsh just hired)
We’d likely also have less credit, and I think both consumers and pols love easy credit and credit booms, so I’m sceptical about real change. They don’t want tight credit, they just want someone else to blame when easy credit blows up.
I endorse your recommendations to Warsh. I noticed, and approve, your subtle hint at Public Choice Theory, as the embedded, vesting extant banks are a citadel with powerful weapons to oppose anything. It important to leave them (politically) stable and profitable, as the dynamic society moves past old institutions.
Professor Cochrane, if the new Fed chair takes a 'whatever it takes' approach, won't he just pump more liquidity to sustain the artificial tech bubble? Tech giants and Warsh claim that a 'dramatic boost in AI productivity' will eventually justify this expansion, but it increasingly feels like a form of fake productivity—one that erodes real purchasing power(PPP) while concentrating wealth into monopolies.
Furthermore, is a dramatic productivity boom even realistic at this point? It seems clear that inflation expectations are already consistently outstripping real economic growth. In the framework of FTPL, if this promised productivity boom turns out to be a mirage while inflation expectations remain unanchored, isn't this 'whatever it takes' commitment a straight path to an stagflationary catastrophe?
We saw the dangers of having "hot money" in the Continental Bank fiasco 30 years earlier but nothing was done. Much of the 2008 failure was really a bad accounting policy issue. But if you look at the bank data you'll see super large loan growth, especially in real estate loans and subsequent securitizations in the years preceding the fall. Plus people bet the ranch on Fannie and Freddie preferred stock. The panic in real estate backed securities spread to other areas. Even though those MBS's were 98% performing, mark to market wiped out much bank capital for no reason. And there was a generational shift from old experienced management to the younger generation that never saw bank failures. We learned a lot from those years, now we need to apply the knowledge.
Can't the Silicon Valley Bank fiasco be distilled down to a combination stupidity and hubris - SVB management thought they could predict interest rates and stretched the maturities on their assets that were funded with short-term deposits. Kind of like Orange County back in, what, 1993? 1994? That guy thought he knew what rates would do as well. Both were wrong.
If I recall, SVB had their Chief Risk Officer position unfilled for something like 12-18 months before the implosion - that may have had somethng to do with it as well. And, of course, the regulators did not flag the asset/liability imbalance.
Thanks much for your contributions/observations.
Well, maybe SVB management was just following FOMC forecasts of permanent low interests rates and inflation despite MMT and fiscal insanity?
But really what the CEO was doing was trying to line his own pocket. Their multiple and stock price was expanding based upon deposit growth, so they just waved in as many deposits as possible and went out as far along the curve as necessary to get some carry and not kill ROA. Equity analysts rewarded this behavior. They sold SVB as a VC play instead of a giant leveraged carry trade that was picking up nickels in front of the steamroller.
Republic, at least, had sort of a real model (their own mortgages), maybe not a great one.
Incredible how many firms got into the extreme carry trade business (à la GFC). When Schwab’ sold off on the SVB news I bought the stock…then I looked at their balance sheet and saw they were a carry trade (pushing their brokerage cash balances out long) rather than a brokerage business…and sold.
Shows how pernicious ZIRP and QE can be. When the Fed is paying people to take stupid risks maybe they shouldn’t be surprised when they do!
I agree, stupidity. If they would have hedged, they had no problems.
If they had hedged, they’d have no carry- or not much. Better to have not taken the deposits at all - but that was a strategy aimed at stock price and CEO pay. Not just stupidity but also greed (same as it ever was)
Who do you think you are? David Byrne?
Perfect explanation of need to kill most financial regulations
Can anyone explain why the idea of Limited Purpose Banking is not the case? Seems clear enough to me that financial crises are mostly the result of fractional reserve banking, over which the Fed rides herd.
Pols get re-elected during boom times and find scapegoats during the comeuppance?
Model seems to work….for them.
The failure of Fed oversight during the excessive ZIRP/QE/fiscal splash out post-Covid coupled with Yellen’s intervention made a mockery of the post GFC reforms.
A big idea was that banks should issue more long-term corporate debt to make runs less likely and secondly to ensure liquid assets were kept against deposits.
By ignoring the credit waterfall and stuffing senior corporate bond holders in favor of what should have been pari passu uninsured deposits, Yellen and Powell completely undermined the use of stable long-term funding and for years destroyed the bank bond market. Insanity.
Of course, SVB was exempt from big bank rules on liquid asset coverage vs deposits, but are regulators blind?
Can a bank nearly double its balance sheet using short term deposits and put it all into 15 year govt-backed mortgages yielding less than 2 percent without attracting regulatory attention (and without a chief risk officer being employed at the bank)?
Perhaps only if the CEO of the bank is a Biden bundler?
The stress test and CCAR has always been structured to fight the last battle- basically a recession, credit crisis and a collapse in interest rates. Maybe now after the inflation and interest rate surge of ‘22 they finally added an updated scenario? Probably just in time for the traditional recession and interest rate collapse 😊
Anyway, sure, a banking system more reliant on long-term debt and equity capital or even uninsured depos trading like closed end funds (you can sell the asset to another investor but it doesn’t take any cash out of the bank- the next investor gives you your cash) would be better. We’d have a less leveraged, less run-prone banking system- à la Mervin King’s ideas (who Warsh just hired)
We’d likely also have less credit, and I think both consumers and pols love easy credit and credit booms, so I’m sceptical about real change. They don’t want tight credit, they just want someone else to blame when easy credit blows up.
Dodd Frank, worst legislation ever.....repeal the whole thing
I endorse your recommendations to Warsh. I noticed, and approve, your subtle hint at Public Choice Theory, as the embedded, vesting extant banks are a citadel with powerful weapons to oppose anything. It important to leave them (politically) stable and profitable, as the dynamic society moves past old institutions.
Utopian and implausible theories of banking galore.
Professor Cochrane, if the new Fed chair takes a 'whatever it takes' approach, won't he just pump more liquidity to sustain the artificial tech bubble? Tech giants and Warsh claim that a 'dramatic boost in AI productivity' will eventually justify this expansion, but it increasingly feels like a form of fake productivity—one that erodes real purchasing power(PPP) while concentrating wealth into monopolies.
Furthermore, is a dramatic productivity boom even realistic at this point? It seems clear that inflation expectations are already consistently outstripping real economic growth. In the framework of FTPL, if this promised productivity boom turns out to be a mirage while inflation expectations remain unanchored, isn't this 'whatever it takes' commitment a straight path to an stagflationary catastrophe?
Insightful, lots of activity on F Reg front.
https://substack.com/@anotherone3/note/p-180628482?r=5rmgdf
We saw the dangers of having "hot money" in the Continental Bank fiasco 30 years earlier but nothing was done. Much of the 2008 failure was really a bad accounting policy issue. But if you look at the bank data you'll see super large loan growth, especially in real estate loans and subsequent securitizations in the years preceding the fall. Plus people bet the ranch on Fannie and Freddie preferred stock. The panic in real estate backed securities spread to other areas. Even though those MBS's were 98% performing, mark to market wiped out much bank capital for no reason. And there was a generational shift from old experienced management to the younger generation that never saw bank failures. We learned a lot from those years, now we need to apply the knowledge.