The intervention by regulators came Sunday night, just as futures opened. The depositors at Silicon Valley Bank (held by SVB Financial Group (SIVB) ) and Signature Bank (SBNY) should be able to carry on as normal, but not so much for the debtholders or equity holders or presumably management.
Banks across the board will be able to borrow from the window, getting par credit for bonds that no longer trade near par.
S&P futures soared as high at 3971 (up 75 points) and were basically unchanged as I typed this piece at 6:30 a.m. ET.
Treasuries too, have been all over the place, with the two-year going as low as 4.15% (now 4.3% at this writing) while the 10-year initially traded a smidge higher in yield, got to as low as 3.49% (crazy) and is back to 3.55%.
The singled biggest theme out there, across markets, is unrealized losses on bond positions.
Everything is connected to unrealized losses on bond positions.
We can get into the nuance of everything that is going on, but at its heart is the fear of the size of losses sitting on books -- of banks in particular, but more broadly than that -- in bond portfolios.
Unlike during the Great Financial Crisis, it isn't hard to value these holdings because in most cases it is high credit quality, even highly liquid bonds that are in question. Sovereign debt started turning stock markets lower as the gravity and scale of unrealized bond losses overwhelmed any other market sentiment. Mortgages, agency and otherwise, are next in line behind sovereign debt when people are questioning the quality of balance sheets. Not credit quality, but the current market value of those bonds due to interest rate risks.
What About the Intervention?
I see a few things here worth commenting on.
It was typical for markets to fade big initial reactions to interventions during the Great Financial Crisis and European Debt Crisis. Some of this fade is normal. Whether we bounce back will be a function of how the market digests several things.
The intervention itself had good and bad features.
It was good the response was quick and aggressive. We will highlight what may have been missed by the response, but it is important to note that this first cut was aggressive. I highlight "first" because, given the aggressive, timely nature of the response, if it doesn't work, we should expect more.
It was bad, in my opinion, because there wasn't a private solution for SVB. I am not sure what happened to the bids regulators were collecting on Sunday afternoon. I heard various smart estimates of high recovery values even from someone buying the assets without giving much value to an ongoing concern analysis. I suspect it was a fob to politicians that their press release had to state that debt holders and equity would be punished (OK, it didn't say punished, but that was the connotation).
Mixing politically necessary statements with saving the banks sends a mixed message. No wonder people were selling bank stocks all night in Europe and once pre-market trading opened in the U.S. I think a backstop of sufficient scope to let companies carry on their ordinary course of business while figuring out if a buyer who would pay to keep SVB's ongoing business intact could be found (they have an amazing network of clients). There were just enough weird mixed messages not to give comfort and certainly to spook equity and debt holders in the banks lined up as the next most likely to have trouble.
It was weak because addressing funding doesn't address the holes in the balance sheet. Funding helps those in urgent need immediately, but the rest of the cheap funding only helps over time, and only if enough has been done to avert the crisis. The early cheap funding of mortgage-backed products in 2007-2008 failed because it didn't stop the declines in housing prices. Similarly, long-term financing options, a European concoction allowing banks to cheaply fund sovereign debt positions for term, took time to kick in. Cheap lending (getting par treatment on bonds not trading at par seems to fit some definition of cheap) isn't a bad thing per se, but it just isn't sufficient. Capital is the only thing that truly fills balance sheet holes.
Some of the reaction is normal and is based on the fact that the intervention is far from perfect, but it also risks missing that the Treasury/Fed/Federal Deposit Insurance Corp. are far from done or out of tools.
The Fed's Prime Directive
I am sure I am going against all sorts of legal documents, but while the Fed has the dual mandate of employment and inflation, it has a prime directive that overrides everything else - don't let bank runs happen!
We can talk until we are blue in the face about inflation responsibility, but there is no way in hell you will convince me that the Fed's main job -- one that rarely comes up, but that it is completely designed for -- is to stop runs on banks.
I'm not sure how the Fed hikes rates when the biggest issue out there is unrealized losses on bond portfolios, which aren't helped by increasing the cost of carrying those losing positions.
I doubt Fed officials are sitting at home this morning congratulating themselves. I am willing to bet (and am betting) that Sunday was just a first salvo. It was a bazooka, but they have more ammo and should buy themselves some time. It will also give banks time to address the concerns for their depositors, creditors and shareholders.
Do The Powers That Be Understand the Internet?
One thing I am concerned about, is how big of a role social media plays in the speed with which these bank runs happen.
The intensity of bearish and fear-mongering posts is real. If social media can affect elections and Covid views, why the heck can't it influence bank runs?
Banks, the Fed, Treasury and the FDIC need to understand the battle is being fought as much or more on Twitter and TikTok as it is in the financial media.
I have my doubts that they understand this, and that concerns me.
Bottom Line
Buy dips on bank fears -- there is more support to come and time will help.
Sell rips because the debt ceiling, already likely to be ugly, will get uglier. And with Chinese President Xi Jinping supposedly heading to Russia, there is a chance of it indicating peace, but I'm leaning toward weapon sales, which the West really doesn't believe that a China that wants to remain a vibrant part of the Western economies will do.
Finally, zero days to expiration, or 0DTE, options aren't going to make this any easier as they will amplify moves in both directions, and I am concerned they have the potential to trigger a much bigger meltdown than melt-up here
