5MF (WEEK 11): US BANKING FAILURES EXPLAINED, CRYPTO IMPACT, ALL EYES ON ETH
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The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
- What Caused SVB to Fail?
- The Banking Bailout Side Effects
- Is Banking Chaos Being Used to Debank Crypto?
- Wait, There’s a Banking Crisis in Europe, Too?
- ETH Withdrawals to Unlock in Approaching Upgrade
US Banking Crisis I: Silicon Valley Bank as the Trigger
- Signature Bank Shut Down by US Regulators Over Systematic Risk Fears (link)
- SVB Facing Fraud Lawsuit for “Mismanaging Events” Prior to Collapse (link)
Clown Bank and Failed Fed Supervision
The US banking sector had its worst week in the last 50 years.
Yes, it was even worse than the Great Financial Crisis (GFC) of 2008.
In a week’s span, three large banks collapsed. All of them were either VC-facing or crypto-facing: Silvergate, Silicon Valley Bank, and Signature Bank.
Only Silvergate closed down in an orderly fashion, opting to liquidate its assets. The other two had a combined worth of deposits at $263.6 billion, just barely topping the GFC.
Source: FDIC, Image credit: re:venture consulting
As the name of the bank suggests, Silicon Valley Bank was deep into commercial lending for venture capital (VC) firms and the healthcare sector. You’ve undoubtedly heard of some of them as funders of top blockchain projects, such as a16z and Sequoia Capital.
These types of FinTech savvy clients are also considered to be less sticky. So when the bank run was triggered, it was more forceful than usual.
JP Morgan analyst, Michael Cembalest, pinpointed Signature Bank (SBNY) and Silicon Valley Bank (SIVB) as odd of the bunch. Image credit: JPMorgan
The bank run itself was sparked by a sale of $1.75 billion worth of SIVB shares on March 8th. That sale was supposed to cover the realized $1.8 billion loss by the firesale of its deprecating $21 billion bond portfolio.
It was then when investors realized that SVB made the wrong bet. Although it is typical for a bank to invest in fixed-income securities (bonds, treasury securities, and mortgage-backed securities), they don’t do well when the Federal Reserve switches from a near-zero interest regime to the fastest hiking cycle in the last 40 years.
That’s because when new securities’ yields rise, they make existing securities less attractive. Therefore, having a large portfolio of long-term US Treasuries, SVB’s liquidity was at risk, triggering the bank run. At the end of 2022, SVB had an enormous percentage of its assets invested in securities, at 57%, in contrast to the average bank’s 24%.
But shouldn’t the bank know all about this? Yes, it should. Let’s recap:
- If a bank invests in 5-year treasuries, it will receive a fixed yield.
- When the Fed hikes interest rates, those yields decrease as the yields on newly issued Treasury bonds increase.
- The bank then stands to lose money in that scenario.
- To hedge against such risk, the bank could conduct an interest rate swap. This just means that the bank agrees to pay a fixed yield to another party and gain variable payments in return.
In the interest rate swap setup, when the Fed is hiking, the bank would then receive more money from the swap as it loses money on its Treasuries investment. And if the Fed starts cutting rates, the bank would earn less from the Treasuries but would also pay less in the swap.
Consequently, the biggest mistake SVB made was failing to hedge against that exposure. In the aftermath, it is now understandable why. Incredibly, SVB didn’t even have a Chief Risk Officer (CRO) since April, after Laura Izurieta left the bank.
The San Francisco Fed, in charge of regulating SVB, is currently probing the bank, scheduled to deliver a full report on May 1st. Not having a CRO for such a large bank is highly unusual. The departure of the previous CRO is also quite indicative, according to Reed Kathrein, a lawyer specialized in shareholder suits:
“It means perhaps management was hiding something or didn’t want to disclose something, or had disagreements over the risks it was taking,”
US Banking Crisis II: Containment and Implications
- Fed Considers New Rules for Midsize Banks After SVB Collapsed with 90% of Deposits Uninsured (link)
Polished Bank Bailouts through BTFP and GSIBs
In the age of social media, bank runs spread like wildfire.
Over the previous week, many US regional bank stocks took a dive. From First Republic Bank (FRC) as the diving leader, to Ally Financial (ALLY), Citizens Financial Group (CFG), to Fifth Third Bancorp (FITB) — and others.
Image credit: Trading View
On Sunday, the Federal Reserve Board formed the Bank Term Funding Program (BTFP) to stop the contagion. This is the financial safety net, a ‘backstop’ of sorts, in cases of disruption of the normal functioning of the financial system.
Of course, as the creator of money, the Federal Reserve is the lender of last resort. When the Fed announced BTFP, it was backstopped by up to $25 billion from the U.S. Treasury Department’s Exchange Stabilization Fund.
The FDIC seized both Silicon Valley Bank (SIVB) and Signature Bank (SBNY) over the weekend, noting that all deposits were secured. Even those above the guaranteed FDIC threshold of $250,000. Moreover, through the BTFP, the Fed will make available one-year loans at a discount to instill consumer confidence.
Image credit: @JoeConsorti
There are multiple and severe implications for these moves:
- JP Morgan analyst Nikolaos Panigirtzoglou surmised that just six regional banks have a combined $460 billion in uninsured deposits. Altogether, US banks outside of the top 5 have a $2 trillion exposure in bonds.
- Combine this with the factoid that only 68% of Americans have confidence in the stability of their banks, according to the latest Ipsos poll.
- Therefore, $2 trillion could be the upper limit of the Fed’s ‘backstopping’.
Things become even more interesting when taking into account the US Treasury Secretary, Janet Yellen. She specifically said that only those depository institutions that are “eligible” and have gone through “systemic risk determination” will be granted funds above the standard FDIC limit.
In turn, it now becomes irrational to hold money in smaller banks, as it is almost guaranteed that the top 4 Too Big To Fail (TBTF) banks will be insured. It’s easy to see how this will lead to significantly higher centralization of the commercial banking system.
Further, the Financial Stability Board, established in the wake of the GFC in 2009, determined these 8 banks to be Global Systemically Important Banks (GSIBs):
- JPMorgan Chase
- Citigroup
- Bank of America
- Wells Fargo
- Goldman Sachs
- Morgan Stanley
- State Street
- BNY Mellon
In total, since Sunday, GSIBs together with the Fed and Treasury injected $100 billion in assistance, with First Republic Bank getting $30 billion. This is $15 billion higher than the AiG’s initial bailout in 2008 of $85 billion, later to climb to $182 billion.
On a macroeconomic level, this means that the Fed is back into the money printing game, already having increased its balance sheet by $297 billion over the week. Such a spike effectively erased the Fed’s hikes since November.
Image credit: Bloomberg
In turn, the market is now pricing in Fed rate cuts, the coveted ‘pivot’, to the range of 3.50–3.75% by the year’s end.
Likewise, the March 22 FOMC expectation shifted from a 50 bps high probability to 13.6% probability of zero hike, and 86% chance of a 25 bps hike.
It’s also worth it to mention here that, in the midst of everything, we are seeing Bitcoin thesis tested in real-time. Bitcoin launched one year after the GFC, as a way to escape the central banking system of manipulated money supply that pincers the economy between booms and busts.
More importantly, Bitcoin is there to eliminate the counterparty risk that banks represent as the outgrowth of the Federal Reserve. While BTC has recently been treated as a risk-on asset, some investors have clearly turned to BTC amid the banking crisis.
While multiple banks have failed, Bitcoin has gained over 22% throughout the course of the week.
US Banking Crisis III: Operation Chokepoint 2.0 Underway?
- Brian Brooks: U.S. Government Using Crisis to Choke Off Crypto Access to Banks (link)
Sneaky Weaponization of Banking Chaos to Debank Crypto?
Over the last month, there has been much talk of the federal government cutting the banking rail off crypto companies, much like it did for online casinos under the Obama admin in 2017. After all, three key US banks for crypto finance/startups have been either liquidated or seized.
But the case of Signature Bank is especially peculiar. The NYDFS seized the bank on Sunday, turning it over to the FDIC. This was despite the bank’s board member and former Rep. Barney Frank saying that the bank was solvent.
Frank, the co-author of the Dodd-Frank Act, clarified that “I speculate that using us as a poster child to say ‘stay away from crypto’ was the reason.”
On Thursday, Rep. Tom Emmer (GOP Majority Whip) quote tweeted a report from Reuters, which claimed that:
“The two sources added that any buyer of Signature must agree to give up all the crypto business at the bank.”
On the same day, Emmer sent a letter to FDIC Chairman Gruenberg because “It’s clear the Biden administration is weaponizing market chaos to kill crypto.”
If that turns out to be true, the Biden admin is in a pickle. Namely, it is illegal to debank a perfectly legal industry, regardless of its present level of regulation. After all, the financial giant Fidelity Investments just opened Bitcoin trading to its multi-million client base.
But further ‘chokepoint’ evidence came from Brian Brooks, the former acting head of the Office of the Comptroller of the Currency (OCC), now CEO of Bitfury.
Brooks said, “there has been a decision across the bank regulatory agencies…that crypto is inherently risky and needs to be extricated from the banking system.”
On the other hand, the FDIC later confirmed its prior (legal) stance that “Banking organizations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type”.
Therefore, Signature Bank’s holdings should be sold entirely without requiring from the buyer any divestment in crypto activities, as reported by Blockworks. At this point, it’s difficult to tell if this is a legal cover presented to the public.
However, actions will speak louder than words, so we will see under which conditions Signature Bank operates in the future.
Regardless, Bitcoin is once again in historic play as a network that eliminates the counterparty risk, alongside short-circuiting central banks and regulatory bodies that can seize banks under suspicious circumstances.
Europe’s Own Banking Crisis on the Horizon
- Credit Suisse Down 28% as its Biggest Backer Refuses Additional Help (link)
What’s Happening with the Swiss Banking Scene?
EU’s financial regulators are not happy about the US’s brand new bailout rebranding under ‘BTFP’. Financial Times reported they are “furious at the handling of the Silicon Valley Bank collapse, privately accusing US authorities of tearing up a rule book for failed banks that they had helped to write.”
And who could blame them? While the Fed effectively started reversing its hikes via rebranded bank bailouts, the ECB hiked its rate by 50 bps on Thursday, bringing the euro funding rate to 3%. As explained in the SVB example, hiking tends to puncture a hole in commercial banks’ balance sheets.
However, in the case of Credit Suisse (CS), it would only be a compounding effect. Anyone who has been paying attention to finance in the last decade could have noticed how this 170-year old legacy bank is ripe with problems:
In 2017, CS received a $5.28 billion fine for toxic securities abuses, which is just one of the penalties out of the multi-billion fines pit. More recently, in 2021, CS lost $4.7 billion to Archegos fund exposure. A year later, CS pleaded guilty to defrauding investors, fined at $475 million.
Credit Default Swap (CDS) for Credit Suisse went through the roof, not seen since the 2008 GFC panic. CDS provides a hedge for investors against the risk of the bank’s default. The rapid spike indicates a loss of confidence. Image credit: CNBC
The streak continued in 2023, as CS delayed its annual report to the SEC, which was supposed to address accounting problems. In the latest news, following Saudi National Bank’s refusal to support it, CS received a $54 billion loan from the Swiss Central Bank.
Interestingly, the Swiss Central Bank itself reported a CHF132 billion ($143 billion) loss in 2022, the largest in its 115-year history.
Although Switzerland is not in the EU, the Swiss Franc is a major European currency and the nation’s economy is tightly integrated into EU’s export-oriented economies.
This is why CS received such a generous bailout, to postpone a major financial destabilization. And that’s why EU financial regulators are so angry at how the SVB collapse was handled.
The fall of CS is the last thing the EU now needs, as ECB Vice President Luis de Guindos already warned on Tuesday that rate hikes may strain some EU banks.
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Ethereum Stake Unlock
- Ethereum’s Shanghai Upgrade to Enable Withdrawals Set for April (link)
Ethereum’s First Big Test After September’s Proof-of-Stake Transition
In the midst of some US banking uncertainty, major crypto happenings are on the horizon. Alongside Fidelity Investments opening Bitcoin trading yesterday, Ethereum is heading for another overhaul.
On April 12, Ethereum will finally deliver its long-awaited Shanghai upgrade. Otherwise dubbed ‘Shapella”, it is the finalization of Ethereum’s transition from proof-of-work to proof-of-stake consensus, going from computing power as a means of securing transactions to using deposited capital (ETH stake).
Presently, Ethereum validators (equivalent to BTC miners but using stakes) have pledged 17.6 million ETH, worth $30.1 billion. Shapella will unlock that hefty capital for withdrawal. There are a couple of ways one can interpret this unlocking of the ETH treasure:
- ETH price could temporarily dip amid the surge of unlocks and subsequent sales. This will largely depend on the market sentiment at the time.
- Validators may decide to keep staking to earn a yield. Presently, it is 3.9–4.3% annual percentage yield (APY).
If more validators partake in ETH staking, the yield is bound to go down. It also bears keeping in mind that, as a decentralized network, Ethereum pays for itself by users paying small fees.
But the bulk of these fees are destroyed, further removing ETH from the supply.
Image credit: ethburned.info
This dynamic creates a deflationary force, shrinking ETH supply and making each ETH more valuable.
Ethereum’s supply chart is the opposite of the Federal Reserve’s balance sheet. Image credit: ultrasound.money
Ahead of Shapella, Coinbase is betting on high unstaking demand. But, the exchange will only begin to take unstaking requests the day after the upgrade’s completion.
Coinbase is the mediator for users’ ETH stakes, so it will depend on the Ethereum network when the unstaked funds, plus staking rewards accrued, are returned.
Tweets of the Week
FedNow comparison vs established payment rails
Banks invested your deposits to lock in 1–3% returns for decades, meanwhile short dated paper pays 5% while they pay you < 1.0% on your savings.
It makes sense that deposits are leaving the banking system.
Price movements of the offshore-issued $USDT vs. American-issued $USDC over the last few days showed how trust was eroded as the US banking crisis unfolded.
NEW: The numbers are in for much the top execs at FTX made. Sam Bankman-Fried walked away with $2.2B before the collapse. What really blows our mind is how little money Caroline got paid for how much risk she took. It seems almost offensive. Crazy!
The only solution, the only way out of this debt problem is to raise the debt ceiling to take on more debt so we can get out of this debt problem…
I wonder if he listens to himself say this later and realizes how dumb this sounds? 🤡
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