Jim Power: As well as banking, SVB turmoil reveals vulnerability of the tech sector
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The legendary Warren Buffett once famously said that it is “only when the tide goes out that you learn who has been swimming naked”.
That is very much how it appears over the past couple of weeks. The tide has gone out and global financial system has been thrown into the eye of a storm as a still small, but significant, number of naked financial institutions have descended into deep distress.
When the markets get nervous about something, then nobody is totally safe, and contagion can spread like wildfire.
Last weekend, Silicon Valley Bank(SVB) became the second largest in US history to collapse and the biggest lender to fail since the 2008 crisis after customers rushed to withdraw cash due to fears over its liquidity.
Another US bank, Signature Bank, was also shut down by the Federal Deposit Insurance Corporation (FDIC) and the First Republic Bank has been aided by its rivals who are clearly worried about contagion.
In Europe, the banking behemoth Credit Suisse First Boston (CSFB) has experienced a collapse in its share price and has called on the Swiss central bank to issue a reassuring statement.
At a time like this we hear arguments to the effect that each institution that gets into difficulty has its own unique characteristics and is not reflective of banking in general. In the case of SVB, it was heavily exposed to the technology sector, which has been having its own woes over the past year.
At the peak of the technology boom, SVB placed $91bn (€84bn) of its $188bn in deposits in long-dated securities such as mortgage bonds and Treasury securities. However, the value of those bonds has fallen heavily as the Federal Reserve increased short-term interest rates aggressively over the past year.
In the case of CSFB, the vultures have been circling for some time due to a series of scandals in recent years, including the largest trading loss in its 167-year history after the implosion of Archegos Capital, and the closure of $10bn of investment funds linked to a collapsed financial firm, Greensill.
It was revealed in recent days that the bank’s auditor, PwC had identified material weaknesses in its financial reporting controls, which delayed the publication of its annual report. Its management structure appears to be seriously lacking.
The fundamental problem is that interest rates everywhere have gone up aggressively over the past year and this is causing untold distress, not least due to the sharp increase in bond yields and the sharp fall in bond prices.
The heavy concentration of bonds on the SVB balance sheet created the main vulnerability for that institution, but there is once again a more general concern about bank regulation, and particularly the deregulation that former US president Donald Trump engineered in 2018 in response to intense lobbying and a somewhat warped ideological belief system.
We have seen a strong official response in the US.
Treasury Secretary Janet Yellen instructed the FDIC to make whole all depositors with both SVB and Signature Bank out of its Deposit Insurance Fund. The cost will be borne by a levy on banks rather than the taxpayer. The aim here is to shore up confidence among all depositors at US banks.
Secondly, the Federal Reserve introduced a new lending facility to provide additional funding to banks that run into liquidity problems. It remains to be seen what happens CSFB as its collapse would pose a huge systemic risk to the Swiss financial reputation and to the European financial system.
On the interest rate front, increasing interest rates any further for now does not make logical sense, despite high inflation. Nevertheless, the ECB delivered its promised 0.5% increase on Thursday. One can never tell, but I’d be surprised if the Federal Reserve followed suit this week.
For Ireland, one hopes that the banking system is solid, but the real issue is what the SVB situation demonstrates about the vulnerability of the tech sector. Employment is one issue, but the possible implications for future corporation tax receipts is a greater concern.
Strange and scary times, but we are becoming accustomed to that.
- Jim Power is a leading Irish economist