"But how can you live and have no story to tell?" Fyodor Dostoevsky
"None of the high priests of finance, who oversaw the debacle, with their huge bonuses and pensions, suffered."
When The Economist starts an article with, "Banking is a confidence trick", you've got to sit up and take notice. The ruse is to keep everyone brimming with trust — it's all fine and dandy — so we don't rush to take out our hard-earned cash.
Because guess what? The money isn't there. There is no vault full of cash at the back of the building. Instead, your money is lent on, invested and moved around to make some profit. That is a risky business.
Plus, as an added complication, things happen at light speed in the era of electronic banking. Hence when a whiff of trouble emerged from Silicon Valley Bank, their techie customers soon got online to move their cash out. In no time, the bank was on the ropes.
Of course, everyone is asking how come this happened. Didn't we learn any lessons from 2008? Where are the regulators? What's gone wrong?
Now let me try to explain. If I get this wrong, please excuse me. I'm neither a banker nor a financial whiz— only a layman trying to comprehend a crazy financial system.
For years interest rates were low and asset prices high. Thus, SVB and others purchased many long-term bonds as solid and safe investments. Traditionally bonds provide a decent return at a fixed date in the future and, as such, are low risk. That's a safe and sensible move.
Then the Fed raised rates at its sharpest pace in four decades, causing the bond prices to plunge. That left the bank holding potentially huge losses.
But, these are paper losses which smaller banks like SVB do not need to report under America's capital rules. Only the large banks must list to market all their bonds that are available to trade. Hence, SVB carried "hidden" risks with its bond holding.
Then the paper losses at SVB became a real issue as unsettled customers got wind of possible problems ahead and sought to withdraw their money.
While a debate is raging about what exactly caused SVB to fail, many factors appear to be at play. Some suggest a "rookie mistake" made in SVB's interest-rate-risk management system that brought about a "classic bank run". In addition, there is speculation that regulation rollbacks contributed by making the bank less risk-averse.
Whatever the causes, it is clear that the bank suffered a run on deposits — this led to a capital crisis and resulted in its collapse. There are also reports that Goldman Sachs's role with SVB is already under scrutiny with echoes of 2008. However, the details are sketchy now, although more will come out in due course.
Following SVB, Signature Bank went the same way as financial stocks lost billions of dollars last week.
All these events raise profound questions about banking systems and regulation. With a third of assets in America held by banks smaller than SVB, they will now rush to tighten lending to strengthen their balance sheets.
In 2008, reckless lending and the packaging of risky mortgages caused the financial crisis. Ultimately, the taxpayers had to rescue the banks and financial institutions. Yet none of the high priests of finance, who oversaw the debacle, with their huge bonuses and pensions, suffered.
It was the ordinary guy in the street who took the hit. Watch the movie "The Big Short" to understand what happened. Likewise, "Margin Call" illustrates the immoral stance of the finance world as decisions impact millions of poor working people. The film explores how corporations only sought to protect themselves and their bounty.
Against that background, public outrage against finance houses and banks is understandable. Thus, latter-day politicians are keen to stress that no public money will be brought forward to save banks. Last week, the UK authorities made a great play that HSBC rescued SVB (UK) without help from the taxpayer.
The problems at Credit Suisse are slightly different, yet the confidence factor is at play again. Credit Suisse has recently faced several challenges and setbacks, including scandals related to its exposure to funds like Archegos Capital and Greensill Capital.
The failure of Greensill Capital in March 2021 caused Credit Suisse's clients to lose as much as US$3 billion. The same year, the collapse of Archegos Capital's fund caused the bank to lose US$5.5 billion.
Then an independent audit found that the bank failed to manage risk efficiently. So this month, asked about any further investment in Credit Suisse, the response from their biggest shareholder, Saudi National Bank, was brutal, "Absolutely not!"
Boom. Other investors then ran away, and the bank looked over the edge. On March 9th, Credit Suisse announced a delay in the publication of its annual report. When the document finally arrived on March 14th, the evidence was clear; Credit Suisse was venting cash.
This weekend UBS stepped in and took over Credit Suisse, while central banks pledged funds to the financial system to further shore up support.
As part of the Credit Suisse deal, overseen by Swiss regulators, 16 billion Swiss francs debt is written down to zero. This move means private investors with the bank, who held Additional Tier 1 bonds, have taken a massive hit.
These investments, AT1 bonds, were created after the last crash to attract more private capital into the banking system. The intent was to make the system stronger. AT1 bonds earn more interest and are considered a good investment for reasons I don't comprehend. That opinion has changed overnight.
Since 2008, UK pension funds switched a fair portion of their portfolio to these bonds. Now that these bonds can get wiped out, pension fund managers will face some tough decisions. In years to come, we may learn that AT1 bonds are another contrivance, like the packaged mortgages that caused the 2008 debacle.
Still, this wipeout also signals to private investors that they can't rely on governments to cover their investments with taxpayer money.
Yet none of this has placated markets in Asia as bank shares continue to fall, as I write. If confidence slips further, many smaller American banks may fail. I suppose the next evolution in this evolving crash will be to discover who else is holding AT1 bonds and is at risk. Hold on!
Walter De Havilland was one of the last of the colonial coppers. He served 35 years in the Royal Hong Kong Police and Hong Kong Police Force. He's long retired.