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I think your explanation is missing one big thing: duration It isn’t that treasury bonds are inherently “risky”. The risk is that when you hold longer duration

I think your explanation is missing one big thing: duration It isn’t that treasury bonds are inherently “risky”. The risk is that when you hold longer duration bonds at low interest rates like SVB did, even modest rate increases will have a large effect on value. Combine that with the bonehead investment in MBS which allegedly only yielded 1.5% at 10 year duration and you have massive losses.

gruez 4y ago
But is that covered by Dodd-Frank? I think what the parent is getting at is that interest rate risk isn't factored in at all, only asset type (ie. whether it's "safe" stuff like treasury or it's "risky" stuff like derivatives). I skimmed https://en.wikipedia.org/wiki/Provisions_of_the_Dodd%E2%80%93Frank_Wall_Street_Reform_and_Consumer_Protection_Act https://en.wikipedia.org/wiki/Provisions_of_the_Dodd%E2%80%9... and can't find anything relating to interest rate risk.
- eep_social 4y ago
  Here is Dean Baker quoted in The Intercept, “SVB would have been required to undergo regular stress tests before the [Dodd-Frank] revision; among the stresses you look at are sharp rises in interest rates, which is apparently what did in SVB. Presumably, if its books had been subject to this test, the risk would have been detected and they would have been required to raise more capital and/or shed deposits.” [1] And in fact we know that the proximate trigger was SVB announcing that they were raising capital. [1] https://theintercept.com/2023/03/11/silicon-valley-bank-used-former-mccarthy-staffers-to-weaken-regulations-lobby-fdic/ https://theintercept.com/2023/03/11/silicon-valley-bank-used...
  - pickovven 4y ago
    The is the most "smoking gun" explanation that I've seen of how everyday corruption caused this. However, I'd love to see a follow that confirms the law resulted in a change in bond purchases by SVB.
    - eep_social 4y ago
      I think that’s fair. I hope we do see that and other details of how this all went sideways come out over the next months and years. I assume though, that like any black swan there were many things that went wrong together. Lately at work, I have been telling people that one in a million happens eight times per day at just 100 requests per second! Shit is going wrong in small ways all the time. So you design for that — but eventually in a big system enough of those minor failures will line up to cause something you notice. You probably remember that huge facebook outage in 2021? Lots of things went wrong and then they were locked out of their own conference rooms. The financial system is different parts at a different scale but the same theory of failure applies. Not smoking guns, more like a bad bet here, and a stupid decision there, and one dumbass VC influencer gets jumpy and runs his dumbass mouth in slack and bobs your uncle bye bye SVB.
  - fwlr 4y ago
    With all due respect to Dean and his fantastic work on the sounding the alarm before the GFC, I think he’s wrong here. The stress test doesn’t really consider sharp changes in Federal Reserve interest rates, it uses one predicted rate for the baseline scenario and a second predicted rate for the adverse scenario. With those rates it calculates the other variables, including bond rates. The highest treasury rate in either scenario in the last three years is like 2.5%, while the current rate right now is almost 4%, so I would argue the interest rate rises considered in the stress test are not quite capturing the pressure SVB was actually under. (There’s room to disagree; the baseline scenario for 2019 does predict 3.6% in 2022, so at least some years might have tested the right amount of stress.) More fundamentally though, the stress test is testing capital, not liquidity. What actually did in SVB was a bank run during a liquidity crisis. Due to interest rate rises, their liquidity got so bad they had to sell long-term assets at a loss, and when they announced they were raising capital to cover that loss, they triggered a bank run: the ultimate and most cruel test of liquidity there is. The stress test they lobbied their way out of would have indicated poor-but-manageable health, it’s not useless, and they should have been required to do it. But the stress test does not involve simulating a bank run, it would not have predicted this collapse.
    - eep_social 4y ago
      I agree that this is not black and white. However as an example, the Europeans are basically saying this situation cannot happen under Basel3 which is exactly what the D-F relaxing allowed SVB to avoid. One thing that will be telling is if another bank collapses under similar circumstances. I don’t think the stress test is meant to model a collapse. As has been mentioned elsewhere, no bank survives outflows of 40-50% of deposits. I understand Baker’s comment to imply that stress tests are not simply “are you over this minimum bar” but also designed to probe for any weakness in lots of different scenarios so the weaknesses are discovered and can be addressed. I imagine it like the regulator is the parent telling the kid to eat their veggies — they might not force them into your mouth but they’re acting as a third party check on your worst impulses. If that’s the case, the stress test should have prompted a discussion about this risk about nine months ago. That this fell apart so fast implies that risk management failed, that those discussions never happened, and so there will presumably be motion to fix that weakness for next time. So you’re right that the run would still have killed them, but better long term risk management would have prevented the blood in the water that spooked the VCs that caused the run. PS: I feel like that one meme from it’s always sunny — everything is connected to everything. Have to look past the first-order effects.
fwlr 4y ago
While we can easily see that long-duration low-yield bonds are risky if interest rates rise, I would point out 2 things. 1. Financial analysts were not devoting much time to analyzing the risks from rapid rate increases, as rapid rate increases were deemed very unlikely (in part because the Federal Reserve itself had offered guidance that it was unlikely!). Furthermore, the time that was spent on analysis of this low-probability event was spread very thin (interest rate increases affect pretty much everything), and the perception of “zero risk” in T bonds would have bumped them to the end of the list for analysis, meaning even less analysis time for this outcome. Just now on Twitter I’ve seen two financial analyses praised for their prescience in this event - one from the FDIC, one from Byrne Hobart. Both of them only picked this up after the rate increases came into effect. 2. Even if there was full awareness of this risk, and plenty of forewarning that the rapid rate increase was definitely coming, the regulations as written would still permit these investments. The bank itself would probably have made smarter decisions and wouldn’t have collapsed, but that would be orthogonal to the regulations under discussion in the OP. (In my initial comment I even sketched out the argument that the regulations would have been mildly opposed to the smarter decisions.)
- evancox100 4y ago
  You're making a lot of very specific assertions in this thread about what bank officers or regulators would/should have done, or what the effect of SIFI stress tests would have been, without any actual evidence to back this up. Do you actually have inside information or prior experience on these things?
  - fwlr 4y ago
    I have no inside information on SVB or their depositors, and no prior experience with managing a bank run. (I also have no exposure to SVB, nor do I have any stock market positions that may be affected by it.) If you want my motivation for discussing it all day: I’m curious, it’s an interesting and fast-moving puzzle that a lot of smart people are discussing. If you want my qualifications for offering so many specific assertions: I’ve read the primary sources and it just doesn’t seem like it would fix or prevent this the way other people assume it would. If in my enthusiasm I’ve oversold myself as an expert, I apologize unreservedly.

gruez 4y ago

But is that covered by Dodd-Frank? I think what the parent is getting at is that interest rate risk isn't factored in at all, only asset type (ie. whether it's "safe" stuff like treasury or it's "risky" stuff like derivatives). I skimmed https://en.wikipedia.org/wiki/Provisions_of_the_Dodd%E2%80%93Frank_Wall_Street_Reform_and_Consumer_Protection_Act https://en.wikipedia.org/wiki/Provisions_of_the_Dodd%E2%80%9... and can't find anything relating to interest rate risk.

eep_social 4y ago
Here is Dean Baker quoted in The Intercept, “SVB would have been required to undergo regular stress tests before the [Dodd-Frank] revision; among the stresses you look at are sharp rises in interest rates, which is apparently what did in SVB. Presumably, if its books had been subject to this test, the risk would have been detected and they would have been required to raise more capital and/or shed deposits.” [1] And in fact we know that the proximate trigger was SVB announcing that they were raising capital. [1] https://theintercept.com/2023/03/11/silicon-valley-bank-used-former-mccarthy-staffers-to-weaken-regulations-lobby-fdic/ https://theintercept.com/2023/03/11/silicon-valley-bank-used...
- pickovven 4y ago
  The is the most "smoking gun" explanation that I've seen of how everyday corruption caused this. However, I'd love to see a follow that confirms the law resulted in a change in bond purchases by SVB.
  - eep_social 4y ago
    I think that’s fair. I hope we do see that and other details of how this all went sideways come out over the next months and years. I assume though, that like any black swan there were many things that went wrong together. Lately at work, I have been telling people that one in a million happens eight times per day at just 100 requests per second! Shit is going wrong in small ways all the time. So you design for that — but eventually in a big system enough of those minor failures will line up to cause something you notice. You probably remember that huge facebook outage in 2021? Lots of things went wrong and then they were locked out of their own conference rooms. The financial system is different parts at a different scale but the same theory of failure applies. Not smoking guns, more like a bad bet here, and a stupid decision there, and one dumbass VC influencer gets jumpy and runs his dumbass mouth in slack and bobs your uncle bye bye SVB.
- fwlr 4y ago
  With all due respect to Dean and his fantastic work on the sounding the alarm before the GFC, I think he’s wrong here. The stress test doesn’t really consider sharp changes in Federal Reserve interest rates, it uses one predicted rate for the baseline scenario and a second predicted rate for the adverse scenario. With those rates it calculates the other variables, including bond rates. The highest treasury rate in either scenario in the last three years is like 2.5%, while the current rate right now is almost 4%, so I would argue the interest rate rises considered in the stress test are not quite capturing the pressure SVB was actually under. (There’s room to disagree; the baseline scenario for 2019 does predict 3.6% in 2022, so at least some years might have tested the right amount of stress.) More fundamentally though, the stress test is testing capital, not liquidity. What actually did in SVB was a bank run during a liquidity crisis. Due to interest rate rises, their liquidity got so bad they had to sell long-term assets at a loss, and when they announced they were raising capital to cover that loss, they triggered a bank run: the ultimate and most cruel test of liquidity there is. The stress test they lobbied their way out of would have indicated poor-but-manageable health, it’s not useless, and they should have been required to do it. But the stress test does not involve simulating a bank run, it would not have predicted this collapse.
  - eep_social 4y ago
    I agree that this is not black and white. However as an example, the Europeans are basically saying this situation cannot happen under Basel3 which is exactly what the D-F relaxing allowed SVB to avoid. One thing that will be telling is if another bank collapses under similar circumstances. I don’t think the stress test is meant to model a collapse. As has been mentioned elsewhere, no bank survives outflows of 40-50% of deposits. I understand Baker’s comment to imply that stress tests are not simply “are you over this minimum bar” but also designed to probe for any weakness in lots of different scenarios so the weaknesses are discovered and can be addressed. I imagine it like the regulator is the parent telling the kid to eat their veggies — they might not force them into your mouth but they’re acting as a third party check on your worst impulses. If that’s the case, the stress test should have prompted a discussion about this risk about nine months ago. That this fell apart so fast implies that risk management failed, that those discussions never happened, and so there will presumably be motion to fix that weakness for next time. So you’re right that the run would still have killed them, but better long term risk management would have prevented the blood in the water that spooked the VCs that caused the run. PS: I feel like that one meme from it’s always sunny — everything is connected to everything. Have to look past the first-order effects.

fwlr 4y ago

While we can easily see that long-duration low-yield bonds are risky if interest rates rise, I would point out 2 things. 1. Financial analysts were not devoting much time to analyzing the risks from rapid rate increases, as rapid rate increases were deemed very unlikely (in part because the Federal Reserve itself had offered guidance that it was unlikely!). Furthermore, the time that was spent on analysis of this low-probability event was spread very thin (interest rate increases affect pretty much everything), and the perception of “zero risk” in T bonds would have bumped them to the end of the list for analysis, meaning even less analysis time for this outcome. Just now on Twitter I’ve seen two financial analyses praised for their prescience in this event - one from the FDIC, one from Byrne Hobart. Both of them only picked this up after the rate increases came into effect. 2. Even if there was full awareness of this risk, and plenty of forewarning that the rapid rate increase was definitely coming, the regulations as written would still permit these investments. The bank itself would probably have made smarter decisions and wouldn’t have collapsed, but that would be orthogonal to the regulations under discussion in the OP. (In my initial comment I even sketched out the argument that the regulations would have been mildly opposed to the smarter decisions.)

evancox100 4y ago
You're making a lot of very specific assertions in this thread about what bank officers or regulators would/should have done, or what the effect of SIFI stress tests would have been, without any actual evidence to back this up. Do you actually have inside information or prior experience on these things?
- fwlr 4y ago
  I have no inside information on SVB or their depositors, and no prior experience with managing a bank run. (I also have no exposure to SVB, nor do I have any stock market positions that may be affected by it.) If you want my motivation for discussing it all day: I’m curious, it’s an interesting and fast-moving puzzle that a lot of smart people are discussing. If you want my qualifications for offering so many specific assertions: I’ve read the primary sources and it just doesn’t seem like it would fix or prevent this the way other people assume it would. If in my enthusiasm I’ve oversold myself as an expert, I apologize unreservedly.