The Week in Review: March 13, 2023
Did the Fed Just Break Something?
Historically, Fed rate hikes break something: Latin American debt in the early 1980s, Orange County’s bankruptcy in 1994, and the so-called Mexico Tequila Crisis during the same year were directly or indirectly tied to Fed policy.
The Fed isn’t trying to create financial dislocations. In some cases, there were those who simply followed the Fed’s lead when it pledged to keep rates low for an extended period.
First bank failure of 2023
Silicon Valley Bank (SVB, trading halted) was shut down by the FDIC on Friday. It’s the first bank failure of 2023, according to Bloomberg, and the 2nd largest ever.
What happened? In part, higher interest rates may have encouraged some depositors to pull funds and look for higher-earning cash returns. More likely, its businesses saw funding dry up, and a drawdown in deposits from these firms forced the tech-focused lender to sell Treasury bonds it held. The average yield on SVBs’ longer-term bond portfolio was under 2%. Today, short-term treasuries are yielding over 5%.
Why is this a problem? Rising bond yields reduce the value of bonds (bond prices and bond yields move in the opposite direction). If held to maturity, it’s not a problem. But in a March 8 mid-quarter update, the bank said it sold $21 billion in securities and took a $1.8 billion loss.
That lit the fuse.
With panic among depositors and shareholders setting in, and the inability to raise additional capital, the FDIC stepped in and closed the bank. So far, no buyer has stepped up to the plate.
Prior management decisions contributed to the bank’s shuttering, as did an aggressive series of Fed rate hikes. Panic by venture capital firms to withdraw deposits that were above the FDIC-insured limit may have been the biggest reason for the debacle.
There will be pain in Silicon Valley, but the latest jobs’ report—payrolls up 311,000 in February per the U.S. BLS, is signaling the economy continues to expand.
Investors were stung by hawkish Fed talk early in the week. Depending on whether it views this as an isolated event, Friday’s bank failure may force a shift in the Fed’s strategy.
Did the Fed break something? If the FDIC lines up a buyer or there is an orderly sale of bank assets, this may quickly become yesterday’s news. If not, fear could spread to depositors of other regional banks. Either way, as the result of SVB’s failure, we are headed for increased short-term volatility in the markets.
If you have any questions or concerns, please do not hesitate to contact me directly.
Two for the Road
A U.S. homebuyer with a $2,500 monthly budget can afford a $384,000 home today compared with a $518,000 home that the same buyer could have purchased with the 3% rates common in 2021. - MarketWatch, February 23, 2023
There are more than four times as many hedge funds as there are Taco Bells. - Financial Times, February 21, 2023
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