In recent weeks the world of finance has been shaken by events on both sides of the Atlantic. First, several regional banks in the United States, including Silicon Valley Bank, faced an existential crisis. Then the Swiss heavyweight Credit Suisse abruptly ended its 166-year journey. Well, let’s ask the traditional questions: who is to blame and what is to be done?
Who Is to Blame?
Silicon Valley Bank: Let’s Call Things by Their Proper Name
In case of Silicon Valley Bank many observers blame a series of interest-rate hikes delivered by the U.S. Federal Reserve in the past year. As a result, many banks have accumulated huge losses due to their investments in long-term bonds. Many bond positions were classified as HTM or “held-to-maturity”. This meant that these positions were allowed not to be revalued or not “marked to market” as accountants put it. As a result, these accumulated unrealized losses were not reflected in profits or as a deduct to equity. Usually, the losses were also not reflected in stress tests or measures of capital adequacy. You could find them in the footnotes only.
But let’s call things by their proper name. In this particular case the issue was not that the Fed was raising interest rates. The issue was that the bank financed their long-term or long-duration assets with short-term or short-duration “pandemic” deposits. In effect, it became a duration speculator. Had the bank’s management team ever heard of interest-rate mismatch risk described in any financial textbook? I would assume that they had. And yet they decided to go ahead with it.
In general, the issue with the Fed and other major central banks is that these interest rates have been too low for too long. As a result, too much money was chasing too few investing possibilities leading to the creation of financial bubbles of various types, shapes, and colors.
If this type of speculation, mismanagement and last-minute insider stock sales is again considered as just another unfortunate business failure, then nothing has changed since the collapse of Lehman Brothers.
Credit Suisse: Complexity Kills
The story of Credit Suisse’s failure has been a “…fiasco in slow-motion” as one observer put it (see Reference 1 below). Over the past 30 years the Swiss giant has been involved in a series of unsuccessful acquisitions both at home and overseas (First Boston, Winterthur Insurance, Donaldson, Lufkin & Jenrette (DLJ) and others) trying to establish itself in niches where it lacked serious expertise and experience: proprietary trading, investment banking and managing other people’s assets.
In the aftermath of all these acquisitions and subsequent divestitures, no one, including members of the bank’s management team, had a clear picture of what was going on within its numerous subsidiaries and divisions. This is the best you can get if you want to lose control of a situation, particularly if you are desperately trying to recoup losses inherited from your previous failures.
You can lose control by allowing a fraudulent employee to engage in suspicious activities over a multiyear period, thereby causing hundreds of millions of dollars’ worth of damage. You can lose control by trying to compete with more experienced players, eventually suffering multibillion-dollar trading losses. You can lose control because of a public display of animosity between executives. Ultimately, you can lose control over the most important metric in banking. What is this metric?
I always insist that accounting is art rather than science. It is like traffic rules: any regulation whether you should turn left or right in a certain situation can be changed overnight without any serious consequences for our everyday lives. That is why it does not matter whether you classify your bond portfolio as marked-to-market, available-for-sale, or held-to-maturity (remember Silicon Valley Bank?). Problems arise when you suddenly need cash and, therefore, are forced to liquidate your bond portfolio at a loss.
That is why for ANY bank the most important metric is not capital adequacy, liquidity, provisions, value at risk, stress tests, etc. These are just accounting and risk management toys that do not work in a crisis.
The most important metric in banking is CONFIDENCE.
When clients, business partners, markets, and others feel confident in dealing with your bank, it can easily function even if its equity is negative: just recall 2008.
“Credit” means “one believes” in Latin. Credit Suisse was eventually transformed into DisСredit Suisse. For any bank this is the indication of an approaching end game. Many observers think that Credit Suisse’s end game was launched exactly two years ago following the collapse of Archegos Capital Management.
Archegos: One Who Leads the Way, or How to Lose 20 Billion Dollars in Two Days
Exactly two years ago some of the world’s largest banks were bruised by events surrounding the New York-based hedge fund Archegos Capital Management. In just two days it lost its entire capital of 20 billion.
The fund was just a family office that primarily managed the assets of Bill Hwang. At that time, this name meant nothing neither to the general public, nor to most finance professionals. This was not surprising. The financial news agency Bloomberg called him “…the greatest trader you’d never heard of.” (see Reference 2 below). Since 2013 he had managed to increase his personal wealth of $200 million, accumulated while he was working as a trader in the famous hedge fund Tiger Management, to $20 billion. If he had decided to liquidate his entire stock portfolio in early March 2021, his fortune would have totaled $30 billion.
Secrecy was his personal strategy. Neither the investment banks that financed him, nor his own analysts often had any idea regarding the exact size of his individual stock positions. Usually hedge funds borrow money aiming to increase the size of their “leveraged” trading positions 2 or 2.5 times. In late March 2021 Bill Hwang’s leverage ratio was 5, while the size of his stock portfolio reached $105 billion. At that time his strategy was to borrow money from several major investment banks with the ultimate goal of building highly concentrated positions in a small number of stocks.
In late 2020 and early in 2021 Bill was accumulating a stock position in ViacomCBS, a US media giant. As a result of Archegos’s aggressive purchases in the previous four months, the company’s stock price tripled. To avoid regulatory scrutiny the fund was building its stock position by engaging in swap transactions with investment banks without changing the legal ownership of stocks.
In late March 2021 ViacomCBS announced an additional sale of stock and convertible debt totaling some $3 billion. The company’s plan was to use these funds in order to develop its streaming services. On 23 March 2021 the company’s stock fell by 9%, and on March 24 by another 23%. On March 25 Archegos’s principal financiers were already scheduling emergency meetings: the fund invested its own capital of $20 billion as well as $80 billion of borrowed money in just a handful of stocks. Only 5% of the fund’s assets were left to cover possible losses…
On March 25 the creditor banks were unable to reach a decision. Late that afternoon, without informing other banks, Morgan Stanley sold its Archegos stock holdings at a discount to other hedge funds. On March 26 Goldman Sachs, Deutsche Bank, Wells Fargo, and UBS followed suit. Credit Suisse, Nomura and Mitsubishi UFJ decided to wait a little bit longer… ViacomCBS stock plummeted by another 50%, while these three banks eventually suffered losses totaling $5.5 billion, $2.9 billion, and $0.3 billion dollars, respectively. To be fair, it should be admitted that Morgan Stanley and UBS did not escape this Archegos accident completely unscathed either. Their losses totaled $0.9 billion and $0.8 billion apiece. Bill Hwang lost everything…
Bill was the son of a pastor and a very religious man. “I try to invest according to the Word of God and by the power of the Holy Spirit,” he once said. “In a way, it’s a fearless way to invest. I’m not afraid of death or money.” (see Reference 2 below). It is no coincidence that “Archegos” means “the one who leads the way” in Greek with a strong biblical connotation. It is good when an individual believes in what he or she is doing. And yet even those who lead the way should look back over their shoulders from time to time. You may recall that Christ sometimes had his moments of doubt too…
The moral of these stories is rather straightforward. If you do not believe in what you are doing, you will achieve nothing. If you succeed wildly in your past endeavors, you may start thinking you will get away with anything. But eventually, if you never question what you are doing, you will lose everything.
What Is to Be Done?
All these developments surrounding U.S. regional banks and Credit Suisse caught central banks and governments at the most inopportune moment. It was quite obvious that central banks could not print money indefinitely. And it was equally obvious that governments could not borrow money indefinitely too. They both were crucial in saving the banking system from collapse in 2008. Maybe, back then they even managed to save capitalism from an existential crisis (at least, for a while).
This time it is very likely that commercial banks will have to dig deeper into their wallets. The Swiss authorities essentially forced another Swiss giant UBS to acquire the agonizing Credit Suisse, while JP Morgan and others considered converting their deposits at First Republic Bank, another troubled U.S. regional bank, into equity.
Therefore, this will come as no surprise to me, if “digging deeper into wallets” would imply many interesting things down the road:
– providing support for troubled banks,
– higher profit taxes for commercial banks,
– government-imposed limits for lending interest rates,
– government-imposed lending targets,
– government-imposed limits for banking fees,
– somebody will face jail time and many others.
Governments and central banks are unlikely to kindly ask commercial banks for a favor anymore. This time they are likely to impose their will because the miracle of printing and borrowing money has exhausted itself, while the survival of capitalism is still at stake. Are you still wondering why is there a surge in the price of gold and cryptos, while the U.S. and European banking stocks are tanking (see Picture below)?
That is why governments and central banks, sooner rather than later, may send a very clear message to commercial banks: we scratched your backs in 2008, now it is your turn to scratch ours.
References:
1. “How Scandal and Mistrust Ended Credit Suisse’s 166-Year Run”, Marion Halftermeyer, Myriam Balezou, Bloomberg News, 20 March 2023.
2. “Bill Hwang Had $20 Billion, Then He Lost It All in Two Days”, Erik Schatzker, Sridhar Natarajan, Katherine Burton, Bloomberg Businessweek, 8 April 2021, updated 27 April 2022.
3. “Billionaire Who Invested ‘According to the Word of God’ Charged with Multibillion-Dollar Fraud”, Emily Belz, Christianity Today, 3 May 2022.
