Will the bankruptcy of Silicon Valley Bank lead to a systemic financial crisis? The response of authorities may be the defining factor.
Both the bankruptcy of Silicon Valley Bank (SVB) and the subsequent Biden administration intervention were completely unanticipated events that were not anticipated by industry analysts.
In fact, many of them thought that despite the bullish movement in the stock market this year, the market was still bearish. For a long period of time, practically all of last year, many analysts and market professionals predicted that aggressive interest rate hikes by the Federal Reserve (Fed) would lead to an economic recession and as a result, would experience a downward correction.
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However, the US economy’s indicators, particularly those related to the labour market, have remained robust throughout this time. For example, the data released on Friday showed that non-farm payrolls exceeded forecasts and inflation was declining, although more slowly than the Fed had hoped.
Interest rate hikes, which were the most aggressive in the US central bank’s history, did not have the negative impact on the US economy that everyone expected. For the banking industry, and more specifically for SVB, the effects of this restrictive monetary policy were deeply felt.
Over the past two years, SVB has grown significantly and has served as the bank for many of America’s technological companies. Such technology businesses had trouble obtaining funding because of the Fed’s interest rate hikes, and this led them to deposit lower amounts of funds with the bank. Also, SVB had adopted a strategy of predominantly investing in long-term treasury bonds and when it was faced with a decline in deposits, the bank had to sell these treasury bonds at a loss as their price dropped due to the increase in interest rates. When the bank attempted to mitigate these losses by selling shares to raise capital, fear quickly began to spread, and the share price fell by more than 60%, leading to the bank’s bankruptcy and intervention.
So, the question now is do we currently have a systemic financial crisis? Probably not. Everything may depend on how the regulatory and monetary authorities respond. The case of SVB is very specific and does not extend to other financial entities. In order to handle the situation, the authorities should take all reasonable steps to protect customer deposits and prevent withdrawals of deposits from other banks.
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What action will the Fed take? It seems that those who criticised overly aggressive interest rate hikes were correct. It would be counterproductive to keep tightening lending requirements in a situation like the current one, where the worry about a systematic catastrophe brought on by the decline in liquidity is mounting.
Fixed income, which is usually ahead of the market, has already started to price in the end of the Fed’s rate hikes. The yield on the 10-year bond fell to 3.70%.
Sources: Bloomberg, Reuters