The Big Bailout Bet

A US government intervention in the banking system wasn’t enough to stave off worries when markets opened on Monday. The three-day move in short-term Treasuries rivaled the tremendous bond market swings during 1987’s Black Monday stock market crash. Three banks have closed their doors in the matter of five days, and there are fears of more trouble under the surface.

A senior Treasury official who briefed Bloomberg reporters over the weekend explained that there are other institutions with similarities to Silicon Valley Bank, which collapsed on Friday, and even New York’s Signature Bank, which was seized on Sunday. If that’s the case, there are two issues at play:

1. To what extent will bad banking practices be allowed to continue?
2. Does the government have the heft to keep shoring up the banking system if more banks keep failing?

As the economist Jason Furman of the Harvard Kennedy School puts it: “No one should feel good about what happened here,” he wrote in a tweet. “The system failed.”

When the government stepped in this weekend, it did two things that drew questions. First, the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. jointly said “no losses will be borne by the taxpayer,” as they put together a way to get 100% of depositor money back to clients of SVB and Signature. President Joe Biden made a similar claim on Monday morning in a news conference, that this is not a bailout by taxpayers: “The money will come from the fees that banks pay into the deposit insurance fund,” he said.

That insurance fund has about $125 billion, with an ability to borrow $100 billion more from the Treasury (though there are questions about whether this ability will be hamstrung given the looming debt ceiling and Treasury’s inability to issue new debt).

“It’s a partial bailout,” Charles Myers, the chairman and founder of Signum Global Advisors, said in an e-mail.

Second, officials created an emergency facility to let banks borrow for a year, with the Treasury making up to $25 billion available to backstop this facility. The idea is to provide money to banks that feel stretched, to stave off collapses like we saw with Signature Bank, SVB and Silvergate Bank over the past week.

But here’s the big catch for the market: The facility will let more banks borrow money for a year while holding their collateral of bonds at par, even though those bonds have drastically fallen in value. In fact, banks have been sitting on more than $600 billion worth of paper losses. This move could create a complications around a big risk in the bond markets: Duration risk.

What comes next? A few things to look out for:

• Do these collapsed banks—especially SVB—sell assets successfully?
• Are there bigger issues for banks like First Republic that are dropping drastically in the stock market on Monday?
• What rules are created to prevent these types of collapses in the banking system, and do they severely strain access to credit across the country as banks comply with new regulations and potentially higher capital requirements?
• What’s the political fallout? Washington is disputing everything from the role of social media in bank runs to whether the Trump-era regulatory rollbacks had set the stage for this trouble. There’s also a question of whether the venture capital community lobbied for these “bailouts” and were saved and whether a bank in the middle of the country supporting more blue-collar jobs would get the same treatment.

To read the newsletter in full, you can click here. What's more is that the week is just starting. Over at Guggenheim Investments, the CIO said this moment was not a Lehman one -- but it may be echoing the signs shown by Bear Stearns in early 2008. According to Anne Walsh, "The risks in the market that catalyzed the SVB collapse are still out there."