When Silicon Valley Bank slipped into a death spiral last week, (in)famous libertarian Peter Thiel stepped into the spotlight. The reason? Last week, its Founders Fund reportedly pulled its business accounts from SVB. This led to angry accusations that Thiel and other venture capitalists had fueled the bank run.
This will stir up a lot of political mud. But there is another, lesser-known, twist that investors should also note. “I had $50 million of my own money trapped in SVB,” Thiel tells me in his defense. Apparently, he failed to escape quickly — no matter what Founders Fund did — because he didn’t fully realize that SVB could fail.
It’s not just random. As Larry Fink, BlackRock’s chief executive, ravaged banks from Credit Suisse to First Republic, as finance suffers from what he calls a “slow-moving” crisis in confidence, three critical points are becoming clear.
The first is that the events surrounding SVB were to blow up a huge “carry trade”. This is the term used by financial traders when they borrow cheaply in an asset (say, a currency or a short-term bond) to invest in a higher-yielding one (such as a different currency or a long-term instrument).
Bankers rarely describe themselves as leveraged traders—they prefer to think of banks as performing carefully controlled maturity transformation (ie, turning deposits into loans) for their clients, along with asset-liability management.
However, maturity transformation is at the heart of banking and SVB did it in such an extreme way that it was similar to a carry trade. Most notably, the bank held $180bn in deposits, which provided cheap but potentially short-term (and flighty) funding. And since demand for loans was weak, he bought long-term bonds that were, foolishly, unhedged.
It made a huge profit for a while. Carry trade usually does. But it suffered last year when the yield curve inverted. And once depositors finally realized that, some (though not Thiel) fled—with shocking results.
Another important point is that SVB was not just a carry trade. Far from it. Many other American banks have also taken a big hit on their bond holdings; Indeed, total unrealized securities losses for US banks are more than $650bn on paper. US regulators have in recent years urged banks to buy these supposedly “safe” assets and imposed looser liquidity and asset/liability matching rules than in Europe. It was also unfair.
And the problem extends beyond banks. “There are many carry trades [in the system], and not all of them can be bailed out,” JPMorgan analysts warned this week. Commercial real estate, say, “was a good investment at zero interest rates” — but not when rates rise. It’s especially bad when commercial real estate is funded with volatile capital, such as a real estate investment trust. (This is why groups like Blackstone have recently gatecrashed some REITs.)
Similarly, while private equity and venture capital do well at low rates, things can also go horribly wrong with higher rates – albeit because part of the funding is locked up and there is less transparency.
“These bank failures are the ‘canary in the coal mine’ of a changing cycle,” warns Ray Dalio, founder of Bridgewater Associates, a hedge fund. DeLeo notes that while “the pain in 2008 was heavy in residential real estate, [now] It is in negative-cash-flow ventures and private equity firms as well as commercial real estate firms”. Ouch.
However, a third crucial point is that it is difficult for most viewers to appreciate the scale of this carry trade unwinding. Depositors like Thiel appear to be particularly blind to the risks at SVB (although they have been raised previously by the Financial Times and others). This is probably because technologists believe that 21st century computer science is infinitely more interesting than issues like cash management or capital adequacy. They only focus on banks when they hope to disrupt them with clever apps or crypto.
But it wasn’t just the tech sector that was naive. A decade of crazy cheap money has left many investors believing low rates are normal. Carry trades have become so common that they go unnoticed—until they blow up.
Of course, this could suggest that low rates could still return if the Federal Reserve ends its tightening cycle to avoid a financial crisis. Finally, former Fed Chairman Paul Volcker stopped raising rates in 1984 when Continental Illinois Bank collapsed.
Conversely, a global recession may also drive market interest rates lower. If so, what investors and bankers will need to worry about next is not just interest rate risk but credit risk—that is, the risk that borrowers will default en masse.
But right now it’s the carry trades that need the most immediate thought. Ultimately, as Fink observes, this “cost . . . decades of easy money. Or, to put it less tactfully, the SVB’s collapse is the result of the Fed leaving monetary policy too loose for too long—even as US bank regulation rolls back have been rotated.
That probably won’t hurt Thiel: his $50mn, like other SVB deposits, is now (arguably) safe. But investors exposed to other carry trades may not be so lucky. Expect them to sound crazy.
gillian.tett@ft.com
