Post #6161 Commentary: A Few Thoughts on the SVB Crisis

 There are some Austrian School of Economics constructs that come to mind when I think of the current crisis, like cheap credit and malinvestment. There are some echos of this that bring to mind the prior S&L crisis or the 2008 economic tsunami, but a detailed comparison and contrast is beyond the scope of this post. I will simply refer the interested reader to the mises.org website and Youtube channel. I still have my academic orientation of thoroughly referencing a relevant post or article. I recently read an investment newsletter email which made similar, highly readable observations to mine (which probably is a common conclusion in the liberty movement), but I don't think or know he's made it available to the general public, and I haven't gotten permission to reprint it. I've written a number of related tweets over the last week or more.

I wouldn't say I have directly relatable experience, but I did have some experience working and living in Silicon Valley. In 1998 I worked as a senior principal consultant with Oracle, based in the Chicago area and working as a senior Apps DBA on projects all over the country, including a months-long project in Oakland. I was eventually replaced on the project when they found a more local consultant without my travel expenses. (I recall for a period of time they only let me fly home every other weekend). I earlier remembered Oracle had lost some money during the earlier Asian crisis, so my offer took a while coming through. Near rhe end of the year, Oracle laid me off. But at the time Silicon Valley was red hot, with Internet companies seemingly starting up overnight: the goal was gaining market share now, damn the cost, or lose it forever. What eventually resulted in my job offer by extortion was a white-hot hiring spree in Silicon Valley. I had specialized since late 1996 on ERPs like market leader SAP (the ERP system, not the company which worked on Oracle and other databases). I got some exposure with Oracle Apps, more recently known as EBS. So all these startups had their own ERP systems which drove demand for technical support specialists like myself.

My client/employer was not one of those companies, but one affected by the tight job market. It was a Japanese chip-testing machine manufacturer with clients like Intel, Micron and IBM. The subsidiary used to be centered in the northwest suburbs of Chicago, but relocated to Santa Clara in the late 90s to be near Intel and other Clients. They had hired a local Apps DBA but they were not paying competitively and he gave notice after 7 months. That's how I ended up on a 5-week temp gig. That eventually got extended to 3 months before the perm job extortion I've described in earlier posts. Vince's new job didn't work out; he actually wanted to be named the client's vacant IT supervisor job and didn't get it. He got himself hired back and wasn't happy the new IT manager had extended me a month. But the real story was he almost immediately gave notice. His earlier employer from a year back offered him stock options. (I've never gotten that. Oracle allowed employees to buy a limited number of shares at a discount on a periodic basis/)

But my 18 months stay in California also covered the beginning of the Nasdaq meltdown. After I left the chip-testing company, a computer consulting company in the San Jose suburbs hired me above my asking salary. But I noticed I wasn't getting placed into more typical weeks or months long. engagements. In one week, I worked at 4 different sites. One of the sites didn't even have a full-time DBA and would let requests build up over visits. I think the strategy was more of a loss leader concept like they hoped I would get their foot in the door if and when they wanted to staff a more lucrative Apps upgrade project. Here's the point: we were getting backed by venture capitalists. The last thing I remember was I heard the VC had axed the CEO. Uh-oh. They sent me for like a 2-day trip to east LA (unusual because they had a local office there). The Native American IT manager of the sugar production company loved me and extended the engagement. But I was in their first wave of layoffs, and I think the company went out of business within a year. Local gigs quickly dried up, I ended up returning to the northwestern suburbs of Chicago to work on a Wisconsin county ERP project, and my new apartment was less than a mile away from the old headquarters of my former chip testing employer.

Long story to point out how venture capitalists play a huge role in a crown jewel of our economy, high tech. But I remember one thing that bugged me several months back when one of my best Chicago area best friends from the mid-90s (he had accompanied me on a Brazilian client project) started engaging in day trading; I got a strong smell of late 90's speculation and gave a tepid response (I may have ticked him off because he hasn't reached out recently).  A few enablers drove stocks to manic heights, including investment tax changes and low Fed rates. I remember kids dropping out of college for high-paying jobs. GDP growth was surpassing its long-term average. It wasn't hard to see in a world with limited labor and other resources, inflation seeping into the economy, and macroeconomic lags to the effects of national policy changes, the Fed finally started a series of interest rate changes by1999 

While I would caution any simple correlation between Fed rate increases in 1999 and 2022 and harder times for venture capitalists, here's what we know: after an early 2020 pandemic-related correction and selloff, the Fed loosened monetary policy and the stock market recovered its losses from March 2020 by July. But higher performing tech stocks, spurred on by pandemic demand for technology solutions, failed to keep up with growth expectations as the economy transitioned back to normal operating conditions. Higher-earning/safer bonds and stocks became more attractive to investors, and the Fed began to hike interest rates,. But especially look at the falloff in the IPO market:

When the tech market is doing well, it's easier to raise related funds via, say, stock offerings, without drawing against funds on deposit. The problem is, as a just-married George Bailey explains in "It's a Wonderful Life"     when S&L customers, in a panic after a town bank run, start their own rush to withdraw:

You're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can.

The problem was that when their customers started to draw down on their deposit to meet expenses, SVB had to cash in assets, much of was in low-earning bonds and MBS like had been the case for years before the Fed started raising rates to levels we haven't seen since 2008. No problem if you wait until the end of the security and can recover the original investment. But as any Finance 101 student can explain, bond price varies inversely with interest rates, which means the price of the bond or security dropped to make the transaction equal to current rates. This means SVB was losing a lot of money meeting withdrawals--and more: this had to be reported.

Now this didn't mean a run, if we were talking deposits capped at the FDIC's limit of $250K per depositor. But many, if not most depositors were above that "SVB had almost 90% of its deposits uninsured by the FDIC.". And word spread at the speed of the Internet to larger depositors that SVB was eating its capital and needed to raise capital. Too little; too late.

How and why SVB didn't hedge its fixed-rate securities is impossible to explain: incompetence in risk assessment? It wasn't like it was lending out money on risky ventures. I read there had been concerns raised by regulators about duration risk of securities. Were they in a state of denial?

I rarely agree with Cherokee Lizzie, but the whole purpose of the Fed was to stabilize banking. You would have thought they would have thought about the spillover effects of multiple interest rate hikes and stress tested scenarios like SBC.