Banking is a Confidence Game

Some thoughts on the banking crisis and recent issue with Silicon Valley Bank. There are continued cracks in the confidence game that is banking.

When the FED 'makes' a dollar that didn't exist when they create new money they do so as a loan to the bank of say $1. That bank can then lend 10X that amount of $10 for every $1 that was created.

A private equity firm borrowing that $10 from the bank and invests in a start-up that issues stock (a form of $) that it values at 100X due to the 'potential' for growth. That start-up starts doing business and uses that stock to borrow money from the bank to grow, and as it grows it deposits the money it is earning with the bank.

The new deposits allow the bank to lend more... to new start-ups. This works well in an expanding economy - just as a Ponzi scheme works as long as there are new participants.

I've been saying for some time now that Safety, Liquidity and Return are the 3 big items we care about and everyone focuses on Safety and Return until they care about Liquidity - as Liquidity always hits you like a truck when it hits.

What contributed to the SIVB failure? (PS - did you know their CFO was at Lehman bank before this bank?)

Example: You are a company, say ROKU, that banks at SIVB. You have $2B sitting in your corporate checking account earning .125%. SIVB is making its money by investing that cash in higher interest-rate-paying treasuries. They are using LAG as we talked about in the Tale of Two Tellers.

The problem? ROKU realizes they could be investing that money in higher interest-rate treasuries too, so they ask for their $2B back to invest it. Where is their money? SIVB had invested it in those higher interest-rate-paying treasuries in the form of long bonds, and what happens when interest rates go up? Those long bonds are worth less. They now have to see those bonds at a big loss, (if the had 3% long bonds - they'll have to sell the at a discount to get the yield up to 5% ((today's rates)) and that was about a $2B discount) to get the cash they needed to give to clients so they could take their money and invest it themselves.

Once they report those losses - customers see those losses and get scared and they try to take their money out too... we've now gone from expansion to contraction and liquidity events based on contraction are like the house of cards you built as a kid - they take a long time to build, a lot of energy and planning (think - 20 years of lending to start-ups) but they collapse in an instant.

We are starting to see this play out, remember about 5 months ago I shared I had moved all my cash into short-term treasuries, and money markets paying 4-5%? That was money the bank was earning the spread on, and now I am earning that spread. This is starting to happen in mass, and that's creating serious liquidity problems globally, just as it is creating a problem for the FED who has to pay all that interest.

This is happening globally now - money can move at a click of a button to a new location, location, location - and that creates additional volatility.

I'm not an economist, but I've been saying the FED will raise rates till inflation is lower OR until something breaks... things are starting to break.

Be nimble and be Liquid.

TIP: This is bad for the markets, but usually good for lenders, as this could drive the FED to intervene sooner and lower rates, or provide other bailouts and stimulus that would drive spirits to be more positive.