Banks are leveraged. Stuff happens.
The failure of Silicon Valley Bank took the world by surprise. It is why bank regulations are proper and necessary.
There is constant lobbying pressure from banks. They want looser regulation. They fight reserve requirements. Then they fail and they get bailed out because it is in the public interest to bail them out. It happens again and again. Bank failures involve more than the bank's managers and stockholders. Banks have customers and those customers have customers. Banks are like airplanes with passengers inside. If the plane crashes the passengers crash.
One view of the Silicon Valley Bank failure is that people "should have seen it coming." In that view, perhaps current laws and regulations are sufficient and we just need to do a better job of enforcing the regulations we already have. That is what the banks say in their lobbying, and that message finds fertile political ground among people who protest too much government regulation of business.
That is a mistake. Bank failures happen by surprise. If they were easy to avoid, banks would avoid them. Let me cite two pieces of evidence. The story involves put options. Those are bets that a stock will fall below a certain price by a certain date.
ONE: A news story from asiamarkets.com
Just hours before it was revealed Silicon Valley Bank – the 18th largest bank in the U.S. – is on the brink of bankruptcy, one options trader executed a trade that would turn $4,000 into just over $1.2 million.
On Tuesday March 7 the trader purchased $4,000 worth of Silicon Valley Bank (NASDAQ: SIVB) put options with a strike price of $200, expiring on 3/17/2023. They took out all volume available at the 13 cents per contract asking price.
Just over 24 hours later on Wednesday, the bank announced it needed to undertake a $2.25 billion share sale (over one third of its market cap) to stave off bankruptcy. For that sole March 7 buyer of the SVB puts it was payday.
The $0.13 cent contract price of the puts exploded to $39.10.
There are lessons here. It could have been you that bought those options! Those 13-cent options were just laying there. If SVB's failure is obvious to you, why didn't you buy them? But you didn't know. That is the point. If "the public" had known, or if there were even a glimmer of a hint of suspicion, people would have scooped them up and driven the price way up.
Maybe that one person made a dumb-luck guess. That trade will be closely examined by the SEC. If the trade was done by an agent of a bank employee or regulator, the profit will be disgorged and the insider fired. But even then, the fact that the put options betting SVB would drop in price were essentially worthless, means that there was no sense of concern circulating about the bank. There could not have been even a glimmer of a hint of suspicion within the financially savvy and ultra-plugged-in tech community that banked there. Had there been, those puts would not have been priced at 13 cents.
TWO: The regulators didn't see it coming either. The Federal Reserve reported on the state of the economy and risks to the banking system when the loan portfolio of Silicon Valley Bank problem had already become a problem.
At the conclusion of its 60 pages of analysis it summarizes with "A Survey of Salient Risks to Financial Stability." It mentioned Ukraine, monetary tightening, economic problems in Europe, tensions with China. It concluded with a concern about market fragility. It is noteworthy for what it does not mention:
There is nothing here about what destroyed Silicon Valley Bank, the fact that it and many other banks might already be insolvent because their legacy loan portfolios had dropped so much in value when interest rates went up.
I draw a political and policy conclusion from this. Again, my thought is informed by the personal history I described yesterday of the clueless hubris of the nation's top bankers. They created and held mortgage loans that were toxic on the day they were issued. Citigroup, along with other mega-banks was going broke and didn't know it. Being large did not make them smart or safe. Leveraged institutions like banks need guardrails. Regulations. They need to be stopped from taking risks that will seem entrepreneurial in the moment and foolish in hindsight.
Banks will complain. Of course. When times are good, bankers act like charged-up teenagers having fun, fun, fun with their daddy's T-Bird. The government cannot take the keys away. We need banks. But governments can require seat belts, airbags, and speed limits. And it can jail lawbreakers.
And don't trust that giant banks are too big and smart to get into the trouble smaller banks got into. We know better. We remember.
Thanks for the reminder that the basic definition of a "put" option is simple: You'll be putting it to someone. Just another example of so-called stock market gambling when the "gamblers" aren't playing by the same rules everyone else is. Again, no surprise there, unfortunately. For every game in life there always seem to be cheaters. Again, unfortunate, as they can ruin it for everyone else.
Yep. Black swans fly. So we really do need air traffic controllers monitoring them.
Speaking of black swans and six-sigma events, also in the Asia Markets is an article about McDonald and predictions of a crash. I tend to be a bit of a permabear (I sold out when the Dow hit 1,000--it looked too toppy to me, more fool I): https://www.asiamarkets.com/stock-market-will-crash-in-60-days/