As The Crisis Deepens

As the Crisis Deepens

Richard Woolf published "Capitalism's Crisis Deepens" in 2016. It doesn't have a lot of relevance here except the prescient title. The collapse of SVB, Signature Bank and the current crisis at Credit Suisse and First Republic are all emblematic of a serious structural problem cause by the Federal Reserve's rapid rise in interest rates and the low interest paid by long term bonds.

However, even those two phenomenon can only be understood in the context of the previous reality - zero interest rates and free money.

During 2020-2021 interest rates were essentially zero.

The 40,000 or so customers of SVB placed a growing amount of cash into accounts held by the bank, and that cash had to generate interest. Then as rates rose in 2022 and 2023 deposits began to shrink. As the Wall Street Journal explained:

The bank's assets and deposits almost doubled in 2021, large amounts of which SVB poured into U.S. Treasurys and other government-sponsored debt securities. Soon after, the Fed began raising rates. That battered the tech startups and venture-capital firms Silicon Valley Bank serves, sparking a faster-than-expected decline in deposits that continues to gain steam.

The key cause of SVB issues had nothing to do with SVB but was symptomatic of a fundamental change in global and local markets. The real causes would be the topic of at least one book. But suffice it to say, what SVB did were symptoms, not causes. And the causes extend well beyond SVB.

This week, after Signature Bank was also seized by regulators, Credit Suisse and First Republic Bank have been thrown into the spotlight, needing billions of dollars of support from other banks.

There are now hundreds of banks in a state of turmoil with investors and depositors, and creditors. Their assets are huge, but so are their liabilities. And without deposits, they cannot pay their bills. The chain of support for these profit-challenged entities is now long. Taking the First Republic as an example, the pack of cards looks like this:

First Republic Bank → JP Morgan and others → Goldman Sachs and Others → FDIC and Federal Reserve

The entire infrastructure only works if backed by large depositors and then, as a last resort, the Government.

In this context, the blame game in the Valley this week makes no sense. Some blame VCs for asking for companies to withdraw funds from SVB late last week. Union Square Ventures is singled out. This is nuts. The run on the bank was not theoretical at that point. Prudence required action. Jessica Lessin at The Information disclosed this week that she transferred funds on 9 March while writing about others asking companies not to. She was right to do so.

It is equally hard to blame SVB management. They made decisions that, at the time they made them, were their only option. As billions of new deposits came into the bank in 2020 and 2021, they needed to earn interest on them. Long-term bonds were the best of lots of bad options. The critics do not have an alternative because there wasn't one.

And selling those long-term bonds at a $1.8 billion loss in order to buy new instruments paying close to market rates of 4% also made sense. The loss would eventually be recovered from the higher interest.

The board of my startup SignalRank recently asked us to consider keeping our cash in Treasury notes and earn 4-5% interest. To do so, we would have done what others were doing - take funds out of SVB. They had to offer higher interest in order to keep customers, and they had to sell loss-making assets to place their capital into better instruments. A rational move.

So, blaming short-term actors for their decisions misses the point. In volatile times, the very structure of an interest-based model creates instability. Banks live in the space between the interest they earn and the interest they pay. If there are dramatic changes in money flows and interest rates it is very hard to make good long-term decisions and the short-term can quickly turn into a crisis.

The scope of this editorial cannot go there, but the very structure of money in circulation (M1, M2, M3) compared to the amount of debt creates a very large schism. There is about $19 trillion of M1 money in the US. Global debt is almost $400 trillion. When times are good, this spread can be sustained. But if all debts were to be called, all bets would be off. Institutions and Governments would fail. Only growth in the real economy, producing real value that backs up the money supply, can close that schism.

That is why innovation and progress are so important. The fundamentals of economics only work when there is growth, otherwise, the debt of the past haunts the inhabitants of the present.

GPT4 launched this week. Reid Hoffman used it to help him write a book. LinkedIn is using it to construct job descriptions and profiles. Microsoft is bringing it into Word, Excel, and Powerpoint. And Google is building its version into Google Workspaces. It is trained on far more data than its predecessor but is still best thought of as a brilliant but flawed friend. I paid up the $20 a month for the pro version and am using it more. There is a lot below about it this week. Enjoy.