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Mar 21, 2023Liked by Vinay Gupta

To me, it seems like this is a critique of the federal reserve system to a large extent. But one thing I don't think thats covered in depth is bank regulation and capital requirements that require them to hold capital (and certain types of capital) in proportion to their deposits. This becomes relevant when banks have losses for one reason or the other. It’s not just about duration risk. Its about matching your assets with your liabilities as a bank and when it goes wrong it can be catastrophic when capital is inadequate. What SVB management did was take on alot of (duration) risk to juice quarterly earnings as it could not deploy the rush of startup deposits gained in recent years into loans. Investing in treasuries was probably because mgmt thought interest rates would remain low, and probably also why they didn't swap from fixed rate to floating rate to minimise rate exposure. The Fed then raised rates at a very rapid pace causing long duration assets to plummet (its pure math why this occurs) and hence the need for SVB to raise capital given the value of treasuries declined. The treasuries declined in value since repayment was so far away (they would still get repaid at par in 10yrs) but the present value of those cash flows changed because discount rates are higher now because if rate increases. SVB had to plug this paper loss by raising more equity in order to have enough regulatory capital and this obviously set off an alarm among a concentrated depositor base that was less sticky than retail deposits which wanted to pull their money causing the run. In essence, it wasn't just one factor that led to SVB’s demise. This was a tinderbox waiting for a rate driven match.

I guess you can criticise the Fed for the pace of rate increases but their mandate is price stability (ie low inflation) and this exercised through rate setting and their operations in the banking sector. Price stability is driven by data. And the thousands of data points the Fed uses forms their view for what rates should be. Now granted the initial Fed view was inflation was transitory was based on available data but the effects of covid -19, labour shocks, supply chain issues and finally war in Ukraine in addition to other things weren't completely obvious in the data, hence the need for aggressive tightening.

This is probably a convo for in person tbh! We have had over 10 years

of almost zero interest rates. The adjustment to what is a normal environment will take some time and is an ongoing process. This is just one casualty to the return to normal, in my view.

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