Why you should care about the Silicon Valley Bank collapse
If you’ve been reading international headlines, you will know that Silicon Valley Bank (SVB) in the US collapsed last week. The Wall Street Journal offered a succinct explanation.
The bank had been investing in what were considered “safe” investments such as government-backed mortgage bonds since the Covid-19 pandemic started. The problem was that, when interest rates started to rise quickly, as they did last year, the fixed interest payments weren’t able to keep up.
“The assets were no longer worth what the bank paid for them, and the bank was sitting on more than $17-billion in potential losses on those assets at the end of last year,” wrote the newspaper’s Telis Demos.
“Then last week, the bank faced a tidal wave of $42-billion of deposit withdrawal requests. It wasn’t able to raise the cash it needed to cover the outflows, which prompted regulators to step in and close the bank.”
The Federal Reserve (the Fed) has moved quickly to limit the contagion from SVB by guaranteeing depositors and announcing a term funding programme to ensure banks and other related institutions can meet their obligations to depositors and manage their liquidity requirements.
Annabel Bishop, a senior economist at Investec Bank, says the Fed is likely to hike interest rates only by 25 basis points next week, rather than the 50 basis points that markets had anticipated.
“Locally, the South African Reserve Bank is likely to follow the Fed’s interest rate decision of next week, also hiking by 25 basis points or even leaving interest rates flat on 30 March if the Fed does the same,” says Bishop.
She adds that a hike of 50 basis points in the repo rate would strengthen the rand.
Iain Cunningham, the co-head of multi-asset growth at asset manager Ninety One, cautions that we might be facing the start, rather than the end, of a broader cycle of delinquency, default and bankruptcy.
“Many will remember from the global financial crisis that it was full-deposit insurance that was ultimately required to halt deposit flight and, as a result, this action should stem the emergence of systemic risk for the time being.
“However, the failure of SVB is a consequence of something much bigger. Over the past 12 months, we have been rapidly exiting from a false equilibrium that began to form in the years after developed world economies emerged from the global financial crisis,” says Cunningham.
“A false equilibrium is a theoretically unstable or unsustainable situation that has been so long-lived that it appears to be a true equilibrium.
“The false equilibrium here is the decade and a half of excessively easy money, through near zero or negative interest rates and quantitative easing.”
In other words, Cunningham says, policymakers have for some time set policy far too loose relative to prevailing economic fundamentals, evidenced by the material appreciation in asset prices over the period. They have been willing to “pivot” or add stimulus at any sign of a wobble, seeking to minimise economic and market volatility.
Such action has increased confidence and deeply embedded this false equilibrium in the decision-making processes of many households, corporations and even governments.
“Unfortunately, history shows that even relatively short periods of mispricing the cost of money can lead to capital misallocation, with economic participants taking more risk than they should and with tolerance for leverage, duration and illiquidity risk all increasing during such periods,” says Cunningham.
“By their nature, false equilibria cannot last forever. The doubling down of easy money during and post the pandemic ultimately created inflation, which broke the condition required to maintain the false equilibrium.”